How to Calculate Tax on Severance Pay in Ontario

Introduction

Severance pay is compensation provided to employees when they leave their jobs, typically after a certain period of service. In Ontario, severance pay is considered taxable income and must be reported to the CRA. The tax calculation involves several steps, including determining your taxable income, applying the appropriate tax rates, and accounting for any deductions.

This guide explains how to calculate tax on severance pay in Ontario, including tax rates, calculation methods, and reporting requirements. We'll also provide an example calculation to help you understand the process.

Ontario Tax Rates

In Ontario, income tax is calculated using a progressive tax system. The tax rates for 2023 are as follows:

These rates are subject to change each year, so it's important to check the latest rates with the CRA or use the tax calculator provided on this page.

Calculation Method

To calculate the tax on your severance pay, follow these steps:

1. Determine your total taxable income for the year, including your severance pay.
2. Apply the Ontario tax rates to your taxable income to calculate your provincial tax.
3. Calculate your federal tax using the federal tax rates.
4. Add your provincial and federal taxes to get your total tax liability.

It's important to note that severance pay is subject to both provincial and federal taxes. The federal tax rates for 2023 are as follows:

Example Calculation

Let's say you receive $20,000 in severance pay and your total taxable income for the year is $60,000. Here's how to calculate the tax on your severance pay:

1. Determine your taxable income: $60,000
2. Apply the Ontario tax rates:
   • $51,446 × 5.06% = $2,598.74
   • ($60,000 - $51,446) × 9.15% = $8,145.25
   • Total provincial tax = $2,598.74 + $8,145.25 = $10,743.99
3. Calculate your federal tax:
   • $53,359 × 15% = $8,003.85
   • ($60,000 - $53,359) × 20.5% = $1,300.10
   • Total federal tax = $8,003.85 + $1,300.10 = $9,303.95
4. Add your provincial and federal taxes to get your total tax liability: $10,743.99 + $9,303.95 = $20,047.94

Therefore, the tax on your $20,000 severance pay is $20,047.94.

Reporting Requirements

When you receive severance pay in Ontario, you must report it to the CRA. The reporting requirements vary depending on the amount of severance pay you receive and your employment status. Here are the general reporting requirements:

• If you receive severance pay in a single payment of $3,000 or more, you must report it on your tax return.
• If you receive severance pay in multiple payments, you must report each payment of $3,000 or more.
• If you are an employee, you must report your severance pay on your T1 General Income Tax and Benefit Return.
• If you are self-employed, you must report your severance pay on your T2125 General Business Tax Return.

It's important to keep accurate records of your severance pay, including the amount received, the date it was received, and any documentation related to your employment.

Common Mistakes

When calculating tax on severance pay in Ontario, there are several common mistakes that people make. Here are some of the most common ones:

1. Not reporting severance pay: If you receive severance pay, you must report it to the CRA. Failure to report it can result in penalties and interest charges.
2. Underreporting severance pay: If you underreport your severance pay, you may owe additional taxes and penalties. It's important to report the full amount of your severance pay.
3. Not accounting for deductions: Severance pay is subject to deductions, such as the Canada Pension Plan (CPP) and Employment Insurance (EI) contributions. Failure to account for these deductions can result in an inaccurate tax calculation.
4. Using the wrong tax rates: The tax rates for severance pay are the same as the tax rates for other income. However, it's important to use the correct tax rates for your specific tax bracket.