SPECIAL PAYMENTS BY EMPLOYERS
1. Overview
Special payments by employers typically refer to amounts provided outside regular wages, such as termination pay, severance packages, bonuses, or settlement payments. These payments can arise during employment, at the time of termination, or under special agreements like lump-sum settlements. The CRA has outlined specific guidelines for the taxation and reporting of such payments to ensure compliance and transparency.
2. Types of Special Payments
- Termination Pay: Payments made when an employee is terminated without adequate notice. This ensures financial support during the transition period and is fully taxable.
- Severance Pay: Compensation provided as recognition for years of service. These payments are considered taxable income and must be reported on the employee’s T4 slip.
- Lump-Sum Settlements: Payments arising from legal disputes, such as wrongful dismissal claims. These are generally taxable unless otherwise exempted under specific provisions.
- Bonuses: Performance-based rewards or discretionary payments provided to employees. These are included in the employee's taxable income.
3. Tax Implications
Special payments by employers are subject to specific tax treatments, depending on their nature and purpose:
- Withholding Requirements: Employers must withhold income tax, CPP contributions, and EI premiums on most special payments, including bonuses and severance.
- Eligible Retiring Allowances: Payments that qualify as retiring allowances can be transferred to the employee’s RRSP without immediate tax implications, up to certain limits.
- Taxable Benefits: Payments intended to encourage resignation or acceptance of new employment are taxable under the Income Tax Act (ITA).
4. Reporting Obligations
Employers are responsible for accurate reporting of special payments to the CRA and employees:
- Include amounts in the employee's T4 slip or T4A slip, as applicable.
- Ensure proper classification of payments, such as differentiating between taxable bonuses and retiring allowances.
- Retain supporting documentation for lump-sum settlements, severance agreements, or legal settlements.
5. CRA Guidelines and Considerations
- Tax-Free Exemptions: Certain payments, such as gifts and awards meeting non-cash criteria, may qualify as tax-free under CRA rules.
- Legal Settlements: Payments classified as damages for emotional distress or pain and suffering may be exempt from tax in some cases. Employers should consult tax professionals for accurate classification.
- Compliance with ITA Section 6(3): Payments made to induce an employee to resign or accept new employment are taxable benefits and must be reported as income.
6. Examples
- Example 1: An employee receives $10,000 as termination pay. This amount is fully taxable and included in their T4 slip.
- Example 2: A lump-sum payment of $50,000 is made as part of a wrongful dismissal settlement. While the full amount is taxable, a portion transferred to an RRSP may be exempt.
7. Conclusion
Special payments by employers serve various purposes, from compensating terminated employees to rewarding performance. Proper classification, reporting, and adherence to CRA guidelines ensure compliance and maximize financial benefits for both employers and employees.
