Understanding Severance Pay and Taxes
Severance pay is a payment made to an employee when they leave their job, often due to layoffs, company restructuring, or mutual agreement. It’s usually a lump sum payment based on factors like seniority, age, and job position. However, the tax implications of severance pay can be complex and affect the amount of money you take home.
How is a Lump Sum Severance Payment Taxed?
A lump sum severance payment is typically taxed at a rate of 30%. However, this doesn’t necessarily mean you’ll only pay 30% in taxes. When you file your tax return, the actual tax rate will be determined based on your overall income, including the severance payment. If you have a high income or receive a large severance payment, you may end up paying an additional 20% or more in taxes.
Continued Payment of Wages
In some cases, you may receive continued payment of wages instead of a lump sum severance payment. This means you’ll continue to receive your regular salary for a certain period. The tax implications of continued payment of wages are similar to your regular salary, with the same tax deductions and credits applying.
How Companies Save Taxes
Companies can save taxes by generating active business income and leaving it in the corporation. This can result in a lower tax rate, often between 9% to 12%, depending on the province or territory. However, this doesn’t apply to severance payments, as they are considered earned income and cannot be converted into active business income.
Investing in a Business to Save Taxes
Investing personal savings in a business may not necessarily save you taxes. The tax rate on a corporation’s capital gains is similar to the top tax rate in most provinces and territories. However, entrepreneurs can use a separate investment holding company to invest their business profits, taking advantage of the small business tax rate.
Saving Taxes on Severance Payments
If you want to save taxes on a severance payment, there are two main options:
- Contributing to a Registered Retirement Savings Plan (RRSP), which can provide tax benefits and help you save for retirement.
- Postponing the severance payment until a future year, which can help reduce your tax liability in the current year.
Conclusion
Severance pay can have significant tax implications, and it’s essential to understand how it’s taxed and how you can save taxes on your payment. By contributing to an RRSP or postponing the payment, you can reduce your tax liability and make the most of your severance package. It’s also important to note that companies can save taxes by generating active business income and using investment holding companies. By understanding the tax implications of severance pay, you can make informed decisions and minimize your tax burden.