The 2024 tax season is going to be spicier with the change in inclusion rates for capital gains and the new Alternative Minimum Tax regulations. By this point you’ve likely had time to digest the 2024 federal budget changes and the increased inclusion rate on capital gains, which also includes employee stock option benefits. Planning around options has always been complicated, but these most recent changes coupled with the changes in 2021 have taken it up a notch. Let’s clear the air on what has changed/is changing, what’s the same, and how you should best proceed.
A fair warning: employee stock options is a heavily jargoned area of finance. Here are is a list of terms and a summary of the federal stock option deduction from the CRA’s website that you might want to glance at before we dive in.
Prior to July 1, 2021, all stock options granted were eligible for the stock option deduction. Receiving a stock option valued at $500 or $500,000 did not impact your ability to claim the 50% tax deduction. As of July 2021, all stock options valued above $200,000 vesting in a given year are considered non-qualified and, when exercised, the benefit will be fully included as income. Based on the example from the CRA, if you received stock options in 2023 and 2024 that both vest in 2025, assuming the 2023 grant is worth $100,000 and the 2024 grant is worth $140,000 at vesting, then 83.33% of the shares received ($200,000/$240,000) are qualified and 16.67% are non-qualified.
Let’s say you then exercised and sold some of those options in 2026 as per the example below:
| Strike Price | $100/share |
| Exercise Price in 2026 | $250/share |
| Stock option benefit per share in 2026 | $150/share |
| Qualified Shares | 2,000 |
| Non-qualified shares | 400 |
| Qualified Stock Option Benefit | $300,000 |
| Non-Qualified Stock Option Benefit | $60,000 |
| Total Stock Option Benefit | $360,000 |
| Stock Option Deduction | $150,000 (=2,000 x $150 x 50%) |
| Total income included on your tax return | $210,000 |
Note that the amount eligible for the stock option deduction is above $200,000; what matters is the value of the benefit when the options vest. After vesting the options may grow (or shrink!) and remain qualified.
I am discussing options that qualify for the stock options benefit deduction, typically 50% of the stock option benefit value, available at the federal and provincial level. To my fellow residents of Quebec: the provincial deduction may be reduced to 25% in certain cases.
Based on the draft legislation, exceeding the threshold of $250,000 in capital gains and stock options benefit, combined, will push you into the new higher inclusion rate announced in the April 2024 Federal budget. Planning to sell your cottage in 2025 and have options expiring that year as well? You may consider exercising some options this year and/or find ways to defer or minimize gains on your cottage next year. Or perhaps the underlying shares of your options have greatly appreciated, leaving you with a sizeable amount in unrealized stock option benefit. With time on your side, you can exercise as much as necessary to stay within the annual threshold and reduce or eliminate the sting of a higher inclusion rate.
If you cross the threshold into the 66.7% inclusion rate in your 2024 taxes, you can elect which source of income is included at 50% and what gets bumped to the higher rate. At first glance, it would make sense to prioritize the stock option benefit over capital gains, since capital gains could be offset by capital losses (if available).
Thankfully, the alternative minimum tax (AMT) will likely not apply (see this technical link) when crossing the $250,000 threshold. In short, triggering less than $250,000 in gains keeps you below the minimum amount of income for AMT to apply, and the higher inclusion rate above the quarter million mark outpaces the increase in taxes from the AMT rules. One less thing to worry about!
There is a huge caveat to this year’s changes: The legislation has not yet passed. It is on the agenda for the House of Commons, but they have not debated or passed it yet. If it does not receive Royal assent before the house rises on Dec. 15th, this may all be for naught!
You’ve worked hard for a company and earned the right to purchase shares at a favourable price. When is a good time to cash in? Exercising means crystalizing a benefit and generating a tax bill. Deferring the exercise date means no immediate taxes, but you remain exposed to a single stock’s volatility with fewer years to cash out.
With enough time until your options expire, deferring taxes is a powerful tool, especially if you foresee significant capital gains. Pay close attention if your expiration window has shrunk to less than 3 years; you’ll need to exercise soon so time it well.
You believe in the value of the company that granted you options, raising the question; why sell a winner? Holding a large position in any single company exposes you to concentration risk, especially if you add in the value you bring to the company: your human capital. When times are good, things are great, but “the bigger they are the harder they fall”.
You’ve read up to here, know the tax implication, and want to hold on to some or all your position in your company. There is happy medium: defer some of the tax. One strategy is to exercise your options, staying below the annual $250,000 inclusion threshold, and then subsequently hold the underlying shares to defer the capital gains tax. This way your options don’t expire, you keep a stake in the company, and you defer taxes until you sell the shares. Seems like you can have your cake and eat it too! Well, not without the taxman taking a bite – remember that you will owe taxes on the net benefit amount from the purchase. Selling a portion of the shares immediately after exercising is one way to cover this bill and we generally recommend doing so. If you don’t you could be left with a big tax bill and shares that have dropped in value substantially in the interim. We’ve seen this happen all too often before!
Amid tax implications, market conditions, and behavioural tilts, one thing is clear: consult your professional entourage before taking deliberate action. You, your accountant, financial planner, wealth advisor, and lawyer (or whichever subset of these form your entourage) each offer valuable insight. The right decision lies at the intersection of this pool of opinions. Trade-offs between current tax regimes, future market performance, and significant financial transactions mean that there is no perfect solution. A decision made from multiple perspectives can bring peace of mind and tax savings, too.
