When an employee leaves your business, you could be responsible for making severance payments. Most importantly, you want to ensure that employees receive their rightful compensation. But, as a business owner, you don’t want to lose more money than you have to. That’s why minimizing taxes is your next area of focus.

Yes, there are tax implications you should be prepared for before you find yourself paying severance to an employee. If you’re already facing this situation and don’t have a game plan yet, you’re probably stressed out. Call us today for a free consulation; we’ll start planning everything so you can peace of mind. That being said, here are the basics of minimizing taxes on severance payments.

How Severance Payments Are Taxed In Canada

In Canada, severance payments are taxable income. This means that when an employee leaves your business, you will need to subtract taxes from their payment before releasing it to them. The most important thing to note is that while some types of payments, such as wages and salaries, have a set tax rate, the applicable tax rate on severance payments will depend on the amount paid out to the employee.

If you know approximately how much you’ll be paying and you’re curious about the taxation rate, here’s a short explainer.

Follow The Canada Labour Code Before Anything Else

The Canada Labour Code outlines the procedures to follow when terminating the employment of individual employees. It also covers what to do in the event of a group termination, classified as 50 or more employees (from a single industrial establishment) who are dismissed simultaneously within a 4-week period. According to the Code, employers must provide the employees with reasonable notice before being terminated, or else 2 weeks of full pay must be included instead. This fact alone could easily cost you tens of thousands.

When Giving Reasonable Notice, Remember This

Reasonable notice ensures that the employee is aware of their termination and gives them sufficient time to prepare for their departure.

This written notice should include all the facts and figures associated with the severance package, such as the amount being paid out, the total number of weeks being compensated for, and any other extra benefits (such as vacation pay) that are part of the agreement.

It’s also important to include information about the employee’s rights during and after their employment has been terminated. The notice should explain how long the employee can expect to have access to benefits like medical coverage or life insurance policies. It should also outline what kind of assistance may be available for transitioning into new employment opportunities or further education opportunities.

Finally, the notification letter should also express appreciation for the employee’s contribution to your business. This creates an atmosphere in which both parties feel respected; don’t overlook the power of that, since it will save you from the squabbles that come with an upset employee.

What If You Have To Pay Instead Of Giving Notice?

In most provinces, pay in lieu must be provided to the employee within a particular timeframe, typically a lump sum after seven days of termination (or by the next pay date, whichever is later). When an employee gets compensation in lieu of notice, it should be equivalent to what their normal salary would have been for the length of the notice period.

Important to note: Pay in lieu is subject to Canada Pension Plan (CPP) contributions, employment insurance (EI) premiums, and income tax deductions; deduct these before handing out the pay.

So Now You Know:

By understanding the rules surrounding reasonable notice and pay in lieu of notice, you can take steps to minimize taxes associated with severance payments, while making sure your employees get their rightful compensation.

If severance payments and taxes still sound complicated to calculate, contact us today; we can easily ensure you’re in compliance with all laws and regulations. At ACM CPA, we have the expertise to help you avoid financial implications, understand tax deductions, and increase your business’ efficiency.