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Lawyer and Chartered Accountant Stephen Du advises
client on:
Minimizing
tax bite: strategies to reduce income taxes payable on the severance
package
Even
when you are wrongfully dismissed, the taxman still wants his cut from
your severance package. However,
with the co-operation of the employer, severance packages can be
structured to lessen the tax burden, resulting in more take-home pay
for you.
"Every man is entitled, if he can, to order his
affairs so that the tax attaching under the appropriate Acts is less
than it otherwise would be" – such are the words pronounced by the British House of Lords in
the 1936 case of IRC v Duke of Westminster, in recognition of a
taxpayer’s right to use legal means at his or her disposal to
minimize the tax grab.
First, an employee should understand what type of
payments on termination are taxable.
Salaries in-lieu-of notice or retiring allowances are fully
taxable, whereas reimbursement of legal fees and settlements paid in respect
of Human Rights complaints are generally not taxable.
Compensation for tort damages, such as for emotional distress
or humiliation suffered as a result of a wrongful dismissal, may or
may not be taxable depending on the circumstances.
Other things that are useful to note is that if you have been
working since before 1996, a portion of your severance package can be
paid directly into your RRSP as a retiring allowance “rollover”,
and therefore not taxed.
The rules regarding emotional distress is quite murky
and courts have been known to rule erratically. However, the principle is quite clear: if the amount is paid
as compensation for personal injury, which includes emotional or
psychological damage, then the amount is not taxable.
If, however, the amount is characterized as payment for lost
employment, then the amount is taxable.
While
emotional distress and psychological damage is
often present in a wrongful dismissal, our experience is that many
severance packages totally ignore psychological damages.
An employee should consult his or her lawyer to ensure that, if
psychological damage is in fact suffered, a portion of any settlement
package should be designated as compensation as psychological damage.
While that designation by itself does not make the compensation
tax free, it goes a long way to prove to the tax department that it
should not be taxed.
If you incurred
legal costs to sue for a settlement
package, your legal costs are deductible as an “other deduction”
on your tax return. Instead
of waiting for your tax refunds, you may also designate a portion of
your severance package as reimbursement for legal expense, with the
employer’s consent. This
way, no withholding tax, CPP or EI premiums will be deducted from such
reimbursements. When times are tough, the added cash flow often comes
as a welcome relief to the wrongfully dismissed employee.
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