How much is hiring a wrongful dismissal lawyer going to cost me? When someone finds him or herself suddenly unemployed questions about the costs of services get serious. Legal services have long had a reputation of being expensive, and there may be a further perception that their cost may put them out of reach to some people. I wish to dispel that myth.
Income Tax Deductions
One has to look beyond the gross cost of legal fees to the net cost. As is explained in Canada Revenue Agency Interpretation Bulletin IT-337R4:
legal expenses paid by a taxpayer to collect or establish a right to damages for wrongful dismissal may be deducted under paragraph 60(o.1) of the Income Tax Act.
Canada Revenue Agency Interpretation Bulletin IT-99R5, further provides that:
¶ 22 Paragraph 8(1)(b) [of the Income Tax Act] permits a deduction in computing income from an office or employment, for legal expenses paid by a taxpayer in the year to collect or to establish a right to salary or wages owed by an employer or former employer. Paragraph 6(1)(j) requires a taxpayer to include in income any award or reimbursement received in respect of amounts for which a deduction under paragraph 8(1)(b) is available. These amounts must be included in income to the extent that they are not otherwise so included or taken into account in computing the amount deducted under subsection 8(1).
¶ 23 A deduction under paragraph 8(1)(b) is allowed only in respect of an amount "owed" by an employer or a former employer. If the taxpayer is not successful in court or otherwise fails to establish that some amount is owed, no deduction for expenses is allowed. However, failure to collect an amount established as owed to the taxpayer does not preclude a deduction under this paragraph. Pension benefits and retiring allowances do not come within the definition of "salary or wages" in subsection 248(1) [of the Income Tax Act]; legal expenses in respect of such income are discussed in ¶s 25 to 27 below.
¶ 24. Paragraph 8(1)(b) does not permit a deduction for legal fees paid to obtain benefits under a "wage loss replacement plan" as described in the current version of IT-428, Wage Loss Replacement Plans. While the amount received under a wage loss replacement plan is included in income under paragraph 6(1)(f) and therefore falls within the definition of "salary or wages" in subsection 248(1), the benefit is generally received from an insurer and the insurer is not the "employer or former employer" referred to in subsection 8(1)(b).
¶ 25. Within the limits set out in paragraph 60(o.1), a taxpayer may deduct legal expenses paid to collect or establish a right to a pension benefit or retiring allowance. The term "retiring allowance" is defined in subsection 248(1) and is broad enough to include damages or settlements for wrongful dismissal of the taxpayer (see also the current version of IT-337, Retiring Allowances). Legal fees to collect or to establish a right to a pension benefit or retiring allowance of a deceased individual are also eligible expenses under paragraph 60(o.1) where the taxpayer who made the payment and who claims the deduction was a dependant, relation or legal representative of the deceased. Eligible legal expenses under paragraph 60(o.1) do not include legal expenses relating to a division or settlement of property arising out of, or on a breakdown of, a marriage. By virtue of paragraph 252(4)(b), the breakdown of a marriage includes the breakdown of a conjugal relationship between two parties described as spouses of each other in paragraph 252(4)(a). Legal fees in respect of benefits under the Canada Pension Plan or similar provincial plan are not eligible under paragraph 60(o.1), but a deduction for such expenses may be available under paragraph 60(o) (see ¶s 7 and 8 above).
¶ 26. The amount of the eligible legal fees paid that may be deducted under paragraph 60(o.1) is limited to the following amount:
(a) the amount of any retiring allowance or pension benefit related to those legal fees which is received and included in the taxpayer's income for the year or a previous year,
(b) any reimbursement of legal expenses included in the taxpayer's income under paragraph 56(1)(l.1) (see ¶ 27 below) for the year or a preceding year,
(c) transfers to a Registered Pension Plan or Registered Retirement Savings Plan deducted pursuant to paragraphs 60(j), (j.01), (j.1) or (j.2); this reduction is only required to be made to the extent that the amounts so transferred are amounts for which legal expenses eligible for deduction under paragraph 60(o.1) were incurred.
