Personal injury settlements are one of the few types of settlements not taxed by the Canada Revenue Agency (“CRA”). In Ontario, you aren’t required to report the settlement on your income taxes – whether it’s a lump sum or paid through installments. Because settlements can take years to receive, it means you’ve likely been anticipating and anxiously awaiting the much-needed money for your pain and suffering or medical bills. The last thing anyone injured in a personal injury claim needs is a hefty tax bill. Knowing what will take place with your settlement and being aware of the potential tax implications in Ontario can help you better understand your personal injury claim. While personal injury settlements are not typically taxed, there are some exclusions and other things that may be rolled into your settlement that could result in a tax bill.
DO YOU PAY TAX ON AN INJURY SETTLEMENT?
There is no income tax on pain and suffering compensation in Ontario. The CRA does not consider the compensation you receive in a personal injury settlement claim as a taxable income. Any amount of a settlement payment for damages for personal injury or death is exempt from tax in Canada. This applies to compensation for car accidents, slip and falls, and other personal injury claims.
THE INCOME TAX ACT
The Income Tax Act governs what is and is not classified as personal income for tax purposes throughout Canada. Section 81(1)(g.1) indicates personal injury awards are excluded from the calculation of income for a taxpayer within a taxation year.
Bulletin IT-365R2 references personal income tax exemptions for personal injury settlements. It does treat most personal injury awards as income. This means that whether it is an out-of-court settlement or a judgment from a judge and/or jury, your personal injury settlement is most likely free from taxation. Of course, there are exceptions to the rule, and we want to emphasize the pain and suffering/personal injury portion of your settlement is tax-free, but that doesn’t necessarily mean your entire settlement is exempt from Canadian taxes.
Special damages are compensation to cover the financial losses and expenses a victim incurred as a result of an accident or negligent medical treatment. These are the tangible costs associated with an injury claim. Special damages are exempt from Canadian taxes.
General damages include the intangible damages – the pain and suffering associated with your claim. Awards for physical pain and any emotional trauma or distress are exempt as well. Here are some exemptions for both special and general damages:
- Reimbursement of out-of-pocket expenses like medical and hospital expenses;
- Loss of both accrued and future earnings;
- Pain and suffering;
- Loss of earning capacity;
- Loss of amenities of life; and
- Shortened life expectancy.
WHY IS MY SETTLEMENT MONEY EXEMPT FROM TAXATION?
It can be complex trying to understand why personal injury settlements are typically exempt from taxes. Although you’re receiving money in a given tax year, it doesn’t count as income or something you “earned.” Pain and suffering awards take on a monetary form, but the money one receives because of pain and suffering is a way to financially compensate the injured party for a loss of their quality of life resulting from an accident. Because of this, pain and suffering compensation isn’t income.
WHAT IS TAXABLE?
Some things not exempt from personal income taxes in Canada include a guaranteed severance payment or compensation that could be classified as employment income. In these situations, it is only that portion of the settlement that is taxed. In addition, any capital gains earned from the post-resolution investment of damages awards are taxable.
If you are no longer able to work, you may be awarded a severance payment. The payment is likely considered a source of employment income and is typically taxable.
A personal injury settlement is typically meant to compensate victims for losses caused by an accident, but there are exceptions. The CRA follows the “surrogatum principle,” which examines the characteristics of what the settlement payment is replacing. For instance, if a business sues over lost revenue from a breach of contract, the settlement award is intended to replace the lost business income and would be taxable because the original income would have been taxable.
Punitive damages are something awarded in cases of willful or reckless behavior that leads to injury or death. Punitive damages are punishment for wrong-doing and aren’t technically classified as compensation for a victim’s loss. Although rare, they are sometimes awarded in some personal injury settlements. Generally speaking, the punitive awards are not taxed.
INVESTING YOUR SETTLEMENT
Any settlement itself is likely to exempt from taxes, but this doesn’t mean what you choose to do with your compensation will be exempt from taxes. You may decide you want to invest a portion of your compensation. Although this can be a smart strategy for making money off your settlement, you need to know the tax implications. If you invest your settlement money for interest, profit, or gain – those earnings or the gain you receive from the investment is a taxable form of income and must be reported to the CRA.
MAKING A STRUCTURED SETTLEMENT EXEMPT
Most personal injury settlements are paid in a lump sum, but this isn’t always the case. Instead of taking a lump sum, some elect to receive settlement payments over an extended duration of time through what is referred to as a structured annuity or structured settlement. A structured settlement is an arrangement where the victim agrees to resolve their claim by receiving all or a portion of their settlement as periodic payments on a specified schedule. The payment may seem more like income, especially since payments may be made weekly, bi-weekly, or monthly. Regardless of the frequency of the payments, it is still the settlement amount and the personal injury compensation portion is fully exempt from taxes in Canada.
The CRA sets the criteria for settlements to be considered structured annuity in Canada:
- The award must be made for personal injury or death;
- Plaintiff and insurer must agree on the terms and frequency of the settlement payments;
- The insurer must purchase an annuity contract that is non-transferable, non-commutable and non-assignable (basically, it means no changes can be made to the terms of the structure); and
- The insurer must remain liable to make payouts according to the agreed settlement.
In addition to being tax-exempt, there are some other benefits associated with structured settlements. One main advantage is that a structured settlement can dedicate funds for things like unforeseen medical advances in technology or medicine. If modern science is able to develop a cure, the injured have funds allocated for it. Structured settlements also offer some creditor protection as well.
To reiterate, personal injury settlements are usually tax-free, but tax laws are complex. All cases and circumstances are unique. For instance, if it takes years to settle your claim, you may have decided to claim medical expenses on your tax return in prior years before receiving the funds, but now you have been reimbursed from the settlement. This could make things a little complicated in the eyes of the CRA. To truly evaluate a case and determine if your personal injury settlement is completely exempt from Canadian taxes, there are numerous details to review.
WE’RE HERE TO HELP
We know the CRA terms and laws are complicated and often confusing. There is a lot of information and it’s a lot to take in and process. Because you’re dealing with the CRA and want to avoid a costly tax surprise, it is crucial to work with an experienced Canadian personal injury lawyer who understands the potential tax implications of a personal injury settlement.
About the Author
Gavin Cosgrove is a graduate of Holy Cross Catholic Secondary School in Kingston. Upon graduation, he attended Manhattan College (New York, NY) on an athletic scholarship where he competed in track and field. Gavin completed his legal studies at the University of New Brunswick.
Gavin joined Bergeron Clifford in the summer of 2009 and is now a partner with our firm.
Gavin is a proud member of the Ontario Trial Lawyers Association, the Frontenac Law Association, the County of Carleton Law Association, The Advocates’ Society, and the County of Lanark Law Association. He represents innocent victims of negligence in auto cases, medical malpractice and negligence cases.