Do I pay Tax on my Long-Term Disability Settlement?

By Matt Lalande in Long-Term Disability on November 14, 2023

Understanding the Tax Implications of Disability Settlements – 6 Quick Points

As Hamilton Disability Lawyers who serve disability claimants all over Ontario, this is one of the most common questions that we are asked. Navigating the complex world of long-term disability (LTD) settlements involves understanding not only the legal aspects but also the intricate tax implications that come with it. This detailed6 part exploration aims to provide a little clarity on the tax consequences associated with full and final settlements in LTD cases, a topic often fraught with confusion and anxiety.

If you’ve been denied long-term disability – call us today. Our Hamilton disability lawyers have been helping claimants who have been denied long-term disability and have recovered millions in compensation since 2003. For a free consultation with an experienced long-term disability lawyer in call Lalande Personal Injury Lawyers at 905–333-8888 or fill out a free Consultation Form today. Alternatively, you can call us toll-free, no matter where in Canada you are located at 1-844-525-2633. Our long-term disability lawyers would happy to schedule a no-obligation consultation with you and your family, and we would be happy to advise you of all of your legal rights and options.

1. The Initial Considerations in LTD Settlements

When resolving an LTD action, there are several factors to consider: the discount rate, whether the benefit is indexed, and the risk contingencies for disability cessation or death. Additionally, the likelihood of the client meeting the disability policy’s criteria is critical.

After addressing these concerns and securing a fair offer from the insurer, taxation becomes a central issue. Taxation of the settlement amount raises questions: What portion is taxable? In which year does taxation apply? Can structured settlements mitigate tax liabilities? This post aims to unravel these complexities.

2. Taxability of Monthly Disability Benefits

Understanding whether monthly disability benefits under a policy are taxable is crucial. As per the Income Tax Act, benefits are taxable if the employer contributed to the plan. If the client paid the entire premium, the benefits are non-taxable. This distinction directly influences the tax implications of a lump sum settlement.

3. Taxability of Lump Sum Settlements

Historically, any lump sum payable in an LTD settlement was considered non-taxable. However, the Supreme Court of Canada’s decision in Tsiaprailis v. Canada changed this perspective. Currently, lump sum benefits for arrears are taxable, while those for future benefits are not.

In Tsiaprailis, the court applied the surrogatum principle, which states that if periodic payments under a contract would have been taxable, so is the lump sum replacing them. Therefore, the part of the settlement intended to replace past disability payments is taxable, while the portion for future benefits, being a capital payment, is not.

4. Applying the Law to Settlements

Applying this law can be challenging, especially when the breakdown of a settlement between arrears and future benefits isn’t clear. Courts have ruled that the nature of the claim affects the settlement structure, and there’s no presumption that every settlement contains an “arrears” portion. The responsibility lies with the plaintiff to declare the portion of the settlement considered taxable income attributed to arrears.

5. Taxation Year for the Settlement

Once a settlement amount is agreed upon, determining the tax year for the settlement is vital. Ideally, spreading the taxable amount over the years when the arrears would have been paid can lead to significant tax savings, as it may be taxed at a lower marginal rate. Insurers can issue a T1198 form to facilitate this process.

6. Structured Settlements in LTD Claims

Structured settlements, common in personal injury law, are less useful in LTD cases. The Canada Revenue Agency (CRA) allows structuring lump sum payments for future benefits, but the structure must mirror the original LTD contract terms. This limitation significantly reduces the appeal of structured settlements in LTD scenarios.

Key Takeaways

The Tsiaprailis decision has clarified that amounts paid for long term disability arrears are taxable if the benefits would have been taxable under the contract. Future benefit payments in a lump sum are not taxable. It is critical to attribute a reasonable portion of the settlement to arrears, reflecting an objective compromise.

While structured settlements are permissible, their utility in LTD cases is limited due to CRA restrictions. Spreading the taxable amount of a settlement over multiple years can offer tax relief, but it’s advisable to consult a tax professional for personalized advice.

Understanding the tax implications of LTD settlements is essential for both legal practitioners and clients. Properly navigating these waters can ensure fair outcomes and prevent unforeseen tax burdens.

Have you been Denied Long-Term Disability Benefits?

If you have been denied long-term disability benefits, it’s crucial to seek the guidance of an experienced long-term disability lawyer to navigate the complexities of your claim and secure the compensation you deserve. At Lalande Personal Injury Lawyers, we understand the profound impact such a denial can have on your life and are committed to advocating for your rights.

Here’s what you can do:

1. Contact Us Immediately: Time is of the essence in disability claims. Reach out to us for a free consultation to discuss your case. You can call us at 905-333-8888 without worrying about upfront fees.
2. Gather Your Documentation: Prepare all relevant documents related to your disability claim, including any denial letters from the insurance company, medical records, and any correspondence that you have had regarding your claim.
3. Meet with Our Team: We can meet with you in person at our Downtown Hamilton office, or virtually via Zoom, Google Meet, Microsoft Teams, or Facetime, depending on what’s most convenient for you.
4. No Upfront Legal Fees: We operate on a contingency basis, meaning you only pay if we are successful in recovering funds for you.
5. Personalized Legal Representation: When you work with us, you get one-on-one attention. You will not be passed around; you will work directly with our dedicated team throughout your case.

If you’re ready to start, you can also send us a confidential email through our website and we will be happy to get right back to you. We are here to provide you with the personalized and effective representation that you need during this challenging time.