Taking stock: A crash course in employee stock options

June 26, 2025

Drew Maginn

Organizations have many different ways of offering attractive benefits to their employees, and employee stock options, or ESOs, are definitely one of them. While you might be familiar with the general concept or some of the terminology, it can be challenging if you come across employee stock options for the first time when they are referenced in an employment agreement you’re about to sign or as a key administrative task in your job description. If you’re new to ESOs, here’s a crash course in understanding what they are and what they mean for human capital management (HCM) professionals.

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What are employee stock options and how do they work?

Employee stock options are a type of compensation that gives employees the opportunity to purchase company stocks, or shares, at a certain price point. If you make the decision to purchase stocks, or “exercise this option,” you enter into an agreement to receive future ownership of these stocks after meeting certain criteria, such as continued employment for a pre-determined amount of time. While they are similar in some aspects, employee stock options should not be confused with employee stock ownership plans, or ESOPs, where employees purchase stocks, typically through payroll deductions, and these stocks are owned immediately or after a short period of time.

Exercise price, vesting schedule and other important terms

When it comes to employee stock options, knowing key terminology can help enhance your understanding, including if you’re tasked with explaining the basics to a colleague as part of their orientation. These key terms include the below.

Exercise price: The set price of the stock an employee can purchase when they exercise their option. This is also referred to as the “strike price.”
Spread: The spread refers to the difference between the market price and exercise price. A positive spread means an employee can profit by exercising their option, while a negative or zero spread means there isn’t an opportunity to profit.
Vesting schedule: The set amount of time that an employee must remain with an employer before they have the right to exercise their stock options.
Vesting limit: The total amount of employee stock options that may vest in an employee in a year and be eligible for the stock options deduction. This is subject to an annual limit of $200,000 in Canada.

Vested options: Stock options that employees can exercise after meeting criteria such as the time period outlined in the vesting schedule.

Unvested options: Stock options that have been granted to employees but are not yet owned. Unvested options are usually forfeited if an employee leaves the company before the end of the vesting schedule.

” In a job market where everyone is looking to create a competitive advantage, businesses that offer these options, with a positive spread, can offer a huge incentive to their workforce. ”

What governs employee stock options in Canada?

Employee stock options are governed by the Income Tax Act, as well as stock option plans and stock option agreements that are specific to each employer. In these documents, employers provide specific information, including the exercise price, the vesting schedule, the expiration date and any additional conditions such as individual performance or key company milestones. Stock option plans and agreements are usually approved by the board of directors and require payroll and human resource professionals to work together to determine taxation, communications and compliance with internal policies and procedures and external rules outlined by the Canadian Revenue Agency (CRA).

What are stock option taxation rules?

According to the CRA, if an employee exercises their stock option, their taxable benefit is typically the difference between the market value of the stock and the exercise price. This benefit is treated as employment income and must be included as part of the employee’s income in the year it was exercised. Keep in mind that taxation of employee stock options can differ between the private and public sectors. For example, in the private sector, employees can defer the taxation of their stock option benefit until they dispose of the stocks. This type of deferral can be advantageous to cash flow, as employees can avoid being taxed immediately.

What steps should HCM professionals follow for stock option taxation?

As a best practice, HCM professionals should consult the CRA website to follow their step-by-step process for stock option taxation, with situational considerations, which includes:

Determine if a stock option agreement was made;
Determine if a stock option agreement was made due to an employment relationship;
Determine if your corporation is private;
Determine if the benefit is taxable and when the benefit must be included in your employee’s income;
Calculate the value of the benefit;
Determine which stock option deductions apply to the stock option benefit;
Determine if the $200,000 vesting limit impacts the deduction;
Calculate the deduction;
Withhold payroll deductions and remit GST/HST; and
Report the benefit on a T4 slip.

Employee stock options are a great way to attract and retain employees, and it’s important for all HCM professionals to know the basics. In a job market where everyone is looking to create a competitive advantage, businesses that offer these options, with a positive spread, can offer a huge incentive to their workforce.

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