Tax season is coming, and many wonder what else they have to pay taxes on. Personal injury settlement is one of them. If you are a victim of any physical or emotional damage, you might be able to get a good settlement amount. Depending on your damage, your compensation amount can be a huge deal. But then comes the question, are legal settlements taxable in Canada?
If you are interested in this particular topic, we may be able to help you. Find out all the information below.
Are Legal Settlements Taxable in Canada?
In general, in the majority of the cases, personal injury settlements are not taxable in Canada. This includes the amount awarded from the judge or the settlement money from the defendant. Neither the provincial government nor the Canada Revenue Agency can tax you on the money you receive as settlement.
But there is a fact to remember. Only the settlement portion that directly compensates for your physical injury is non-taxable.
You don’t have to pay taxes for the following portions of a settlement:
- Physical injury or illness
- Medical expenses
- Pain and suffering
- Emotional distress
- Lost wages
- Attorney fees or legal costs
These are the parts where you are not entitled to pay taxes. However, there are some scopes where the government can tax you, but they are sporadic. For example:
- Breach of contract
- Punitive damages
- Interest earned on a judgment
Exceptions to Personal Injury Tax Rules
If any of your personal injury claims are related to something other than physical injury, the case will be different. That portion of your compensation may be taxable. Suppose the breach of contract caused your injury. Then, you may still pay taxes on the part of your award or settlement that is directly related to the violation itself.
Similarly, award or settlement money received for punitive damages may also be taxed. The judge will often differentiate between compensatory (non-taxable) damages and punitive damages. So there is a clear understanding of the compensation that may be taxable. This also helps show the Revenue agency that you have money that is compensatory and cannot be taxed.
Here are other questions; do minors pay taxes in Canada? Are settlements taxable in Canada for minors? If the victim is a minor, here is the rule the same?
Well, yes, the rule is the same. First of all, regardless of age, anyone who has the minimum income has to pay tax. Usually, minors don’t earn the primary amount (which is around 11,000 CAD), meaning no tax liability.
Secondly, the taxing rules of settlements are also the same. There will be no taxing in personal injury settlements for minors as well.
Why are Personal Injury Settlements Non-Taxable?
The reason is not easy to describe. This has to do with the pain and suffering in the personal injury case. The compensation you are getting is actually to compensate for the physical and emotional loss. So it can be described as the financial conversion of suffering and pain. And there is no tax on pain and suffering, according to the Income Tax Act and ICBC both.
Another reason can be that the ICBC manages the settlement. Therefore, they will adjust all the facts before paying you your amount. For example, when they calculate the loss wage, they already deduct the tax amount you had to pay if earned. However, this will only be removed if your loss wage reaches the margin of tax eligibility.
Things You Should Remember While Claiming for a Non-taxable Personal Injury Settlement
Remember that for your settlement to be non-taxable, it must involve a physical injury or illness. Your payment will be taxable if your claim relates to emotional harm due to employment discrimination.
Suppose your personal injury claim involves more than one claim, one physical and one non-physical. Then you may have to pay taxes on any compensation you receive for the non-physical injury claim. Make sure you and your attorney clearly identify the amount of damage you are seeking related to physical injuries versus any non-physical injuries.
Also, if your settlement amount comes with a severance payment, it can act as a source of income. And if the amount is eligible for tax, you have to pay tax for that.
Contact a Professional
If you have any confusion, it will be better to contact a professional lawyer who has the expertise to help you. And if you have a serious case in hand, you can talk to more than one lawyer.
In case of settlement tax, you can consult with:
- Insurance attorney
- Tax specialist attorney
- Personal injury lawyer
We advise you to consult a tax specialist attorney because, even though your settlement money is not taxable, the investment of that money may lead to taxable income. This is because if you invest that money in something, the return will be considered as a source of income.
You can talk to a financial consultant too. A financial advisor will be a great option in case you want to have a sound understanding of what to do better with the settlement money. They will lead you to a better investment in the settlement.
Final verdict
Tax law is complicated. There are rules, regulations and complex situations. So, generally, you may wonder, do you pay tax on lawsuit settlements in Canada? That is why we always recommend you to get in touch with a professional. They will be able to break down the complex parts and make them easier for you to understand. So, you will be able to get the full benefits of your settlement amount.
Frequently Asked Questions
How are legal settlements taxed in Canada?
No, in most cases, legal settlements are not taxed in Canada. Although this rule strictly means the settlement for a personal injury claim.
Are settlement payments taxable income Canada?
No, settlement payments are not taxable income in Canada. However, there are some exceptions that might be taxable, but that is very rare.
What type of legal settlements are not taxable?
The physical injury settlements are not taxable. This means if you face bodily injury and get a settlement, you don't have to pay tax. But this only applies to physical damage and the emotional damage caused by that. This doesn't include emotional distress.
How much tax do you pay on settlement money?
The general rule is that you do not pay any tax on settlement money. If your case is no exception and doesn't have anything other than direct compensation, you don't pay any tax.
What type of lawsuit settlements are taxable?
Any bodily injury and other injuries resulting from that are not under taxing. But other than this, any non-physical injury, punitive damages or emotional distress settlements are taxable.
