Recently, we addressed the question whether long-term disability benefits are taxable in Canada. As we saw, the answer to that question is complicated — some types of benefits are always taxable, some are never taxable, and some are only sometimes taxed. Today, we want to consider a similar question that has a much simpler answer: Are income-replacement benefits taxable?
As we’ll see, the answer is no. And that fits in with a broader pattern in how Canadian tax law treats personal-injury recoveries: Normally, no income tax is due on an award of damages or settlement amounts in a personal-injury case. In this regard, income-replacement benefits are analogous to damages for lost wages in an Ontario personal-injury lawsuit.
In this post, we’re going to take a closer look at income-replacement benefits and how Canada’s tax law treats them. But first, a quick reminder: We’re not tax lawyers. If you have questions about your particular financial circumstances or about how the following tax discussion applies to you, you should contact a knowledgeable Ontario tax professional.
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What are income-replacement benefits?
Income-replacement benefits are payments made to a person who, as the result of an automobile accident, becomes unable to work. The benefits are offered as part of Ontario’s Statutory Accident Benefits (SABs), which every auto insurance policy in Ontario must provide.
In general, income-replacement benefits will be equal to 70% of your gross weekly income before the accident provided you were employed and not self employed. Gross weekly income is determined by dividing one of the following amounts by 52:
- Your gross income for the 52 weeks before the accident; or
- 13 multiplied by your gross income for the four weeks before the accident.
However, income-replacement benefits are limited to $400 per week (or a higher amount if you purchased an optional add-on for your automobile insurance policy). In addition, your benefits will be reduced based on any collateral benefits you receive, such as disability benefits under the Canada Pension Plan or a private disability insurance policy.
The Tax Treatment of Damages, Settlements, and Similar Receipts
We’ve noted before that the Income Tax Act excludes from taxable income “the income . . . from any property acquired . . . as an award of, or pursuant to an action for, damages in respect of physical or mental injury.”
In 1987, the Canada Revenue Agency (CRA) issued an interpretation bulletin in which it expanded on that exclusion. There, the CRA explained that the exclusion extends to both general and special damages, including the following:
- Out-of-pocket medical expenses
- Accrued and future lost earnings
- Pain and suffering
- Loss of amenities of life
- Lost earning capacity
- Shortened life expectation.
The CRA made clear that “[a]ll amounts . . . that qualify as special or general damages for personal injury or death will be excluded from income regardless of the fact that the amount of such damages may have been determined with reference to the loss of earnings” (emphasis added).
In short, a damage award or settlement amount in a personal-injury lawsuit will normally not be taxed, even though part of it (lost wages) is effectively a replacement for what would have been taxable income.
Income-Replacement Benefits and Taxes in Canada
Given how the Income Tax Act treats personal-injury damages, it should come as no surprise that income-replacement benefits are also not taxed. However, although this is a real advantage, remember that these benefits will always be 30% less than your pre-injury income (which, for many Canadians, will mimic the effect of income taxes), and may be reduced still further if you receive similar benefits from other sources.
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A Quick Note on Wage-Loss Replacement Plans
To help clear up some confusion we’ve noticed online, we should say a few words about the difference between income-replacement benefits under auto insurance policies and what the CRA calls “wage-loss replacement plans.” Although “wage-loss replacement” sounds very similar to “income replacement,” income-replacement benefits are not part of a wage-loss replacement plan.
As the CRA has explained, a wage-loss replacement plan “is any arrangement . . . between an employer and employees” under which an employee will receive benefits if he or she “suffers a loss of employment income as a consequence of sickness, maternity or accident.” Obviously, an individual’s automobile insurance policy doesn’t match that description.
The difference here matters, because proceeds from wage-loss replacement plans are generally subject to tax if your employer made any contributions to them and should be reported on line 104 of your T1. But as we’ve just seen, income-replacement benefits are received tax-free.
Thankfully, the Income Tax Act’s treatment of income-replacement benefits is not as convoluted as its treatment of long-term disability benefits. When you receive income-replacement benefits, you do not pay tax on them, just like you don’t pay tax on a damage award resulting from personal injury.
But as easy as that principle is to understand, qualifying for income-replacement benefits can be more complicated. In the first place, not everyone is eligible for income-replacement benefits in Ontario. In addition, insurance companies are notorious for how much they resist any application for benefits, even when their liability is clear.
To help ensure a smooth application process, or for help holding a recalcitrant insurance company to its word, contact one of the experienced Toronto personal-injury lawyers of Preszler Law Firm today.