Considered to be in the same category as a bonus, a retro payment will tax the employee on a higher tax bracket than a regular pay cheque. This happens because CRA (Canada Revenue Agency – better known as the “government”) feels you didn’t pay enough in income taxes. Before we get to the how a retro is taxed, let’s start with the definitions of a retro:
Retroactive Adjust – the raise is processed after the date is was expected
Did you ever get promised a raise will happen on a specific date and it doesn’t? Well this results in someone forgetting to putt in the paperwork; the paperwork is completed incorrectly; the paperwork gets lost on the bottom of a pile on someone else’s desk. At one point in our careers this has happened to all of us.
Retroactive Increase – this usually reflects an increase that should have happened in the past but is being recognized today
For those of you that are familiar with union collective agreements, this is a very common phenomenon. Collective agreements have expiry dates. They need to be renegotiated with every expiration. As we all know this is a lengthy process and highly unusual that they are ratified (signed off on/agreed upon by all parties) by the expiration date. During this negotiation process, rate increases are discussed. When the collective agreement is finally ratified, the increases for unionized employees will go back to the date of the expiration. Every hour the employee worked between the time, the contract expired until the time it was ratified, is subjected to the new increased rate.
Long story short, the raises were negotiated today buy are reflective of a date sometime in the past and all hours worked could be subjected to the increase
Retroactive Payment – this is compensation for time missed
This is a tender subject because it usually means the employee has decided to take action upon termination and they won a court case. The courts have overturned the dismissal, approved a reinstatement with full pay for time missed.
In essence whichever of these cases applies to your situation, for taxation purposes it doesn’t matter – they are taxed the same way. The components of the taxes are:
- value of pay at old rate
- taxes paid on the pay with old rate
- value of pay with new rate
- taxes that should have been paid with the new rate
- the difference between the two taxes
- the number of pays lapsed (how many pays before the increase happened)
|Employee Paid Weekly – 52 pays/year|
|Old Salary #1||New Salary #3|
|Income Tax||56.38 #2||75.07 #4|
|Increase was to happen||3-Aug-12|
|Total Retro Owed||400.00||$100 / week for 4 weeks|
|Difference in Taxes||18.69 #5|
|Total Taxes Due on Retro||74.76|
You will note the amount of income taxes on the retro owed was much higher than those paid on the original Regular pay (old salary). Let’s not forget, that the employee will also have to pay taxes on their NEW regular pay since the increase has happened this week. On this pay, the employee will pay a total of $149.83 (74.76 retro tax + 75.07 regular salary tax) in come taxes only. This does not include any other statutory, company compulsory or voluntary deductions that could change as a result of a pay increase.
Helping you understand a little better what’s in your pocket
Until next time