LTD Lump Sum Settlements and Taxation

Disability Insurance
1

I’m trying to understand the implications of taxation on a lump sum settlement.
I am currently in receipt of LTD benefits and they payments are taxable.
As an example, assume I was currently getting $20,000 a year from the insurer.
Also assume that I was cut off today and and in one-year was offered $100,000 to settle my claim.

In this case would $20,000 be taxable as that is for past service and would $80,000 be NON-taxable as that would be for future service.

Appreciate any help. Also I should move this as a reply to a previously asked question I am happy to do that.

Thanks

2

I think the whole thing would be taxable but you could put in in an RRSP or TFSA.
Maybe some else knows for sure.

3

In this thread -

@David_Brannen said,
“Taxation of LTD settlements has changed over the past few years. Basically, if your payments were non-taxable then the entire lump settement is non-taxable. However, if your monthly LTD payments were taxable, then the portion of the LTD Lump Sump payment attributable to past payments (as opposed to future payments) would be taxable. Also, if you incur a legal fee, a portion of the legal fee is tax deductible as long as the lawyer provides the correct paperwork and declarations to you.”

I just want to make sure if I have a basic understanding of the rule.

4

Sounds like you have it correct then.

1 Like
5

I can only speak in general terms and not about your specific situation. The Courts have ruled that the portion of a lump sum settlement that can be attributed to past periodic payments, is taxable as income. The insurance company issuing that type of lump sum payment would by law have to designate the exact amount attributed to past benefits and issue a T4A for that amount. If the portion of past benefits would have been paid out over two or more years, then you would want the insurer to also issue a T1198 so that taxation could be spread over the years the benefits would have been paid. This lessens the tax burden.

The insurance company would then withhold 30% of the past benefits portion and send it to Revenue Canada on your behalf as a tax payment. Often they send too much, and you can apply to get some of it your next years tax return. Revenue Canada is very strict about this and insurance companies are extremely careful.

David Brannen

Disability Lawyer with Resolute Legal

The response posted above is based on the limited factual information made available and is not intended as a full and complete response to the question. The only reliable manner to obtain complete and adequate legal advice is to consult with a lawyer, fully explain your situation, and allow the lawyer enough time to research the applicable law and facts required to give an adequate opinion. The basic information provided above is intended as a public service only, a full one-on-one discussion with a lawyer should be done before taking any any action. The information posted on this forum is available to the viewing public and is not intended to create a lawyer client relationship with any person. If you want one-on-one advice, please click here to request a free consultation or call toll free 1-877-282-5188 to speak with a member with our disability claim support team.

1 Like
6

Hi David,

I have a question in this regard. From your reply, I gather that settlement lump sum in-lieu of future LTD payments wont’ be taxable irrespective of whether the LTD monthly payments are taxable or not.

I want to make sure for my scenario below as tax payable will significantly affect my lump sum.

My case:

  1. Primary LTD plan – Monthly amount taxable and No Cost of living adjustment (COLA) (Tax is deducted monthly and T4A slip is issued)
  2. Secondary LTD plan - Monthly amount Non-taxable and COLA adjusted yearly (Tax is not deducted monthly and T4A slip is NOT issued)

I have been offered a settlement and I am planning to accept it. Settlement is in lieu of future LTD payments covering both primary and secondary plans. This settlement does not involve any past payments.

I got the following reply from the insurer on my question if the lump-sum is taxable.

Q: I want to know the tax implication on the settlement amount. I gather that as lump sum settlement is in lieu of future monthly payments (and not past payments), no tax need to be deducted by for CRA. Is this a valid understanding?

A: The Canada Revenue Agency takes the position that settlements, like this one, do not need to be reported for federal income tax purposes. is not required to issue and therefore will not be issuing a tax information slip for this settlement. However, we recommend that you consult a professional tax advisor in order to discuss your own situation.

From this and the settlement offer there is no reference tax deduction at source by the Insurer for CRA and the full offer amount is mentioned. From this, I gather that there will not be any tax to be paid to CRA even if CRA queries about this settlement in future.

I am confused about the statement from the insurer “However, we recommend that you consult a professional tax advisor in order to discuss your own situation.”.

I am not sure what this means. I understand that they are trying to safeguard themselves with this statement. I understand that any income generated from this settlement will be taxable and will be applied to my individual income calculation. But, if the insurer is not going to issue any tax slip and won’t be deducting tax from the settlement, I am assuming there is not tax to be paid from my end on the settlement amount when I file tax for 2020 in 2021. Am I missing something from the insurer’s statement. Could you please share your inputs on this.

Thanks very much for all the help.

1 Like
7

Unfortunately, we can’t give legal advice via this forum on specific situations like you are setting out. What is or is not taxable will depend on how any settlement is structured and what T4As are issued.

Courts have ruled the portion of a lump sum settlement designated as “future benefits” are not taxable and that is how people in the industry understand it. However, this is always subject to Revenue Canada agreeing that the designation of the past vs future benefits is done correctly as some people try to get creative to minimize taxation implications.

Everyone gets nervous when stating the anticipated impact on taxes because Revenue Canada can change the rules at any time.

We offer a service to provide independent legal advice on this issue. Usually, the insurer will reimburse you for getting this advice if you aren’t represented by a lawyer: https://www.resolutelegal.ca/independent-legal-advice-session

David Brannen

Disability Lawyer with Resolute Legal

The response posted above is based on the limited factual information made available and is not intended as a full and complete response to the question. The only reliable manner to obtain complete and adequate legal advice is to consult with a lawyer, fully explain your situation, and allow the lawyer enough time to research the applicable law and facts required to give an adequate opinion. The basic information provided above is intended as a public service only, a full one-on-one discussion with a lawyer should be done before taking any any action. The information posted on this forum is available to the viewing public and is not intended to create a lawyer client relationship with any person. If you want one-on-one advice, please click here to request a free consultation or call toll free 1-877-282-5188 to speak with a member with our disability claim support team.

