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If you are fired and get a severance package or court-awarded damages, the way in which these amounts are characterized by the Canada Revenue Agency can have a significant impact on how much you have left after taxes.
When wages are paid instead of notice under terms of an employment contract or employment standards legislation, these amounts are viewed as employment income by CRA, even though time has elapsed after you left the company. Taxes at your marginal rate will be withheld along with CPP contributions and EI premiums.
You will also have to pay back Employment Insurance benefits you collected before receiving a wage settlement for the same period.
Common law damages for wrongful dismissal over and above statutory minimums are treated as a retiring allowance. A retiring allowance also includes payments for unused sick leave credits when you were fired. It does not include payments for accumulated vacation leave not taken before you left the company.
When a retiring allowance is paid out, your former employer must withhold and send to CRA:
- 10 per cent (5 per cent for Quebec) on amounts up to and including $5,000.
- 20 per cent (10 per cent for Quebec) on amounts over $5,000 up to and including $15,000.
- 30 per cent (15per cent for Quebec) on amounts over $15,000.
You may also have to pay additional taxes when you file your annual return. However deduction of CPP contributions and EI premiums from retiring allowances is not required.
If you have RRSP contribution room, your employer can directly transfer your retiring allowance to your RRSP without withholding taxes. You are also entitled to additional RRSP room of:
- $2,000/year for years prior to 1996 that you were employed by the company.
- An additional $1,500 for each year or part of year of service before 1989 in which your employer did not contribute to your pension or deferred profit- sharing plan.
Another way to minimize taxes owing if you are fired late in the year is to ask your former employer to split the lump sum and pay part in each of two tax years. This assumes your income may be lower in the second year if you do not immediately find a new job.
However, amounts paid in a wrongful dismissal case for reimbursement of legal fees, and punitive damages are typically not taxable. The same applies for settlements or awards paid for Human Rights complaints.
You can try to have any damages paid for wrongful dismissal characterized as punitive damages to minimize taxes payable, but your former employer may be reluctant to admit wrongdoing or set a precedent. Furthermore, CRA has the power to request supporting documentation and reject this allocation, thus triggering a tax obligation.
In all cases you should seek advice from an experienced employment lawyer about the tax implications of a proposed settlement or court award for wrongful dismissal.