Our law firm had a record number of Long Term Disability Claims settle in the last quarter of 2014. In particular, the last month of 2014 was a mediation bonanza for our lawyers when it came resolving long term disability (LTD) disputes.
One of the things which we caution our clients on when it comes to settling LTD claims are the tax implications of the settlement.
Damages for pain and suffering are non taxable. Damages for past and future income loss are taxable. But these heads of damages apply to tort claims such as car accident and general negligence cases (slip and fall, dog bite, etc.)
But what happens for Long Term Disability Claims when it comes to tax implications for the settlement?
Look no further than the wording of your policy. I will be in there. I guarantee it!
Some policies state that benefits are taxable. This means less money in the client’s pocket because they have to pay tax on any amount recovered.
Other policies state that the benefits are NOT taxable. This is much better for the client because they don’t have to pay the tax man for any amount recovered in the case.
If you don’t know whether your LTD benefits are taxable or not, then just ask your insurance broker, union rep or even your employer who is funding the benefits. They will have an answer for you. You can also call the insurer who is underwriting the policy (Great West Life, SunLife, Manulife, Equitable Life, SSQ, RBC Insurance, Co-operators, Desjardins etc.) and ask an agent directly. They will have an answer for you as well.
Effective January 1, 2015, Revenue Canada introduced some important rule changes which impact the tax implications on any taxable LTD settlement. If you have an LTD claim before the Courts, it’s very important to understand these rule changes because they will likely impact on your settlement.
Before January 1, 2015, when a disability claimant entered in to a lump sum settlement with an LTD insurer, and the benefits were taxable; that insurer would issue a T-1198 form. The T-1198 form is called a “Statement of Qualifying Retroactive Lump Sum Payment Form“. Basically, it states that the insurer has paid you a certain amount of money for lump sum payments on your benefits.
The insurer would also write a cheque for the entire lump sum about, and issue those funds to your lawyer, along with the T-1198 form.
It would then be the client’s responsibility to file the T-1198 form with Revenue Canada, and pay the taxes on the lump sum payment detailed in the T-1198 form.
This worked on the honour system. If the client did not present the T-1198 form to Revenue Canada, or report these taxable earnings, then Revenue Canada would have a difficult time collecting tax on the settlement funds. They would have to do a lot of leg work by contacting the client, lawyer and/or insurer to determine what the status of the case was, and how much back payments were owing.
Essentially, what was happening is that many disability claimants were NOT paying their taxes on the lump sum settlements. Or, if they were paying taxes on those settlements, their accountants were finding creative ways to either defer those taxes, or avoid them all together.
As my tax professor taught me: Tax avoidance is legal. Tax evasion is illegal. Tax avoidance is finding creative ways to minimize a client’s tax liability. Tax evasion is simply NOT paying taxes and thereby breaking the law. Isn’t it interesting how personal injury law and tax law collide? Fun sidebar.
Revenue Canada isn’t stupid. They caught on and have changed the rules effective January 1, 2015.
From what I understand from the rule change (and it’s only 6 days old as writing this Toronto Injury Lawyer Blog Post); is that instead of issuing the lump sum payments to the lawyer and client upon settlement and rely on the client to pay the taxes; they are now required to pay the taxes on the settlement directly to Revenue Canada. This creates a situation whereby the insurer withholds to tax on the lump sum settlement and pays it directly to Revenue Canada to satisfy the tax consequences of the settlement.
So, in a situation whereby there is a $100,000 LTD settlement, and $12,500 is taxable, the client would end up receiving a cheque of $87,500 instead of $100,000. The insurer would then send the $12,500 withheld in tax directly to Revenue Canada.
What is the impact of this new rule change? It basically means there’s less money in the client’s pocket because the client isn’t afforded any creative way of getting around these tax implications. The money is paid directly to Revenue Canada. Getting it back by way of tax rebate would take some creative accounting.
We have yet to see the rule in action as Plaintiff lawyers across Ontario are still coming to grips with it. The interpretation of the rule change is still under debate, but many lawyer I have spoken to who work for those large LTD Insurers, insist that what I have explained above (tax withholding) is the new normal.
Does this new rule change make sure that the tax gets paid on the LTD lump sum settlement? Yes it does.
Does it also take away any potential creativity for a disability claimant to defer these taxes, or minimize their tax liability? Yes it does that as well.
Enough talk about LTD benefits and tax? Sure.
How about we discuss Team Canada’s excellent Gold Medal Run at the World Juniors in Toronto. What a performance! What a fabulous gold medal game! I’m very proud of all of the players, but was particularly impressed by Max Domi of our home town London Knights. Max and I eat the same thing for lunch at the Convent Garden Market; which is right across the street from the home of the London Knights, and steps away from the Goldfinger Personal Injury Law London Office. I wish Max the best of luck for the remainder of the season with the Knights, and good fortunes in the NHL. I think he will be a cross between Theo Fleury and Patrick Kane. Both under sized players, with big hearts and huge skill sets.