Key Takeaways
- In Ontario, personal injury damages are not taxable. However, there are exemptions to this tax-free status depending on how the settlement is structured.
- Canada’s Income Tax Act doesn’t consider personal injury compensation or awards as income for tax purposes.
- Investment income from your personal injury compensation may be taxable. For instance, if you invest the compensation amount, the income you earn should be reported on your tax returns.
- Severance pay, lump sum payment from your employer, or a portion of a settlement to compensate your business for revenue lost due to an accident may be taxable.
Injuries and other losses from an accident can leave you struggling to cope with physical pain and financial challenges. When you finally get financial compensation, that amount can be substantial, especially if you suffered serious or life-threatening injuries. The prospect of losing part of your personal injury awards to taxation can be quite upsetting.
The good news is that personal injury settlements aren’t taxable in Ontario and across Canada. However, there are some exceptions to this tax-free status of personal injury awards. That means some tax implications may arise from how the settlement is structured.
Consult an experienced motor vehicle accident lawyer to understand the tax treatment of the settlement payments you receive.
Damages in a Personal Injury Case
If you have been in an incident caused by another person’s negligence or fault, you’re entitled to bring a personal injury claim seeking financial compensation for the injuries and other losses you suffered. The purpose of the damages in personal injury lawsuits is to compensate the injured party for both special damages (direct financial losses) and general damages (also known as non-pecuniary damages).
Special damages are the direct financial expenses and losses you suffered due to the incident. These include hospital expenses, lost income, and other out-of-pocket expenses. On the other hand, general damages refer to the losses that aren’t quantifiable in monetary terms. For instance, pain and suffering damages may be awarded if the claimant suffered due to the incident.
Therefore, the financial compensation you receive will be categorized as pecuniary (the direct financial losses you suffered) or non-pecuniary (the overall impact of the injuries and other losses on your life). To determine the general or non-pecuniary damages, Ontario courts consider all relevant factors.
These factors include the nature and severity of your injuries, your recovery journey, and the degree to which these injuries have affected your life.
Are These Damages Taxable?
Canada’s Income Tax Act outlines what’s considered taxable personal income. Specifically, section 81(1)(g.1), the law indicates that personal injury settlements aren’t considered ‘income’ for any taxation purposes.
In addition, the Canada Revenue Agency (CRA) doesn’t consider financial compensation for personal injuries as ‘income.’ That means the settlement payment(s) you receive will not be taxed.
Why Are Personal Injury Settlements Tax Exempt?
Personal injury claims are tax-exempt for various reasons. For instance, the concept of financial compensation for pain and suffering seeks to ‘restore’ you for the diminished quality of life caused by the injuries you suffered. Sure, you may be receiving money in a given taxation year. However, this money isn’t something you ‘earned’ based on the CRA interpretation of taxable income.
Another reason personal injury settlements aren’t classified as taxable income is how lawyers calculate damages in personal injury cases. These lawsuits often involve a loss of income because of the plaintiff’s inability to return to work.
This loss of income is calculated on a ‘net basis.’ That means the lost wages already account for the relevant taxes the plaintiff would have paid if they were working. By the time the compensation is paid out, the recipient will have, in theory, paid taxes on it.
What Damages Are Taxable?
Not every settlement amount received after an accident is exempt from personal income tax in Canada. A guaranteed severance payment or compensation that qualifies as employment income is taxable. Only that portion of the entire settlement amount is affected. In addition, capital gains (investment income) earned from investing settlement funds are considered taxable income.
Severance Pay
In some cases, an injured person may no longer be able to continue working. When this happens, a severance payment may form part of the settlement amount paid. This type of payment is generally treated as a continuation of employment income rather than compensation for injury.
As such, the Canada Revenue Agency views it as taxable income. The payment is considered employment income, and standard deductions and tax rates apply. Therefore, it is important to clearly distinguish between compensation for personal injury and severance payment when structuring a settlement.
Surrogatum Principle
While most personal injury settlements are tax-free, the CRA applies the surrogatum principle in certain cases. This principle considers ‘what the payment is meant to replace.’ If the settlement replaces something that would normally be taxable, then the settlement amount itself becomes taxable.
For example, if a business files a claim for lost revenue caused by another party’s negligence, the damages awarded are to replace taxable business income or capital assets. In this situation, the compensation is not treated like personal injury damages but rather as taxable earnings. This is because the underlying income would have been taxed if earned normally.
Punitive Damages
Punitive damages differ from standard personal injury compensation. They are awarded when a defendant’s conduct is reckless, malicious, or willfully harmful, and the court wants to punish the behavior rather than compensate the victim.
These awards are rare in Canadian personal injury law and are usually granted in exceptional cases. Because punitive damages are not considered to replace income or losses, they do not fall under the same tax exemption rules as earnings. In general, punitive damages are non-taxable amounts.
Structured Settlements & Tax Implications
Most personal injury settlements in Canada are paid as a single lump sum award. However, there is another option known as a structured settlement. In this arrangement, compensation is paid out in scheduled installments over time rather than all at once.
This can be helpful for individuals who face long-term medical costs or who cannot return to work. Receiving payments over time can ensure financial stability and reduce the risk of quickly using all the settlement money within a short period.
Structured settlements may also protect funds from creditors in certain cases, adding another layer of security. To qualify for tax exemption, the arrangement must meet the requirements set out by the CRA. When properly structured, these periodic payments are not taxed.
Consult a personal injury lawyer to ensure your settlement is designed to reduce your taxpayer obligations and protect your financial future.
Contact Our Law Firm for Professional Advice
Seeking legal advice is the best way to protect your settlement money. Our personal injury lawyer can explain how tax rules may apply, structure your compensation properly, and ensure you keep as much of your compensation as possible while planning for long-term financial security. Schedule a free consultation today and discuss your case with our lawyers.
