Tax Implications of Severance Pay
In the current economy, it’s not uncommon for employers to cut staff or even close down altogether. For those affected, there are often severance packages on offer to help ease the transition into a new role or onto another job.
If you’re getting a severance package or considering it, understanding the tax implications is crucial for your near-term financial health. This blog will discuss the basics of severance pay Ontario, including how it is calculated and what obligations your employer has to meet when offering it.
Under the Employment Standards Act (ESA), a severance package is compensation paid to an employee on their date of termination. It acknowledges the employee’s years of service with the company and provides them with a safety net while they look for a new job. The ESA specifies that severance pay can be up to 26 weeks of regular wages.
Tax Implications of Severance Pay in Ontario
However, this amount can vary widely depending on the size of the company and other factors such as why the employer is terminating an employee. Generally speaking, larger companies are more likely to offer severance pay.
Regardless of the reason for your departure, whether it be layoffs or an involuntary decision, your employer is required to provide you with some form of severance payment as per the ESA. Typically, it will be a lump-sum payment to offset the loss of income.
If you receive your severance pay as a lump sum, your employer will withhold the appropriate amount of income tax from your payment. However, they won’t withhold Canada pension plan (CPP) contributions, Quebec pension plan (QPP) payments or employment insurance (EI) premiums.
On the other hand, if your employer gives you your severance package in the form of salary continuance or deferred payments, your tax situation will be different. You will be receiving your severance pay over a period of months, meaning that the total amount of income hitting you all at once could potentially bump you into a higher tax bracket.
This will depend on how your severance pay is structured and what you immediately do with it. If it’s a lump-sum payment, you can choose to immediately invest it into an RRSP or other retirement savings vehicle. If you decide to keep it, it’s wise to consult with a tax professional to ensure you claim it correctly on your taxes. It’s also a good idea to consider the possibility of using your severance package as a bridge loan, rather than immediately investing it, if you’re unsure how to best handle the sudden increase in income. This will allow you to maximize your tax breaks while protecting your overall financial position. The key is to seek out an experienced tax professional who can advise you on the best way to manage your severance pay ontario.