Structured Settlements, Tax and ODSP: What Happens to the Money

Is the settlement taxable?

The answer depends on what the payment is for, how it is paid and what is done with it afterward, and it should be confirmed with an accountant for the person's own circumstances. Two points can be taken from the statutes.

First, the Income Tax Act has a targeted rule for investment income on injury damages. Paragraph 81(1)(g.1) deals with income from property that a person received through a damages award or lawsuit over physical or mental injury, and it covers capital gains on that property as well. Income of this kind is left out of the person's income in two situations: when it relates to a period ending before the tax year in which the person reaches 21, and, in any other case, when the person was under 21 at some point in the year. The paragraph is narrow, and its wording should be read closely for any particular situation.

Second, the Courts of Justice Act takes account of tax on invested awards. If no order for instalments is made, the damages awarded must include a sum covering tax on the investment income (s. 116(5)).

A settlement reached without a court award may be treated differently, and the details turn on how the payments are structured and documented. A tax professional should confirm the treatment of both the principal and any income earned on it.

What a structured settlement is

Instead of taking the whole amount as cash, part or all of it may be paid out over time. One way to arrange this is for an annuity to be purchased that pays a defined stream of payments, which may be set up with different schedules or features. The terms of any particular structure come from the annuity contract and the settlement documents.

Section 116 of the Courts of Justice Act deals with periodic payment in personal injury proceedings. It works in two steps:

• With the consent of every affected party, the court may direct that some or all of the damages be paid in instalments (s. 116(1)(a)).
• If the plaintiff asks for the award to include a tax offset, the court must direct instalment payments, unless the parties agree otherwise or the court concludes this would not serve the plaintiff's best interests (s. 116(1)(b) and (2)).

When weighing best interests, the court considers three things: whether the defendant could finance a sound payment scheme, whether the plaintiff has a better way of managing the money, and whether instalments are workable on the facts (s. 116(3)). With everyone's consent, the order can also allow the award to be revisited later (s. 116(4)).

Whether a structure can be changed once it is purchased depends on the annuity contract, and the terms should be read before signing. Some settlements combine cash for immediate needs with periodic payments for the longer term, and a lawyer can advise on how a particular mix might work.

ODSP and other benefits: the rules of the program matter

Whether a lump sum, a periodic payment or a trust affects eligibility depends on the benefit program's current rules and on how the funds are held and paid. Questions people commonly raise include:

• Whether the settlement amount will be counted as an asset or as income under the program's rules
• Whether a trust, sometimes called a Henson trust in Ontario, is suitable, and how its terms would be treated by the program
• Whether a registered disability savings plan is available, depending on eligibility
• Whether any exemption applies to the amounts or purposes involved

Those questions are usually raised before a settlement is signed, because the form of the settlement is difficult to change afterward. A lawyer, together with an accountant or trustee where the amounts warrant it, can review them against the program's current rules. The program itself can also confirm how it would treat a particular arrangement.

Minors and people under a disability

The Rules of Civil Procedure provide that a proceeding on behalf of a party under disability is, unless the court orders or a statute provides otherwise, commenced, continued or defended by a litigation guardian (r. 7.01(1)). A settlement of a claim made by a person under disability needs a judge's approval before it binds that person (r. 7.08(1)).

The rules also address where the funds go. For a minor, a settlement or order amount is deposited with the court, although the court can direct something different after considering certain provisions of the Children's Law Reform Act (r. 7.09(1.1)). For an adult under disability, the default is the same deposit, subject to a different direction from a judge (r. 7.09(1)). See also the guide on child injury claims.

Where a settlement involves a person under disability, how funds are held and invested is typically a significant part of the approval process, and a lawyer can explain how it works for the claim in question.

Questions that influence the decision

Questions a lawyer and accountant typically look at include:

1. How long the money has to last, and what future care or income needs there are
2. Whether the person receives, or may need, a means-tested benefit, and what that program's rules say
3. What immediate needs exist, such as home modification, a vehicle or debts
4. Whether there are capacity or vulnerability concerns
5. What tax would apply to investment income on the amount involved
6. How much certainty is wanted about future payments, and who carries the risks

Issues that commonly arise

• Considering the form of payment only at the mediation table, without the numbers having been worked through beforehand
• Treating the choice as all lump sum or all structure, when a combination may be possible
• Raising benefit eligibility only after the funds have arrived
• Assuming the tax position without confirming it with an accountant
• Not planning who will manage the money