Long-term disability payments could come with a tax liability

By Paul Russell, LegalMatters Staff • People forced to rely on long-term disability (LTD) insurance as an income replacement after an injury or disability may wonder if those payments are taxable. The answer depends on a variety of factors, says Ontario disability and personal injury lawyer Joshua Goldberg.

“The tax implications of LTD income can be complicated and many recipients do not fully understand how the Canada Revenue Agency (CRA) will view that money,” says Goldberg, principal of Joshua Goldberg Law. “That is why people who are injured need to discuss their long-term disability policy with an Ontario disability lawyer who can provide guidance in this area.”

He explains that LTD insurance generally begins when the following benefits end:

• short-term disability insurance;
• sick leave from your employer; or
• Employment Insurance sickness benefits.

“Many LTD policies replace 60 to 70 per cent of your normal income for up to two years if you’re unable to return to your job,” Goldberg tells LegalMattersCanada.ca. “After that, people who are unable to perform any job may be eligible to continue to receive benefits.”

Simple rule of thumb

When it comes to deciding if those payments are taxable, he says a simple rule of thumb applies in most cases.

“Generally, if you have been paying the disability premium yourself, your disability benefits will be tax-free,” says Goldberg. “However, if your employer has been paying all or part of the disability premium, those benefits will be subject to income taxes.”

In the latter case, the LTD benefits will be added to your other income and used to determine your tax liability, he says.

• Common issues arising from pedestrian/automobile accidents
• AD&D insurance claim denials are common but can be appealed
• Higher speeds on Ontario highways may lead to more collisions

“In the past, lump sum payments in an LTD settlement were considered non-taxable,” says Goldberg. “But that changed in 2005 with the Supreme Court of Canada (SCC) decision in Tsiaprailis v. Canada.

In Tsiaprailis, the SCC upheld a finding that a portion of settlement funds was taxable as income, he says.

‘The court applied the surrogatum principle, which is based on the idea that if periodic payments under a contract would have been taxable, so is the lump sum replacing them,” explains Goldberg. “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.”

Sometimes the difference between arrears and future benefits isn’t clear in an LTD settlement, he says, making it more difficult to determine the tax implications.

Recipients might have to pay taxes

“In addition, if the settlement includes something other than special or general damages, then recipients might have to pay taxes on some of that money,” says Goldberg. “For example, a guaranteed severance payment could be considered employment income and taxable.”

Once an LTD settlement is reached, it is a good idea to spread the taxable amount over the years when the arrears would have been paid, he says, by filing a T1198 form with the CRA.

“The Canada Revenue Agency allows you to treat this lump sum as if you received it spread out during a few years so that you do not have an undue tax burden in the year you receive the money,” says Goldberg. “Instead, the CRA will calculate the amount of income tax, CPP, and EI you should pay on the lump sum as if it were added to the amount you made in the relevant years.”

He says the tax implications of an LTD settlement can be significant, especially for recipients who rely on those payments for basic expenditures.

“A disability lawyer will be able to help you understand the terms of your  LTD policy while properly filing a claim,” says Goldberg.