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