By Alan McEwen
The 2012 federal budget, delivered on March 29, announced changes to the income tax treatment of wage loss replacement plans (WLRP). With the release of Bill C-45, introduced on Oct. 18, we can now describe the full impact of these changes.
But before we describe these, it's important to put them in context. WLRPs provide employees with replacement income when they can't work due to illness or accident. Employer contributions to group WLRPs have not been taxable income. Instead, where there have been employer contributions, the benefits received have been taxable, less a deduction for the amount of any employee contributions.
Where a WLRP is provided to individual employees in other than a group plan, this treatment is reversed — the employer contributions are a taxable benefit, and any benefits received are tax-free.
Before the 2012 federal budget changes, group WLRP benefits received were not taxable under any of the following conditions:
•the benefits were provided on a lump-sum basis
•there was no loss of employee income
•the sum total of employee eligible contributions exceeded the amount of benefits received.
The federal budget changes, announced on March 29 and implemented in Bill C-45, in part address all three of these points.
Under the new WLRP rules, where benefits under the plan are to be provided on a lump-sum basis, it's the employer contribution that is a taxable benefit, not the lump-sum benefits received. Previously, such lump-sum benefits would have been taxable income in the year received.
It's important to understand the distinction between lump sum and periodic benefits. As applied by the Canada Revenue Agency (CRA), this distinction is based on an employee's right to plan benefits, rather than the frequency with which benefits may actually have been paid.
For example, an insurance company may initially deny an employee's claim to WLRP benefits, but later settle by paying a lump sum in lieu of benefits that, if they had initially been approved, would have been provided on a periodic basis. In this situation, the CRA will consider the benefits as periodic.
Another change in these new rules is that, where WLRP benefits may be provided without a loss of employee income, employer contributions are now taxable income. Previously, unless such benefits would have been provided on a lump-sum basis, group WLRP benefits received, without a loss of income, were never subject to income tax.
The two changes described above are effective for employer contributions made on or after March 29, 2012, for WLRP coverage after 2012. For any such employer contributions made between March 29 and Dec. 31, 2012, the contributions are taxable income in 2013, not 2012. Note, employer contributions made after the budget, but in 2012 and for coverage in 2012, are not affected by these changes. Starting in 2013, any such employer contributions are taxable in the year the contribution is made.
The third point above deals with employee WLRP contributions. Where there are mixed employer-employee contributions, WLRP benefits received on a periodic basis, for loss of income, are a taxable benefit. The amount included in taxable income is the gross WLRP benefits received, less any employee contributions.
These rules aren't changed in either the 2012 federal budget or Bill C-45. However, where these measures make employer contribution a taxable benefit, as described above, employee contributions no longer affect the amount included in income. In other words, where WLRP benefits received are taxable, the taxable benefit is reduced by employee contributions. But employee contributions no longer have any impact, when employer contributions are themselves the taxable benefit.
What practical impact will these changes have in payroll?
Where a WLRP provides benefits, some of which may be provided on a lump-sum basis or some of which may be provided when there is no loss of employee income, WLRP contributions will have to be split so they reflect the new rules described above.
For example, a WLRP may provide what are termed accidental death or dismemberment benefits, or critical illness benefits, as lump-sum amounts. This may be on top of traditional periodic benefits for loss of income due to illness or disease. For source deduction purposes, employer contributions to such a WLRP will have to be split in two, to reflect that portion of any employer contribution which is tax-free, as against that portion which is not.
Any employer WLRP contributions that are a taxable benefit are also subject to CPP contributions in the year the employer contributions are recognized as taxable income.
The treatment of WLRP by Revenue Quebec follows that of the CRA, under the rules that applied before the 2012 federal budget and Bill C-45. There is no indication whether or not Revenue Quebec will be adopting the new federal rules described above.
Alan McEwen is a payroll consultant and freelance writer with 20 years' experience in all aspects of the industry. He can be reached at firstname.lastname@example.org, (905) 401-4052 or visit www.alanrmcewen.com for more information.