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Tax Implications of Wrongful Dismissal Settlements

When you are terminated from your employment, do not sign the severance package offer, assuming you have been terminated from your employment without cause, before you consult with an experienced employment lawyer.

If the employment lawyer determines that the severance package offered is not reasonable in the circumstances, counsel should first attempt to negotiate a settlement and the revert to litigation if the negotiations do not bear fruit. If your lawyer is successful in enhancing your severance package, whether through negotiation or subsequently litigation, there will be tax implications of any settlement you may receive.

Typically, employees’ prefer a clean break from their former employers; to that end, there is a preference for a lump sum settlement over a series of salary continuance payments for the duration of the notice period. Any lump sum payment will have tax implications, which will likely be different from the tax rate applied to your typical payroll receipts.

A retiring allowance is a sum of money received by a departing employee on account of a retirement payment for long service. Many lump sum payments on account of the termination of employment are classified as retiring allowances. The taxation of retiring allowances is prescribed by the CRA as follows:

-10{a739806ea1ec03325fdb6a8791d85aad1201ada6e9f0c1ac6e9348733b242bdc} on the first $5,000;
-20{a739806ea1ec03325fdb6a8791d85aad1201ada6e9f0c1ac6e9348733b242bdc} for amounts between $5,000 and $15,000; and
-30{a739806ea1ec03325fdb6a8791d85aad1201ada6e9f0c1ac6e9348733b242bdc} for amounts over $15,000.

In order to avoid the above-noted tax, terminated employees have various choices including (1) allocation a portion of the settlement to an RRSP, so long as there is sufficient contribution room for the year; (2) classifying a portion of the settlement towards legal fees (“legal fee allocation”); or (3) classifying a portion of the damages as general damages on account of human rights claims.

If you are seeking counsel to negotiate an employment settlement, please contact our law firm today.

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