How To Handle Claims for Unreported Income
By David Share
How is This Relevant to Disability Insurance Claims?
In general, when considering the question of “unreported income”, this is usually a reference to a plaintiff’s failure to have filed tax returns, or to have declared income to the Canada Revenue Agency, which forms the basis for a claim for past and future income loss in a claim for damages in tort, or in the context of a disability claim, with respect to establishing entitlement to disability insurance benefits on the basis of past earnings.
The relevance to disability claims arises in two particular circumstances, which will be discussed further below:
(i) Establishing a base of prior earnings for purposes of assessing entitlement to partial or residual disability benefits under a private or individual disability policy (applies to certain group policies as well);
(ii) Allegations of a claimant working “under the table” and the impact on entitlement to disability benefits – both pre and post a claim for disability.
Background: Can Plaintiffs Recover Future Loss of Income Where They Have Failed to Report Their Income to the Canada Revenue Agency?
In the case of Frenette v. Audet , the New Brunswick Court of Appeal disallowed any claim for future loss of income based on a past history of income that was unreported to CRA, citing the principle of ex dolo malo non ortur ation (no Court will lend its aid to a man who founds his cause of action upon an immoral or an illegal act). The immoral or illegal act being the failure to report income to the tax authorities.
There has been conflicting case law to this ruling, in particular, the British Columbia Court of Appeal in Iannone v. Hoogenraad I came to a different conclusion regarding the inclusion of unreported income in assessing entitlement to an award of future income loss. The BCCA focused on the evidence that established that the Plaintiff was unable to work and then acknowledged that using unreported income to establish the basis for an award of future income loss may be difficult, but not impossible.
There are numerous other cases that have addressed this issue since, and it seems that the particular facts of the case in question and the nature of the activities that resulted in the unreported income, will have a significant bearing on how a court is likely to treat a claim of unreported income.
Unless the Courts strictly adhere to the principles enunciated in Frenette, it seems that establishing past loss of income, in the absence of reporting it to the tax authorities, will not pose an absolute bar to recovering an award of future income loss, however, the burden of proof for such a plaintiff may be significant and the credibility of the plaintiff, together with the burden to produce credible evidence of such income should be scrutinized carefully.
(i) Claims Under Private/Individual Disability Policies
The question of unreported income for purpose of establishing entitlement to disability benefits does not usually arise in the same context as it would in a Tort claim, the question of quantifying past earnings can arise depending on the particular wording of a specific disability policy.
Most individual disability policies are sold on the basis of providing a prescribed amount of monthly benefit, whereas Group policies are usually based on the insurable earnings as reported or paid by an employer to their employee.
For self-employed individuals (business owners, professionals, high earners), the policy they purchase is usually based on the level of earnings they could establish when purchasing the policy — production of income tax returns is usually required at the time these policies are underwritten, and most such policies include the ability to increase the amount of coverage as income grows.
When a claim is submitted, the past earnings are not always scrutinized, but are definitely scrutinized if the claim is for partial or residual benefits. Partial or Residual benefits will usually pay a proportionate benefit or fixed percentage of the benefit based on establishing an amount of prior earned income. The prior earnings could be based on any number of scenarios, and by way of example, the prior twelve months, the prior tax year, the highest average prior average monthly earnings over a longer period, etc.
The heaviest scrutiny of such claims will come when it appears from the financial disclosure provided that it appears that the business was losing money for a significant period that cannot simply be explained by the claimants declining health.
Example: Cabbie reduces hours because of chronic back condition – revenue in decline because of Uber — disability or declining industry?
By way of a topical example, let’s say the self-employed person was a taxi driver, who had the wherewithal and presence of mind to purchase disability insurance. They are diagnosed with a back condition that results in them reducing their hours, and they claim for residual disability benefits under their private disability policy.
A review of their financial records shows declining income over the past 2-3 years. His medical history shows back complaints going on for 5-6 years, but only now has it gotten to the point where he has reduced his hours.
In the midst of such a claim is the ever present reality of the fact that the taxi industry has been disrupted by the emergence of Uber as an alternative for consumers, and many cab drivers have suffered reductions in their income.
An insurer might be tempted to suggest that the claim is motivated by declining business as opposed to a legitimate back condition that limits the drivers’ hours.
I haven’t commented on whether the cabbie can prove all of his income and has declared it to CRA, which raises additional potential challenges.
The Plaintiff’s theory would be to focus on the medical history to establish that the condition has been worsening over this time frame and that any reduction in hours was solely as a result of the medical condition rather than any market conditions.
Focus on the worsening market conditions that are impacting all taxicab drivers and deconstruct the medical records to show that the condition hasn’t really worsened over the years, and the cabbie has managed to continue working in spite of his chronic back condition.
Corporate Structure/Income Splitting
For self-employed who have incorporated and done some income splitting, rather than a question of unreported income, there may be questions that arise regarding any attempt to maximize the prior earned income for purposes of maximizing the residual/partial benefits under the policy.
Insurers will want to keep the prior earned income figure down as low as possible, as any residual earning capacity divided by the prior earned income will produce the proportionate calculation of entitlement.
Example for illustration purposes:
|Pre-Disability Monthly Income||$30,000.00||$20,000.00|
|LTD Benefit Amount – Total Disabilty||$10,000.00||$10,000.00|
|Loss of Earning – 2/3rd’s||66.67%||50%|
|Proportionate Amount of LTD||$6,667.00||$5,000.00|