Only legal fees paid in connection with the income described above are eligible for deduction. Any otherwise eligible legal fees which are not deductible because they exceed such income may be carried forward and may be deducted in any of up to seven subsequent years, to the extent that further related income arises and to the extent that the amounts in question were not previously deductible.
¶ 27. Under paragraph 56(1)(l.1), amounts received by the taxpayer as an award or reimbursement of the types of eligible legal expenses described in ¶s 25 and 26 above must be included in income. This inclusion in income may be offset by the deduction available under paragraph 60(o.1).
The following example is taken verbatim from IT-99R5:
In 1994, Mr. Superannuate incurred legal expenses of $3,000 and, in 1995, an additional $6,000 in an attempt to establish a right to receive a retiring allowance from his former employer.
In 1996, he incurred further legal expenses of $1,000 to establish his right to and to collect a retiring allowance. In 1996, Mr. Superannuate's former employer paid him a retiring allowance of $15,000 and a $7,500 reimbursement of legal expenses and agreed to pay him further retiring allowances of $10,000 in 1997 and $5,000 in 1998. Mr. Superannuate transferred the $15,000 received in 1996 to his RRSP.
In 1997, Mr. Superannuate received $10,000 under the agreement with his former employer and he transferred it to his RRSP.
In 1998, Mr. Superannuate received the final $5,000 under the agreement with his former employer and he transferred $2,500 of it to his RRSP.
In 1994 or 1995, Mr. Superannuate was not entitled to deduct any of the legal expenses that he incurred to establish a right to a retiring allowance because he had not received a reimbursement of those legal expenses or a retiring allowance in either of those years.
In 1996, Mr. Superannuate is required to include the $7,500 reimbursement of legal expenses in income pursuant to paragraph 56(1)(l.1). While he has incurred legal expenses of $10,000 in establishing the right to, and collecting the retiring allowance, his deduction under paragraph 60(o.1) is limited to $7,500-the aggregate of the retiring allowance received in the year and the reimbursement of legal expenses, less the amount transferred to his RRSP. The $2,500 of legal expenses that were not deductible in 1996 may be carried forward and deducted in later years to the extent that Mr. Superannuate receives a further retiring allowance or reimbursement of legal expenses from his former employer and to the extent that those payments can be associated with the legal expenses incurred in 1994 to 1996.
In 1997, Mr. Superannuate was unable to deduct any part of the $2,500 in legal expenses that he carried forward since he transferred all of the retiring allowance that he received in that year into his RRSP.
In 1998, pursuant to paragraph 60(o.1), Mr. Superannuate will be able to deduct the $2,500 of legal expenses that he carried forward since he transferred only $2,500 of the retiring allowance that he received in that year into his RRSP.
As the commentary above illustrates, incurring legal expenses can potentially result in a reduction of income tax otherwise payable.
What this means is that paying a lawyer to represent you in a wrongful dismissal case can potentially save you some money on your income tax otherwise payable. This reality has the effect of reducing the cost of legal services.
While it is important to consider the gross cost of services, it is more important to focus on the net cost. As I advise my clients, the only number that really counts is the amount that you see in your bank account at the end of the day.
If you have recently been dismissed and have been offered a severance package it is always prudent to seek professional legal advice. First of all, as is contemplated in my post about wrongful dismissal, it is possible that you have been offered less than that to which you’re entitled. Second, as is contemplated in my post about the income tax implications of wrongful dismissal damages, by seeking legal and/or accounting advice you may be able to save a significant amount of money by reducing your income tax burdens.
Therefore, if you are an employee who has been recently terminated and want advice about either the reasonableness of your offer, or advice on how to structure your offer so as to best address the income tax implications of it, the employment lawyers at Kelly Santini LLP would also be happy to speak to you. To see the full range of employment law services that we provide to employees please click here.
As always, everyone’s situation is different. The above is not intended to be legal advice for any particular situation and it is always prudent to seek professional legal advice before taking any decisions on one’s own case.
Sean P. Bawden is an Ottawa, Ontario employment lawyer and wrongful dismissal lawyer practicing with Kelly Santini LLP, and part- time professor at Algonquin College teaching Trial Advocacy for Paralegals. He is a trustee of the County of Carleton Law Association for 2013.