Save some of that wrongful dismissal settlement for the CRA

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If you feel you have been wrongfully dismissed from your job, you have the right to sue for damages. Often, your former employer may be tempted to settle the case privately without the added hassle, time commitment, legal expense and publicity of going to court.

But even if you do enter into a private settlement, be forewarned that the amount you receive as payment to settle your claim for wrongful dismissal is still taxable and subject to source withholdings.

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Save some of that wrongful dismissal settlement for the CRA Back to video

Take the recent case of a Saskatchewan employee who sued her employer for wrongful dismissal. She settled in October 2013 for $100,000. Her former employer, however, cut her a cheque for only $70,000, claiming that the remaining $30,000 must be withheld and remitted to the Canada Revenue Agency as “income tax on lump-sum retirement allowances.”

The employee complained and ultimately sued her former employer in Saskatchewan Court for the $30,000 withheld arguing that the “minutes of settlement” contained no details regarding the withholding of such funds. She further asserted that if her former employer “had intended to deduct income tax from the $100,000 award” this would have been “explicitly” set out in the settlement agreement. She therefore felt that she should receive her full $100,000 as an award of damages.

Thus the issue before the Saskatchewan court was whether her former employer properly withheld the $30,000 for tax purposes.

The  judge cited various cases which all found that an award given pursuant to a wrongful dismissal settlement is fully taxable under the Income Tax Act and, “as an implied term of such settlements, the employer will make all necessary income tax deductions from the initial award.”

Quoting prior jurisprudence, the judge concluded that all wrongful dismissal damages are fully taxable, whether awarded by a court or through private settlement. The authority for this is the Tax Act itself which includes in income “all retiring allowances,” which is further defined to include damages received upon the loss of employment.

Moreover, the CRA guidelines define a “retiring allowance” to include any amount someone receives when her “employment is terminated, even if the amount is for damages (such as wrongful dismissal) when the employee does not return to work.”

Since a retiring allowance is considered to be a “lump-sum payment” for income tax purposes, the employer is required to deduct income tax in accordance with the lump-sum withholding rates. The rate for payments over $15,000 is 30% and accordingly, the judge concluded that the employer was correct to withhold 30% or $30,000 for income tax.

Although a painful lesson for the employee, an important reminder to the rest of us that before you spend that wrongful dismissal award, be sure to set aside a portion of that settlement for the tax man.

Jamie.Golombek@cibc.com

Jamie Golombek is the managing director, tax & estate planning with CIBC Wealth Advisory Services in Toronto.