THE TAX COST OF GETTING FIRED
What happens for tax purposes if you are fired from your job? You will normally receive one or both of the following kinds of payments:
- An extension of your salary during a period while you are still employed. For example, you might be given 3 months' notice of termination, and continue working during that period.
- A severance payment. For example, you might get 6 months' salary. This might not come until you consult a lawyer and threaten to bring a lawsuit for wrongful dismissal.
Or it might not come until you actually take your former employer to court and get a court award.
Payments that continue your salary are treated as regular employment income, and given the same tax treatment (and withholding at source) as your salary was before you were given notice. All other payments in respect of the loss of employment - whether simply offered by the employer, paid to settle a wrongful-dismissal lawsuit, or awarded by a court- fall into what the Income Tax Act calls a "retiring allowance". (This term will also cover a payment genuinely made in recognition of long service when someone retires.) A retiring allowance is taxable, but there are a number of important differences from regular income:
- Part or all of the retiring allowance can be transferred to your RRSP. You can transfer up to $2,000 for each calendar year ( or part of a year ) during which you were employed with that employer before 1996. As well, if you were not a member of a deferred profit sharing plan or pension plan to which your rights have vested, you can transfer an additional $1,500 for each such year before 1998.
If the transfer is done directly by your employer to the financial institution that holds your RRSP, then no tax will be withheld from the payment. However, if this is not done, you can still do the transfer yourself, provided you do it by 60 days after year-end (the same deadline as for regular RRSP contributions).
Before 1998, there was a possible Alternative Minimum Tax (AMT) problem when large amounts of retiring allowance were rolled into an RRSP in this way. The February 18, 1998 budget announced that this problem will be eliminated: RRSP contributions, including retiring allowance rollovers, are no longer considered tax preferences for AMT purposes.
- The retiring allowance is not considered employment income for tax purposes. This means that it does not create RRSP contribution room (except for the rollover described above), and does not count as earned income for purposes of the child-care deduction.
- The withholding tax on that portion of the retiring allowance which has not been transferred to an RRSP is a flat 10% for amounts up to $5,000, 20% for $5,000.01 to $15,000, and 30% for $15,000.01 and over. (In Quebec, the withholding is 25%, 33% and 38% respectively.) This is simply a prepayment of your tax.: the actual tax you pay will be calculated on your tax return for the year by including the retiring allowance in your income, and you will receive a credit for the tax withheld. So if you are in a 50% bracket, you may need to set aside 20% of the payment to cover the tax that will be owing next spring.
- If you become non-resident before you receive the retiring allowance, the only tax will be a flat 25% withholding tax, rather that the regular tax at rates of up to 50%. If you are considering leaving Canada, you should therefore arrange to do so, and "cut your ties" with Canada sufficiently to become non-resident, before you receive the payment.
Is there any way to make the settlement tax-free? Aside from the RRSP rollover described above, there are other ways in which payments for wrongful dismissal can become at least partially tax-free. If the fired employee sues the employer for injury such as mental distress or defamation, and the settlement or Court award explicitly allocates some amount to these types of damage, that amount will be non-taxable. Revenue Canada may challenge this on the grounds that the payment really was for loss of employment, so the facts and the documentation have to be able to support the claim that the payment was for injury. Several taxpayers have succeeded with this argument in the Courts. It may also be possible, in cases of severe wrongdoing by the employer to have a Court classify part of a award as "punitive damages" or exemplary damages", which might also not be taxable. Another planning tip would be to arrange for the employer to provide reemployment or retirement counselling services as part of the settlement. These are non-taxable benefits under the Income Tax Act. Finally, note that amounts paid by the employer to your lawyer to cover your legal expenses are not taxable. Conversely, if you receive the funds and pay your lawyer yourself, the legal fees are deductible against the settlement to reduce the "retiring allowance" on which you must pay tax.
