Severance pay refers to the compensation an employer provides to an employee when their employment ends, typically as pay in lieu of notice after a termination without cause. In Alberta, employers often provide severance instead of working-notice to help employees transition after job loss.
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How Severance Pay Is Taxed in Alberta
In Alberta, an employer’s obligation to provide severance may come from the Employment Standards Code, your employment contract, or common law reasonable notice. No matter the source, all severance pay is taxable income.
According to the CRA, severance (or pay in lieu of notice) is treated as a retiring allowance, a form of accelerated income meant to replace earnings you would have received over the notice period.
This means severance is fully taxable, but how it is withheld depends on the structure of your payment.
Taxes vs. Withholdings: What’s the Difference?
In the context of severance pay, withholdings and taxes are related but not the same. Understanding this difference is important.
What Are Withholdings?
Withholdings are the amounts your employer deducts from your severance payment at the time it is paid. These deductions include:
- Income tax
- Canadian Pension Plan (CPP) contributions (in some cases)
- Employment Insurance (EI) premiums (in some cases)
These withholdings are essentially prepayments sent to the Canada Revenue Agency (CRA) on your behalf. Withholding rates on lump-sum severance payments are often lower than the tax rate you will ultimately owe.
What Are Taxes?
Taxes, on the other hand, are the actual amount you are legally required to pay based on your total income for the year. When you file your tax return, the CRA calculates your true tax liability using your marginal tax rate. If your employer’s withholdings were too low, you may owe additional tax. If they deducted too much, you may receive a refund.
Understanding this distinction is crucial when evaluating the real, after-tax value of a severance package.
Tax on Lump-Sum Severance Payments in Alberta
If your employer pays severance as a lump-sum payment, income tax will be deducted at the source using standardized rates.
Alberta lump-sum severance payments can be treated as a retiring allowance. Alberta standard withholding rates as of 2026:
- 10% on amounts up to $5,000
- 20% on amounts from $5,000 to $15,000
- 30% on amounts over $15,000
Advantages of Lump-Sum Severance
A key advantage for employees is that CPP contributions and EI premiums are generally not deducted from lump-sum severance payments. This can create short-term tax savings.
However, when you file your tax return, the Canada Revenue Agency will review your total income for the year. If the tax withheld on your severance is lower than your marginal tax rate, you may owe additional taxes at year-end.
Salary Continuance: How It Affects Severance Taxation
Instead of a lump-sum amount, some employers offer salary continuance, where your regular pay (and sometimes benefits) continue for a set period after termination.
How salary continuance is taxed:
- Your severance is taxed like regular employment income
- CPP, EI, and RPP contributions apply
- Your employer withholds tax at your usual rate
While this may provide income stability, it does not offer the lower withholding rates associated with lump-sum severance payments.
RRSP Transfers: A Tax-Deferral Strategy for Severance Pay in Alberta
Employees may be able to defer immediate taxation by asking the employer to directly transfer the lump-sum severance amount to an RRSP or RPP.
When the payment is transferred directly:
- No tax is withheld at source
- You pay tax only when withdrawing funds from your RRSP later
- You must have sufficient RRSP contribution room
This strategy can significantly reduce immediate tax liability if handled correctly.
Non-Taxable Damages in Severance Settlements
Not every payment made on termination is taxable. Certain damages may fall outside the definition of “retiring allowance” and can be non-taxable.
Types of Non-Taxable Damages
- Aggravated damages arising from bad-faith or improper treatment during termination
- General damages awarded for human rights violations or discriminatory termination
However, employees cannot simply label part of a severance package as “damages” to avoid tax, these payments must be supported by legitimate legal claims and grounded in evidence.
Tax Deductions for Legal Fees Related to Severance
Legal fees incurred in connection with a severance dispute can, in many cases, be tax-deductible, which helps reduce the overall financial impact of pursuing your entitlements.
What Legal Fees Are Deductible?
The Canada Revenue Agency allows employees to deduct legal fees paid to recover or establish a right to employment income. Including:
- Wrongful dismissal damages
- Severance pay
- Pay in lieu of notice
This means that if you hire a lawyer to negotiate or litigate your severance package, the portion of legal fees related to securing taxable employment income may be claimed as a deduction on your tax return.
This has been confirmed by the Tax Court of Canada.
What Legal Fees Are NOT Deductible?
It’s important to note that only legal fees incurred to obtain taxable amounts are deductible. Fees related to pursuing non-taxable damages are not deductible, such as:
- Human rights damages or aggravated damages
- Fees paid for general employment advice
- Career counselling services
To support your deduction, your lawyer should provide an invoice breaking down services related to taxable and non-taxable claims. By properly claiming deductible legal fees, employees can significantly offset the tax burden associated with receiving a severance package, improving the net value of their settlement.
Release Agreements and Tax Liability
Most severance packages require the employee to sign a release. These agreements often contain clauses stating that the employee is responsible for any unexpected or additional tax consequences arising from the settlement.
Because of this, employees should be cautious when allocating amounts between taxable severance and non-taxable damages. A poorly drafted release can leave you responsible for tax reassessments later.
Get Expert Advice Before Accepting Your Severance Package
Understanding the tax implications of your severance package is essential. The structure of your payout (lump sum, salary continuance, RRSP transfer, or damages) directly affects how much tax you will ultimately pay.
If you have been offered a severance package or need help understanding your options, our Calgary employment lawyers can ensure your rights and financial interests are protected.
Book a consultation with our office if you need further information or advice.