Introduction - Employee Legal Expenses Tax Guidance
In some circumstances, taxpayers earning income from employment may be able to deduct employment related expenses from their income to reduce the income tax they owe to the Canada Revenue Agency. However the types of expenses that can be deducted as an employment expense are strictly limited to those specifically enumerated in the Income Tax Act. Canadian income tax law does allow employees to claim deductions relating to certain specific employment related legal expenses, which can be a source of significant tax savings for taxpayers. This article provides tax guidance as to those deductible expenses.
Collecting or Establishing a Right to Salaries or Wages - Employee Legal Expenses Tax Guidance
Under paragraph 8(1)(b) of the Income Tax Act, employees can deduct amounts paid in a year on account of legal expenses paid by the employees to collect, or to establish a right to, an amount that if paid to the employee would be taxed as employment income under Canadian income tax law. The relevant type of amounts include salaries and wages, but also other types of employment income such as taxable employee benefits or employee stock option benefits.
The relevant amount must be an amount allegedly already owed to the employee relating to past services performed. Paragraph 8(1)(b) does not cover expenses relating to protecting an employee's job or establishing a right to earn future income through employment. Legal expenses associated with negotiating an employment contract or establishing a right to a promotion are also not deductible. A different provision of the act discussed below addresses wrongful dismissal cases.
The Courts have repeatedly found that legal expenses of the type described above are deductible regardless of whether the employee's claim for wages is well founded in law or is likely to succeed. The CRA however has expressed the view that that deductibility of legal expenses for claiming retroactive performance pay depends on whether the legal action is successful. If the Canada Revenue Agency has denied your deduction claim for employment related legal expenses, you should contact an expert Toronto tax lawyer to advise on whether there are grounds for disputing CRA's decision to deny the deduction claim.
If an employee's qualifying legal expenses exceeds his or her income from employment, then that employee has a loss from employment that can be applied against other types of income. If there is insufficient income to make use of the loss during the relevant year, the loss can be carried over to other years as a non-capital loss.
Pensions and Retiring Allowances - Employee Legal Expenses Tax Guidance
Paragraph 60(o.1) of the Income Tax Act, allows employees, within certain limits, to deduct legal expenses paid to collect or establish a right to pension benefits or a "retiring allowance". This deduction is not applicable to legal actions for pension benefits under the Canada Pension Plan or Quebec Pension Plan. Legal expenses relating to the division or settlement of property arising out of the breakdown of a marriage or common law partnership are specifically excluded from being covered by this paragraph of the Income Tax Act. For the most part, legal expenses relating to separation, divorce and family disputes are not deductible. A key exception is some legal expenses related to legal actions to collect or increase support payments paid by recipient of the support payments. The full details of the legal deductibility of family law related legal expenses are beyond the scope of this article. The deduction can only be claimed for a tax year if the legal expenses were paid in that year or one of the preceding seven tax years.
A retiring allowance includes an amount received by an individual:
- on or after retirement of the individual from employment in recognition of the individual's long service; or
- in respect of loss of employment of the individual, whether or not received as, on account of or in lieu of payment of, damages or pursuant to an order or judgement of a competent tribunal.
Note that this means damages arising from wrongful dismissal or loss of employment often qualify as a retiring allowance and can ground a corresponding claim for deducting related legal expenses.
When an individual dies and an amount of one of the types described above is received by the individual's dependant, relation or legal representative the receipt may also be a retiring allowance. In those circumstances the dependant, relation or legal representative can claim a deduction for legal expenses paid to collect or establish a right to the retiring allowance of the deceased individual provided all other criteria are met.
The amount of expenses that can be deducted is subject to certain limitations. In particular the amount of expenses claimed cannot exceed the amount of pension benefits or retiring allowance received by the taxpayer and included in their income plus any amounts reimbursed to the taxpayer for the legal expenses and included in the taxpayer's income. This effectively means that the taxpayer's ability to claim legal expenses is largely determined by the extent to which the taxpayer is successful in his or her legal action and that unsuccessful taxpayers may not be able to access the deduction at all. In effect the employee loses twice: no amount received and no deduction for legal expenses incurred. The quantum of expenses the taxpayer can claim is also adjusted downward to the extent any of the amounts received as a result of the legal action give rise to a deduction for the taxpayer relating to the transfer of the relevant amount to a registered pension plan or registered retirement savings plan.
Pro Tax Tips - Employee Legal Expenses Tax Guidance
Employment cases can involve issues relevant to both paragraphs 8(1)(b) and 60(o.1). In such cases it may be important for taxpayers to track how much legal work is being done on distinct issues so as to maximize their legal expense deduction and defend their claims for legal expense deductions against CRA tax audits. Great care may also need to be taken when negotiating a settlement as they way the settlement allocates damages between different issues under dispute can effect what amounts the taxpayer can deduct. If the legal expenses for an employment case are anticipated to be significant, it is essential to consult an experienced Toronto tax advisor for advice on these issues.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.