Severance Pay Tax Guide

What Qualifies as Severance?

Retiring Allowance Includes

• Severance or termination pay
• Payment for loss of office
• Retirement incentive payments
• Damages for wrongful dismissal
• Payment for unused sick leave (in some cases)

Not Included

• Payment in lieu of notice (regular salary)
• Vacation pay (regular income)
• Pension benefits
• Death benefits (different rules)

How Severance Is Taxed

Lump Sum Payment

• Employer withholds tax at source
• Withholding rates for lump sums:

Quebec: Add provincial withholding

Actual Tax Rate

• Withholding is not final tax
• Actual tax at your marginal rate
• May owe more or get refund
• Depends on total annual income

RRSP Transfer Rules

Eligible Rollover Amount

You can transfer severance directly to RRSP for:

• $2,000 per year of service before 1996
• Plus $1,500 per year before 1989 if no pension
• This is IN ADDITION to regular RRSP room

Example Calculation

Employee worked from 1985 to 2024:

• Years before 1996: 11 (1985-1995)
• Years before 1989 (no pension): 4 (1985-1988)
• Eligible transfer:
• 11 × $2,000 = $22,000
• Plus 4 × $1,500 = $6,000 (if no pension)
• Total eligible: $28,000

Direct Transfer Requirement

• Must transfer directly to RRSP
• Employer transfers on your behalf
• No tax withheld on transferred amount
• Report on T4A but offset by RRSP deduction

Using Regular RRSP Room

Beyond the Eligible Amount

• Use existing RRSP contribution room
• Receive severance, contribute to RRSP
• Claim deduction to offset income
• Reduces tax on severance

Strategic Approach

1. Calculate eligible rollover (pre-1996 service)
2. Have employer transfer that amount directly
3. Receive balance as taxable
4. Contribute from taxable portion using RRSP room
5. Claim deductions on return

Spreading Severance Over Years

Salary Continuance

• Receive severance as ongoing payments
• Spreads income over multiple tax years
• May keep you in lower brackets
• Negotiate with employer if possible

Structured Settlements

• Court awards may be spread over time
• Tax planning opportunity
• Professional advice recommended

Severance and EI

Impact on EI Eligibility

• Severance doesn't disqualify from EI
• But may delay start date
• Allocated over insurable weeks
• Contact Service Canada for specifics

Tax Planning

• Severance in Year 1
• EI benefits possibly in Year 2
• May result in lower total tax

Reporting Severance

T4A Slip

Employer issues T4A showing:

• Box 26: Retiring allowance (eligible for transfer)
• Box 27: Retiring allowance (non-eligible)
• Box 22: Income tax deducted

Where to Report

• Line 13000: Other income (from Box 26, 27)
• Line 20800: RRSP deduction (if contributed)
• Net effect reduces taxable income

Tax Planning Strategies

Maximize RRSP Transfers

• Calculate your eligible amount
• Use all pre-1996 service room
• Coordinate with employer

Time Your Departure

• January termination spreads income
• December receives all in one year
• Consider your total annual income

Negotiate Payment Structure

• Lump sum vs salary continuance
• Direct RRSP transfer
• Timing of payments

Consider TFSA

• After-tax severance to TFSA
• Grows tax-free
• Available for emergencies

Wrongful Dismissal Awards

Court Awards

• Damages for wrongful dismissal = retiring allowance
• Generally taxable
• Legal fees may be deductible
• Interest component may be taxable

Settlements

• Settlement payments typically taxable
• Allocate between different components
• Legal advice recommended

Legal Fees

• Fees to collect severance may be deductible
• Claim on Line 23200
• Limited to retiring allowance received (minus transfers)
• Keep detailed receipts