Employee Legal Expenses Deduction – Current Tax Guidance

Posted on by Tax Partners
30
Dec

Introduction: Understanding Deduction of Employment-Related Legal Expenses

Canadian employees are generally limited in the types of expenses they can deduct to reduce their taxable income. However, specific provisions of the Income Tax Act allow for the deduction of certain legal expenses incurred by employees under particular circumstances. These deductions can provide substantial tax relief, particularly in cases involving disputes over employment income, pensions, or wrongful dismissal.

This article outlines the deduction rules for legal expenses incurred in employment disputes and offers practical tax guidance for employees.

Legal Expenses for Collecting or Establishing a Right to Employment Income

Under paragraph 8(1)(b) of the Income Tax Act, employees may deduct legal fees paid in the year to collect or establish a right to employment income. This includes:

  • Salaries and wages owed for past services performed.
  • Other forms of employment income, such as taxable benefits or stock option benefits.

However, the deduction does not apply to legal expenses related to:

  • Protecting or securing a job.
  • Establishing rights to future employment income or promotions.

Important Notes on Deduction Eligibility:

  1. Unfounded Claims: Legal fees are deductible regardless of whether the claim is well-founded or likely to succeed.
  2. CRA Stance on Retroactive Pay: The CRA may challenge deductions for unsuccessful claims, but courts have consistently upheld employees’ rights to deduct such expenses.
  3. Net Employment Losses: If qualifying legal expenses exceed employment income, the excess can result in an employment loss. This loss can offset other income types and be carried forward as a non-capital loss.

Deduction of Legal Expenses for Pensions and Retiring Allowances

Paragraph 60(o.1) of the Income Tax Act permits employees to deduct legal fees incurred to:

  • Collect or establish a right to pension benefits or a retiring allowance.
  • Recover amounts related to wrongful dismissal or job loss damages.

What Qualifies as a Retiring Allowance?

A retiring allowance includes amounts received:

  1. Upon retirement in recognition of long service.
  2. As compensation for loss of employment, including court-ordered or negotiated damages.

Limitations:

  • Legal expenses must be incurred in the year or within the preceding seven years.
  • Deduction is limited to the amounts received as pension benefits or retiring allowance, adjusted for amounts transferred to a registered plan (e.g., RRSP, RPP).
  • Unsuccessful cases generally do not qualify for deductions, as no amounts are received to offset the legal expenses.

Legal Expenses for Survivors and Estates

If a deceased individual’s dependent or legal representative receives a retiring allowance, they may also deduct legal expenses incurred to collect the allowance, provided all criteria are met.

Key Distinctions Between Deduction Types

  • Paragraph 8(1)(b): Covers legal expenses related to employment income (e.g., wages, benefits).
  • Paragraph 60(o.1): Applies to legal fees for pensions and retiring allowances, including wrongful dismissal cases.

Proper tracking and allocation of legal expenses across these categories are essential to maximize deductions.

Pro Tax Tips: Maximizing Legal Expense Deductions

  1. Detailed Records: Keep itemized invoices from your legal counsel, distinguishing work related to employment income, pensions, or wrongful dismissal claims.
  2. Settlement Agreements: When negotiating settlements, carefully allocate amounts to specific claims (e.g., wages vs. damages) to preserve your ability to deduct legal expenses.
  3. Documentation for CRA Review: Maintain all supporting documents, including legal invoices, settlement agreements, and payment receipts, to defend against CRA audits.
  4. Expert Tax Guidance: Legal expense claims can be complex. An experienced tax professional can help structure settlements and maximize deductions.

Conclusion

Legal expense deductions offer valuable tax relief for employees involved in disputes over wages, pensions, or wrongful dismissal. Proper understanding of the Income Tax Act’s provisions and detailed record-keeping are crucial to ensuring successful claims. If you’re navigating a legal dispute involving employment income, consulting a knowledgeable tax advisor can help you achieve optimal outcomes while minimizing tax liabilities.

This article is written for educational purposes.

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.

Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.

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