8

Thanks very much for your inputs David.

I tried using Resolute Legal ILA service. Unfortunately, due to schedule/availability I couldn’t.

With email records from the insurer that no tax will be deducted and no Tax slip will be issued for this settlement, I accepted the offer. Offer document did not mention any tax deduction at source. This is a voluntary request from me for settlement (in lieu of future payments) and no litigation for past payments.

Based on my search, the court ruling you are mentioning, I believe is “Tsiaprailis v. Canada - supreme court of Canada” Case number# 29777 in 2005. Not sure if there are more recent cases but I couldn’t find any other case in this regard.

As my settlement total is combination of present value for two plans - Primary and secondary (detailed in my post above), If next year, insurer go back on their words and issue a tax slip for this settlement, may be I will be stuck with tax, hopefully only for Primary LTD plan which was taxable for past monthly payments.

Thanks very much for all your help.

9

Really curious how this turned out. Did you have to pay tax on the lump sum payment?

10

Hi RaptorFan, Thanks for your query. I was about to post about a mistake by insurer in T4 (separate post below).

To your query on tax on lump sum settlement:-

When I received the settlement, no tax was deducted and I received the full amount offered by the insurer without any tax withholding. I had validated this through email communication with my insurance contact who was coordinating the settlement before accepting the settlement. Nothing about tax and withholding was mentioned in the settlement papers I signed.

This is part of the story. Now tax time, issue started. My post on that below.

1 Like
11

Hi,
I initiated LTD settlement discussion and accepted settlement last year. No tax was withheld and/or deducted in the settlement offered and accepted.

Now tax time, insurer made a mistake in T4A.

In the incorrect T4A,
Box 107 - wage loss replacement plan= contains (A + C) = (A- lump-sum amount towards future taxable monthly LTD payments) + (C - total of taxable regular monthly payments made prior to settlement in 2020)
Box 22 - Income tax deducted - contains only tax deducted towards C, the regular monthly taxable payments made prior to settlement.
Box 18 - Lump-sum payments - BLANK

A is a 5 digit $ amount and C is 4 digit $ amount.

The T4A should have been,
Box 107 - C = total of taxable regular monthly payments made prior to settlement (exclude “A”)
Box 22 - Income tax deducted - same as in incorrect T4A as there is no change in it.
All other boxes blank.

I believe as per CRA, if lump sum payments are taxable, Payer is supposed to deduct and remit the tax to CRA and show it on the T4A. As this is not done by the insurer when the settlement was paid out , I believe they are responsible for correcting the mistake in T4A and amend it with CRA.

I wrote to my settlement contact and received an acknowledgement that they made a mistake in T4A and included settlement amount in it. They would be issuing a corrected T4A/correct the reporting to CRA (to report only the taxable monthly payments made prior to settlement) and apology for the mistake.

My queries in this regard:-

i)If I receive the corrected T4A and if CRA T4A is amended before the tax deadline, Will I get any query/audit from CRA after tax filing -(i.e… CRA automatic software catching the 5 digit $ amount difference between original and amended T4As)?
I did not make any mistake but how do I deal this with CRA for insurer’s mistake?

ii) What should I do if I get the corrected T4A but T4A is not amended with CRA before the tax deadline. I reckon, I Should still go ahead with corrected T4A for tax filing.

iii) What other things can I do proactively to deal with this issue. Please share your thoughts.

If anyone has experience on T4 mistakes and how they dealt with T4 correction and amended T4 with CRA, please share your experience and it will be of great help.

Thanks very much.

12

Thanks for responding to my question. I really appreciate it!!!

That’s a drag the insurer made a mistake on the T4A. Hopefully, you get a corrected T4A before you have to file. I don’t know what to do about filling if you don’t get the corrected T4A in time.

By the sounds of it I don’t think you’ll have any issues with the CRA if you do get the corrected T4A.

13

Wait until they file the corrected slip but if time runs out file using the correct numbers. Keep a copy of the email from them agreeing that the slip was wrong and will be fixed. And keep on them to file the amended slip. You can check your slips online to see when it gets filed.

1 Like
14

Thanks Caro for your inputs.
I am told that their tax department is handling it as a priority and will get back to me on corrected T4A as soon as possible.
As you have pointed out, I have to keep following up with them to amend the return with CRA, as it is as important as issuing corrected T4A to me.
I have been checking my account online on a daily basis and that’s how I found the incorrect T4A.

15

Hi Disab023

Are you able to confirm if the buyout on the taxable benefit should have had a withholding tax applied of 30% (if it was over $15K)? Im wondering what the tax would be on a 500K offer buyout on a taxable sunlife LTD claim?

16

Generally speaking, lump sum settlements are not taxable if they involve future payments. However, any lump sum that includes past taxable benefits is taxable as income to the extent of those past payments. Keep in mind this is the current law and may change in the future.

David Brannen

Disability Lawyer with Resolute Legal

The response posted above is based on the limited factual information made available and is not intended as a full and complete response to the question. The only reliable manner to obtain complete and adequate legal advice is to consult with a lawyer, fully explain your situation, and allow the lawyer enough time to research the applicable law and facts required to give an adequate opinion. The basic information provided above is intended as a public service only, a full one-on-one discussion with a lawyer should be done before taking any any action. The information posted on this forum is available to the viewing public and is not intended to create a lawyer client relationship with any person. If you want one-on-one advice, please click here to request a free consultation or call toll free 1-877-917-7050 to speak with a member with our disability claim support team.