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ADVANTAGES OF INCORPORATION Limited Liability Liability protection is generally the main non-tax reason to incorporate, and is the main motivation for most incorporations to take place. While a sole proprietor or partner in a general partnership has unlimited liability to creditors of the business, shareholders of a corporation have no such risk. Without the protection of limited liability most entrepreneurs would not take the risks of going into business. Director's Liability While shareholders have limited liability, directors of a corporation are subject to various liabilities. These include liabilities for unremitted source deductions, unremitted P.S.T. and G.S.T. and certain environmental liabilities. Furthermore, passive directors who may not be involved in running the business may still be subject to certain of these liabilities. Passive directors should be aware of what the corporations doing and should ensure that director's liability insurance is in place to protect them. Disadvantages of Incorporation Losses Trapped Any business which is not operating at the break even point should not incorporate from a tax point of view, although it may be sensible to incorporate when considering limiting liability. A loss earned in a corporation cannot be transferred to its shareholders. Conversely, owners of an unincorporated business would be able to utilize losses which they incurred against other sources of income or against future earnings. Losses which arise in a corporation can only be offset against earnings in that corporation. Double Taxation A potential taxation trap exists if an active business earns too much profit. Corporate profits from active business income in excess of $200,000 per year are taxed at full corporate rates. Integration of the personal and corporate tax systems does not work at that rate, resulting in a element of double taxation. Therefore all income in excess of $200,000 should usually be paid out of the corporation by way of salary or bonus to avoid this double taxation trap.
DENTIST FIGHTS BACK! If a patient, associate, or member of the public files a complaint against you with your professional college you must respond. You must defend yourself thoroughly and rebut all allegations. A few complaints succeed. A large number of complaints are dismissed after an initial investigation. Some complaints are dismissed after a hearing. For the complainant the process is risk free requiring only an investment in time and the cost of a stamp. The economic cost to the profession in lost business and legal fees may be considerable. Can you defray some of these costs?
Dr. Zaven Tahtadjian describes his experience with a disgruntled patient: "Further to our telephone conversation, I am sending you a rather condensed report of the case I had against a patient who filed a complaint against me with the Royal College of Dental Surgeons of Ontario. As I said, the decision is being appealed and I can go into greater detail once the appeal is over or abandoned. Back in 1994 a patient owed me money for services rendered. He refused to settle his account, so I took the matter to Small Claims Court. The amount claimed was $540. The patient, apparently with the guidance of another dentist, sent a letter of complaint to the College making false accusations against me. He settled his account just prior to the trial date and agreed, in writing, to drop his complaint against me. But when the College asked him personally if he wanted the investigation to stop he answered "no" and requested that the investigation go forward. The College investigated the matter thoroughly, decided that my work met professional standards and ruled that no further action be taken. I was so upset at the patient's attitude towards me that I decided to sue him a second time, seeking compensation for the time and trouble he put me through answering his unjustified complaint. I filed another claim in small Claims Court for $5000. The matter went to pre-trial first; the patient showed up with a lawyer who refused to make any settlement. So the case went to trial. At trial the patient showed up with the same lawyer and the trial lasted a full day. The patient lied several times while under oath and in the end the judge reserved judgment. After a month, the judgment was mailed to both parties and the judge said: "I find his (defendant) complaint unjustified, vexatious and malicious...his actions are tortious and worthy of compensation."
In his conclusion the judge said: "He (defendant) was not justified in making his complaint with the result that it constituted a nuisance against the Plaintiff, causing him to incur time and expense to defend himself before the College." In his decision the judge said: "Here the harm caused the Plaintiff is greater than he ought to be required to bear under the circumstances with the result that there is judgment for the Plaintiff against the Defendant in nuisance for the substantial annoyance caused him...the Plaintiff shall have judgment against the Defendant for $2800, plus costs $70, plus prejudgment interest from ...to.... plus post judgment interest from ...to.... both as per the Courts of Justice Act." The patient has decided to appeal the decision and has already served the Notice of
Appeal upon me.
It is up to the Appellant to order transcripts of the trial and he has sought relief from compliance with that rule. I opposed the motion, claiming that the transcripts are necessary. The Motion was dismissed and it appears that the patient is unwilling to pay the cost for ordering the transcripts. So the Appeal may be abandoned, or I may bring a motion for dismissal of the Appeal because of delay. But it is too early to tell. In publishing this report, I authorize you to mention my name if you so wish, and if any of your readers, who find themselves in the same predicament, wish to get in touch with me for further information, or are contemplating taking similar action, they can reach me at (416) 536-0861 during the day, or (416) 256-0147 in the evenings. Please find enclosed a cheque for $10 for my yearly subscription to your newsletter." Dr. Tahtadjian tried to submit this letter to the RCDS for publication in DISPATCH. He was advised that the RCDS was not interested in publicizing his article or assisting its members in dealing with harassing patients. It was too controversial!
JW Legal Dental News welcomes your articles, letters and reports of your experience in any facet of your practice. It is the policy of this newsletter to be an independent source of news, views and information about and for the dental profession.
J.W. |
