Are insurance settlements taxable in Canada? Many of our clients are worried about the tax implications of winning a large sum of money all at once.
The short answer: No, you do not pay tax on lawsuit settlements in Canada. However, the long answer does present some additional complications and issues you should stay aware of.
In broad terms, here is what you need to know.
Why Aren’t Settlements Taxed?
Settlements themselves are not taxed because the CRA does not consider a personal injury settlement to be “income.” Your settlement is considered “compensation” for expenses incurred by another person’s negligence.
Indeed, personal injury settlements rarely function as any kind of windfall. The myth that people get rich on personal injury settlements is, in general, just that: a myth.
Instead, personal injury lawyers help you get your bills paid after an accident. In some cases, the money you receive is money that you’re meant to live on for years because you can no longer work and your disability insurance payments have run out. This money is simply righting, to the best of anyone’s ability, the wrong of an accident having taken place. The time you lost can’t be replaced, your health can’t be replaced, but some portions of your threatened life can be saved by having the at-fault party payout.
Note that jury awards aren’t taxed either. The CRA treats them exactly the same way they treat settlements.
Personal injury settlements actually benefit from an exception in taxation law. Most settlements are covered under a principle known as the surrogatum principle. That is, the settlement takes on the attributes of that which it is meant to replace and is taxed accordingly. Normally if a settlement is intended to replace a lost investment, for example, then it would be taxed as investment income.
Personal injury settlements may replace income in part, but they are not taxed like income, simply because what’s being replaced is something that ultimately can’t be: your body, your health, and your ability to work.
In addition, attempting to tax a personal injury settlement would be a little bit like “double-dipping” for the government. For example, your injury settlement will pay your hospital bills and your legal bills before the remainder comes to you. That money serves as revenue for your hospital and your lawyer respectively. That revenue will be reported and taxed on their own annual tax statements.
What Happens When You Structure Your Settlement?
A structured settlement allows you to receive personal injury funds on a monthly basis. Once you choose a structured payment you can’t convert it out to a lump sum. You will generally be paid until your settlement money is used up.
Since structured settlements work by purchasing an annuity they might earn interest, but the interest remains tax-free. This is not the case when you invest a lump sum settlement and start earning interest on the investment.
Read More: Handle Settlement Cases for Personal Injury
What Happens When You Invest Your Settlement?
Any investment is subject to capital gains tax. This includes stocks, bonds, real estate that you rent out, and any other interest-bearing investment that you care to name.
Capital gains only tax half of what you actually earned over and above the initial investment amount.
For example, if you invest $100,000 and your balance by the end of the year is $110,000, you’re not taxed on $110,000. Your capital gain is only $10,000 and you only are taxed on half of that. $5000 will be added to your income at the end of the year, and then your entire income will be taxed at regular tax rates.
If you leave that investment alone for another year and it grows to $120,000 you’d be taxed on the next $10,000, you would not be taxed on the $20,000.
Many investments actually don’t force you to calculate the tax at all until you begin making withdrawals. Speak to your accountant to better understand the potential tax implications of any investments you intend to make.
Read More: Settlement Timeline after a Car Accident
Taxes aren’t the only thing many of our clients need to worry about. Some will be disabled for life, unable to work ever again. They’ll need to know how their personal injury settlement will interact with programs like AISH, which ensures that disabled Albertans receive a living allowance, medical care, and dental care.
Programs like AISH are means-tested, which means that receiving a large sum of money can complicate matters. But AISH is well aware that many of the disabled people the program serves come to it through accidents that would involve personal injury cases.
Thus, you have 365 days to invest your injury settlement into an exempt account so that you don’t lose your benefits. That account will be capped at $100,000. If you have more than $100,000 you will need to speak to your caseworker about what you can do with the rest of that money while retaining AISH benefits.
Why Trust Us?
Before you can worry about the tax implications of your personal injury settlement, you have to secure one.
Most of the lawyers in our office have 20 to 30 years of experience handling personal injury cases for Alberta residents just like you. We work on car accident cases, truck accident cases, motorcycle cases, pedestrian cases, slip and fall cases, product liability cases, and more.
We’re known as savvy negotiators and fearless litigators. We fight hard to protect your rights and your interests throughout any personal injury case.
We’re responsive and kind to clients though, and take the time to answer your questions, meet your concerns, and explain the process to you at every step of the way.
We’re also convenient for you! You don’t have to leave your bed if you don’t want to. We’ll meet with you via Zoom and start the process on your behalf. We can even deal with insurance companies for you! Call (780) 413-9777 to set up your risk-free appointment today.