Losing your job is never a pleasant experience. And while you might think that the taxman would be sympathetic to such circumstances, this is unfortunately not the case. When you receive a severance package upon termination of your employment, that money received is taxable. However, there are some tricks at your disposable to minimize the full tax burden.
What is taxable?
Severance packages are referred to in the Income Tax Act as “retirement allowances.” Section 248(1) of the Act defines these retirement allowances as an amount received by the taxpayer:
- on or after retirement of a taxpayer from an office or employment in recognition of the taxpayer's long service, or
- in respect of a loss of office or employment of a taxpayer A retirement allowance may include payment for unused sick leave; however, it does not include accumulated vacation leave credits or income from a retirement compensation arrangement. The amount, which may be paid by installments, may be received by the former employee, or after his or her death, by a dependant or a relation. Section 56(1)(a)(ii) of the Act makes it clear that your retirement allowance received must be included as income. However, it is possible to defer payment of some of the associated tax.
Deferring tax from your Severance
Section 60(j.1) of the Income Tax Act permits a taxpayer who has received a retirement allowance to defer payment of some or all of the income tax on the amount received by making a payment to a registered pension plan (RPP) or to a registered retirement savings plan (RRSP) belonging to the taxpayer. The amount that can be transferred is determined in part by reference to the number of years of employment before 1996 with the employer who made the payment. By transferring the eligible amount of your severance pay directly to an RRSP, the tax will not be deducted or withheld.
The amount of your retirement allowance that is eligible to be transferred to an RPP or RRSP is determined as follows:
- $2,000 for each year or part year of service with the employer before 1996 from the employer paying the retirement allowance, and
- An additional $1,500 for years of service which occurred before 1989 in which the employer`s contributions to a company pension plan had not yet vested with the employee.
We Can Help With Your Severance Package
The foregoing was just a brief overview of the complex topic of severance packages and their tax implications. In order to ensure that you are taking complete advantage of every deduction and deferment possible, contact the tax accountants at Tax Doctors Canada.. We are ready to help you today!
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