is severance taxable?

When an employee is let go there are usually three cash items owing to them upon exit: (1) salary up to the last day of employment, (2) any accrued vacation owing, and (3) a payment in lieu of providing notice and/or compensation eligibility for length of service.    Occasionally there can also be additional severance if (1) you want to be proactive about providing additional severance tied to a release and settlement of all claims against the company or (2) you are taken to court and you have to pay additional severance.  Of course, all of these items are less the applicable statutory withholdings.

Recently we got the following question:

I have a client who has recently paid a settlement to a would-have-been employee. Would the settlement be considered a taxable income for the employee or not? How do we treat it in our books?

This is a very interesting question.  We contacted the person for more information and it turns out the individual was let go after a signed offer letter but before the actual start date.  A job was offered to the individual but when he got there apparently there was no job available for him. The individual decided to file a claim against the company citing that he’s owed compensation due to the fact that he was offered a job by the company and that he had to leave his previous company and now had no job to go to.  Yes, he won his claim against the company and, yes, this is a very good reminder about the contractual obligation of extending an employment offer.  Now, back to the question:

How would we treat the settlement amount in our books? Would it be considered part of payroll expense? If so, would it be taxable income to that individual? (e.g. a T4) or just plain legal cost?

I know at first blush it may seem like a legal cost but the settlement is actually the severance owed to the individual for the Company breaking its contractual obligation.  So, yes, it is a payroll expense and deductions should be made at source and remitted and reported accordingly.

As this question came from a consultant in Vancouver, BC we directed the person to two sites for good guidance on termination responsibilities in the future:

• BC Employment Standards Act fact sheet on termination.  The Act requires written notice or compensation based on length of service under certain situations.  This is for after employment has begun.
• Canadian Revenue Agency guidance on what to do should an employee leave.

To be clear, the severance the individual received in the example above was not under provincial labour standards but was a settlement based in contractual law.  But a good reminder, nonetheless, about taking employment offers and termination responsibilities very seriously.

Another great question from you, our readers!  Keep them coming through our contact form.  We love answering your questions so others can learn from your experiences as well.