Any sudden influx of unexpected cash is defined as a windfall. If you have recently received a windfall, such as a large inheritance or lottery winnings, you may be wondering how your taxes might be affected.
Types of Windfalls
According to the Canada Revenue Agency, windfalls include several different types of unexpected payments, such as:
Windfalls also include:
- disability or death benefits paid on behalf of war veterans
- life insurance benefits received after the loss of a loved one
Difficulties in Defining Various Windfalls
Some items, such as gifts from relatives, are easily defined as windfalls.
Others are more subjective and harder to categorize. For instance, if a boss gives his employee a gift, it may be classified as a taxable bonus rather than as a non-taxable windfall. Cash awards or near-cash awards such as gift cards are almost always considered to be taxable employment benefits. This means the award will be considered as part of your income and should be reported on your T4- Statement of Remuneration Paid in Box 40. Your employer will deduct income tax, Canada Pension Plan (CCP) and in some cases, Employment Insurance (EI) premiums on this type of award or prize.
Currently, much of the criteria used for defining windfalls is drawn from an old court case regarding a cash payment made to a shareholder. The shareholder argued that the payment was not taxable, but when the CRA disagreed, the case was taken before the Federal Court of Appeals.
Ultimately, the court classified the payment as a non-taxable windfall and created a list of criteria defining windfall for future taxpayers. According to the court, the money was a windfall because the taxpayer made no organized effort to obtain or solicit it, and he had no expectation that it would be made. Additionally, the payment was from a non-customary income source, and it was a one-time payment with no foreseeable recurrence.
According to the CRA, windfalls are not taxed, and taxpayers do not have to report them on their income tax returns.
However, though the Canada Revenue Agency (CRA) does not tax a windfall itself, you may need to pay taxes on any income that is generated if you invest that money in a non-registered investment or account.
- You put your lottery prize in the bank, any interest earned on that account will be taxable.
- You invest some of your inheritance in stocks or mutual funds, any dividends earned on the investments will be taxable. As will any Capital Gains you may make when you dispose of or sell the investments.
For this reason, if you do plan on investing your winnings, you may want to consider investing in your Tax Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) if you have the available contribution room. This TurboTax article explains further Paying Taxes on Investments.
Exceptions for Professional Gamblers
Gambling and lottery winnings are considered non-taxable windfalls unless they are earned by professional gamblers.
In the case of professional gamblers, the winnings are considered to be coming from customary income sources, and as such, they are taxable. Professional gamblers are defined as those who gamble frequently to earn their livelihood, rather than those who gamble infrequently for fun. If you have special knowledge about the game that reduces the element of chance that may also classify you as a professional gambler and you may be required to pay taxes on your winnings.
Professional gamblers may deduct gambling losses from their winnings, however, they may not claim more losses than winnings and create a Non-Capital Business Loss.
Special Considerations for Lawsuit Awards
Lawsuit awards are also considered as non-taxable windfalls as long as they are not related to business or property losses.
For example, if you win an award in a personal injury case, you do not have to report that as income or pay tax on it. However, if you win a lawsuit on behalf of your business, that is not considered a windfall.
Canada Revenue Agency has a complete list in this article – CRA: Amounts that are not taxed.