Are Long Term Disability Settlements Taxable?

COVID-19 and disability claims

We know there are a lot of COVID-19 concerns lately. That being said, we still want to provide you with all the information we possibly can regarding any long term disability claims you may make as a result of this situation. We hope this doesn’t happen. If you get sick you may have to apply for disability through your work. If this happens, keep in mind: your long term disability compensation may be taxable. 

Of course, the coronavirus is not the only disability you could sustain in order to apply for long term disability benefits. You may be disabled due to a car accident, disease, degenerative or chronic pain, amongst other things. As long as you are unable to work (for whatever medical reason) then you should be given the opportunity to receive long term disability payments. Of course, you will need to meet the specific disability test as set out in your long term disability policy. Every policy is different so you will need to look into this detail about your policy.

As you may know, in 2015 the Canada Revenue Agency updated its disability benefit tax withholding requirements. The changes impacted the method of calculating taxable disability benefits for both STD (short-term disability) and LTD (long-term disability) plans.

In Ontario, and in the rest of Canada, you are taxed on all compensation you receive from your employer. It does not matter what the compensation was for: salaries, wages, one-time bonuses, etc.

There are generally two ways in which Ottawans pay premiums for long-term disability insurance. First, they may pay those premiums entirely by themselves. Second, their employer may pay part or all of the premiums.

Employer Paid Premiums:

If your employer paid your premiums for long term disability then the amount you receive for any compensation for a long term disability claim are taxable. 

Employee Paid Premiums:

On the flipside, when you pay the premiums from your pay cheque for your own long-term disability insurance, you do so using “after-tax” dollars. This means that compensation you receive for long term disability benefits are NOT taxable.

This is a very important distinction that you should share with your lawyer if you decide to hire one. It could save a lot of grief down the road. If you would prefer not to hire a lawyer then you can perhaps look to your previous paystubs to see if any amount of money came out of your pay cheque for disability benefits. You can also check with your Human Resources department to see how your long term disability payments were made. 

If you are negotiating a settlement with the insurance company make sure you don’t let the insurance company get away with reducing your settlement for tax dollars when they really shouldn’t. This will give you negotiating leverage against the insurance company because they will know that you understand the rules on taxation on long term disability settlements.