Personal Injury and the Canada Revenue Agency
Is the government going to take a cut of your settlement?
Many people suing for damages in a personal injury lawsuit don’t know if they’ll be taxed when they win their case. They may have heard horror stories about people who desperately needed money to cover their medical expenses only to have a big chunk of their settlement money siphoned off in taxes.
People file personal injury lawsuits for many reasons. They may be trying to recover lost wages or cover medical and rehabilitation expenses. Perhaps there’s compensation for pain and suffering involved. Whether your injuries are the result of a car accident, a slip and fall, medical malpractice, or any other reason, you need to know if the damages you’re awarded will compensate you for your losses. Losing any of that compensation to taxes might have terrible consequences, especially if your injuries leave you unable to work.
Fortunately, this is usually not the case, and the horror stories you might have heard are typically American in origin. This usually isn’t the case in Canada. That being said, there are certain things to consider to ensure your settlement stays yours and doesn’t end up in government coffers. Below, we’ll examine what the Canada Revenue Agency (CRA) won’t tax, what they will, and what you can do to make sure they don’t touch any of it.
Exemptions in the Canadian Tax Codes
The Canadian Income Tax Act specifies what you will and won’t have to pay the government when you submit your annual income tax return. Subdivision G of the Act deals with such things as income from personal injury awards, including:
“the income for the year from any property acquired by or on behalf of a person as an award of, or pursuant to an action for, damages in respect of physical or mental injury to that person.”
In a nutshell, the Act grants an exemption to personal injury settlements and doesn’t consider them as regular income.
Another exemption is given by the CRA to “compensation received from a province or territory if you were a victim of a criminal act or a motor vehicle accident.”
You might expect that if a provincial or territorial agency was found to be responsible for your injury, they might be eager to recoup some of their losses through taxation. Luckily, they aren’t allowed to do so. Any compensation paid by a province or territory in a personal injury settlement is still tax exempt and will not be lumped in with your taxable income.
Damages for Lost Income
A portion of almost every personal injury settlement covers lost wages. Had you been able to work and not lost those wages, the CRA would have considered them as taxable income. Therefore, it stands to reason that recovered wages would also be taxable.
But the Act is generous when it comes to personal injury victims, and even the recovery of lost wages is considered tax-free income. Let’s say you earn $75,000 a year. If that were regular income, the government would take about 30%, leaving you with only $52,500 after taxes (roughly). If you were awarded that same value as compensation for lost wages in a personal injury settlement, you would keep it all.
Of course, taxation is a tricky matter and everyone’s income tax situation is unique. Make sure you deal with a qualified tax professional at tax time to make sure your personal injury settlement is protected.
Pain and Suffering
In a personal injury lawsuit, the cost for pain and suffering is known as non-pecuniary damages. In non-legal terms, it refers to the things you can’t put a price on. They have no cash value. Clients often wonder if these damages will have to be split with the CRA.
Again, pain and suffering get a pass on taxation. Income tax only applies to money you earned, and the CRA doesn’t consider compensation for non-pecuniary damages as income. Instead, it falls under the category of windfall. Basically, the victim didn’t make a conscious effort to get hurt and spend the rest of their life in pain, so this payment isn’t something they tried to earn.
Investments and Structured Settlements
There is one instance where the CRA might tax your personal injury settlement. If you take the money you’re awarded and invest it, any interest, profit, or gain is taxable. Let’s say you obtain a settlement of $250,000 and you choose to invest it. That investment will earn income. And all investment income is taxable, even if it initially came from a personal injury payout. The principal investment will be safe, while it’s sheltered, but all interest payments will be taxed.
To protect yourself from this, there may be situations where it makes sense to negotiate a structured settlement. If your settlement is structured, rather than taking your settlement in a lump sum and trying to manage it personally, you take it instead in the form of a structured annuity. This arrangement will pay you on a regular basis for a specified time period. And the best part is that the annuity also earns interest, all tax-free and payable to you.
In order to have your personal injury settlement negotiated as a structured annuity, certain conditions must be met. The money awarded must be compensation for a personal injury or death. The plaintiff (i.e., the injured party) and the insurance company must agree to the terms of payment and whether the fund payments will be periodic, fixed, or life term.
The annuity contract must also be nontransferable, non-commutable, and non-assignable. In other words, you won’t be able to:
- transfer any of the payments to anyone else
- change your mind about the terms and ask for it all in a lump sum
- assign the payments to anyone else
The annuity contract will make the insurer liable for honoring the terms of the settlement agreement.
Putting a Limit on Pain and Suffering
One notable difference between the legal systems of the United States and Canada is the way each country treats cases involving pain and suffering. While multi-million-dollar settlements are not unheard of in the states, Canada has a strict upper limit on how much can be paid out in non-pecuniary damages.
Legal precedent was set in 1978 when the Supreme Court of Canada (SCC) heard three cases that would come to be known collectively as “the Trilogy.” With these cases, the SCC ruled that there should be a limit to compensation for pain and suffering. They set that limit at $100,000.
Adjusting for inflation over the last 41 years, the maximum award for pain and suffering damages is now approximately $360,000.
The Fine Art of Holding onto Your Compensation
If you’re afraid the CRA might take a significant portion of your personal injury settlement in taxes, the best thing you can do is make sure you’re represented by an experienced and reputable personal injury lawyer. The right lawyer will be able to handle all your legal needs, which includes winning you the compensation you deserve and answering any questions you might have. They’ll also be able to make sure your payout is awarded in a tax-free structured annuity.
The money you obtain in a personal injury settlement will cover a variety of expenses, some of which you’ll be paying for years to come. A structured settlement will guarantee that money won’t be going anywhere else and you’ll be able to meet all your financial obligations.
Get Effective Representation
The first step to making sure you don’t lose any portion of your settlement in taxes is making sure you have the ideal legal team to win you the compensation you deserve. Contact the dedicated personal injury team at Mackesy Smye using the contact link below. Tell us the details of your case and we’ll provide a free, no obligation consultation.