Bonuses, Severance, and Lump Sum Payments

Introduction
Understanding bonuses severance and lump sum payments is essential for employers, HR managers, payroll professionals, and business owners who need to compensate employees fairly while staying compliant with CRA and Revenu Québec rules. Bonuses, severance packages, retention bonuses, payout of unused vacation, and retiring allowances all have different tax treatments. Errors can trigger payroll reassessments, penalties, and employee complaints. Québec adds an extra layer of complexity with its own income tax, QPP/QPIP, HSF, and CNESST requirements. This guide provides a complete explanation of bonuses severance and lump sum payments—how they are taxed, reported, and processed in Canada.

Legal and Regulatory Framework
Bonuses severance and lump sum payments fall under:

• Income Tax Act
• Canada Pension Plan Act (CPP)
• Employment Insurance Act (EI)
• Québec Taxation Act
• QPP and QPIP rules
• Employment Standards Acts (provincial)
• CRA and Revenu Québec payroll regulations

Employers must calculate, withhold, and remit:

• Income tax
• CPP (or QPP)
• EI (or QPIP)
• HSF in Québec
• CNESST obligations

Failure to comply results in heavy penalties.

1. Bonuses (Performance, Retention, Holiday, Commission Top-Ups)

Bonuses are taxable income for employees.
Tax withholding must follow CRA and Revenu Québec lump-sum withholding rules:

Federal withholding on lump sums:
• 10% for amounts up to $5,000
• 20% for $5,001–$15,000
• 30% for amounts over $15,000

Québec withholding:
• 8% for Québec provincial tax on lump sums
PLUS federal withholding.

CPP/QPP and EI/QPIP apply normally unless employee has reached annual maximums.

Bonuses severance and lump sum payments must be reported on T4 and RL-1 under employment income.

2. Severance Pay (Termination Pay)

Severance is taxable but treated differently depending on what it represents:

Types of severance:

• Statutory termination pay
• Pay in lieu of notice
• Damages for wrongful dismissal
• Severance required by employment standards

All of these are taxable and require withholding.

Severance is subject to:

• Income tax
• CPP/QPP
• EI/QPIP (depending on classification)
• HSF
• CNESST (in Québec)

If classified as retiring allowance, EI/QPIP may not apply.
Understanding the classification is essential for bonuses severance and lump sum payments compliance.

3. Lump-Sum Payments

Lump-sum payments include:

• Bonuses
• retroactive pay
• unused vacation payout
• overtime settlements
• employer-paid damages
• settlement agreements
• retiring allowances

Lump-sum withholding rules apply at the source.
Lump-sum payments are generally:

• Taxable
• included in pensionable earnings
• subject to CPP/QPP
• subject to EI/QPIP (unless excluded by law)

Vacation payouts always require full CPP/EI and QPP/QPIP deductions.

4. Retiring Allowances

A retiring allowance (RA) is a lump-sum payment given when an employee retires or is terminated.

Part of the RA may be transferred to an RRSP without withholding if:

• the employee has eligible RRSP “room for retiring allowance,” and
• the employer transfers the amount directly to the RRSP.

This reduces withholding taxes dramatically.
Retiring allowances must be reported on:

• T4A (box 66/67)
• RL-2 in Québec

This classification is a key component of bonuses severance and lump sum payments compliance.

5. Québec-Specific Payroll Requirements

Québec payroll requires separate calculations for:

• QPP
• QPIP
• Québec income tax
• HSF
• CNESST
• QST on taxable benefits (in some cases)

Bonuses, severance, and lump sum payments must be reported on both T4 and RL-1.

Quebec applies unique withholding formulas and requires strict reconciliation of:

• QPP contributions
• QPIP premiums
• Employer contributions to HSF
• CNESST annual declarations

Key Court Decisions

Courts have ruled on bonuses severance and lump sum payments:

• damages for termination are usually taxable unless strictly non-employment in nature
• payments disguised to avoid tax can be reclassified by CRA
• RRSP-direct transfer eligibility requires proper documentation
• severance paid in installments may still be considered a lump sum
• Québec courts enforce strict RL-1 treatment for lump-sum payouts

These rulings demonstrate the importance of classifying payouts correctly.

Why CRA and Revenu Québec Audit These Payments

Payroll audits frequently target bonuses severance and lump sum payments because:

• lump-sum withholding errors are common
• taxable benefits are often missing
• severance is sometimes misclassified
• employers try to avoid CPP/QPP or EI/QPIP
• RRSP transfers are mishandled
• bonuses paid “off-cycle” are not processed through payroll
• discrepancies appear between T4 and RL-1 slips
• settlement agreements may be structured incorrectly

Audit triggers include:

• unusually large year-end bonuses
• severance paid outside payroll
• RRSP transfers without matching documentation
• multiple amendments to T4 or RL-1 slips
• court settlements involving former employees

Mackisen Strategy

Mackisen CPA provides full support for bonuses severance and lump sum payments:

• calculating proper withholding under CRA and Quebec rules
• determining correct classification (bonus, severance, RA, damages)
• optimizing RRSP-direct transfers to minimize tax
• preparing T4, T4A, RL-1 and RL-2 slips accurately
• ensuring CPP/QPP, EI/QPIP and HSF compliance
• advising employers on settlement agreements
• reviewing employment contracts for tax implications
• managing CRA and Revenu Québec audits related to payouts
• correcting past payroll errors through amendments

Our team ensures all payouts are legally compliant and tax-efficient.

Real Client Experience

Many employers contact Mackisen due to payroll issues related to bonuses severance and lump sum payments:

• A tech firm paid bonuses late in the year without proper withholding. CRA charged interest. Mackisen recalculated and corrected payroll.
• A Québec company paid severance but deducted EI instead of QPIP. We corrected slips and resolved Revenu Québec penalties.
• An employer misclassified a retiring allowance as severance, denying RRSP transfer benefits. We restructured payments and minimized tax.
• A business issued a settlement payment without proper classification. CRA treated it as employment income. Mackisen negotiated adjustments.
• A corporation failed to include unused vacation payout in payroll. We corrected the T4/RL-1 and prevented further issues.

These cases demonstrate the complexity of bonuses severance and lump sum payments.

Common Questions

• Are bonuses taxable?
Yes—fully taxable with lump-sum withholding.

• Is severance taxable?
Yes—classified as income or retiring allowance depending on circumstances.

• Are RRSP transfers allowed from severance?
Yes—if structured as a retiring allowance.

• Do QPP and QPIP apply?
Yes for Québec employees, unless specifically excluded.

• Do I need to issue a slip for lump-sum payments?
Yes—T4, T4A, RL-1 or RL-2 depending on classification.

• Are damages taxable?
Usually yes, unless strictly unrelated to employment.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps businesses stay compliant while recovering the taxes they’re entitled to. Whether you're issuing bonuses, negotiating severance, or processing lump sum payouts, our expert team ensures precision, transparency and protection from audit risk. When managing bonuses severance and lump sum payments, Mackisen provides full payroll calculation, classification, documentation and audit-defense services.