Taxing Compensation and Benefits: What Is Exempt and What Is Not

Category: National Insurance | Reading time: about 8 minutes

The principle that explains almost everything

Tax law has a long-standing principle: compensation follows what it replaces. Compensation that stands in place of ongoing income — a salary, a business profit — steps into its shoes and is taxed like it. Compensation that stands in place of an asset, or that is meant to cover the bodily injury itself, is capital in nature, and for it the Ordinance sets out express exemptions.

Two questions therefore come before all others: who is paying, and for what exactly. Those two answers determine the tax charge almost every time.

National Insurance benefits — exempt

Section 9(6c) of the Ordinance expressly exempts the principal benefits paid by the National Insurance Institute:

• Work-injury disability benefit — for victims of work accidents and occupational disease;
• General disability benefit;
• Survivors' and dependants' benefits;
• Old-age benefit.

This exemption is full and is not conditional on the degree of disability. Nor does it require an application: the benefit simply does not form part of taxable income.

Separately, section 9(6) exempts allowances for hostile-action casualties, for IDF disabled veterans and for the families of soldiers who fell in action, as well as benefits paid in respect of war wounds and to the dependants of those who fell — including under the law on allowances for families of persons abducted or missing in a hostile action.

Private loss-of-earning-capacity cover — taxable, and what to do about it

A monthly benefit under a loss-of-earning-capacity policy is intended to replace the salary you stopped receiving. On the principle we opened with, it steps into the salary's shoes — and is therefore subject to income tax like any personal-exertion income.

Hence a practical point worth knowing: the insurer is obliged to withhold tax at source, and its default is withholding at a high rate — unless it is shown a certificate from the assessing officer for reduced withholding. A recipient who does not attend to this pays excess tax every month, and waits for a refund at year end at best — receiving none at all if no return is filed.

What can be done: apply to the assessing officer for a tax coordination and a reduced-withholding certificate, and examine in parallel whether the disability exemption applies (see below) — because if it does, it applies to this income too.

Capital compensation for death or injury — fully exempt

Section 9(7) is short and unambiguous: "any capital sum received as global compensation for death or injury" is exempt from tax. This is the basis for exempting personal-injury damages paid to an injured person or their survivors, whether by judgment or by settlement.

Note two words in the section. "Capital sum" — the exemption is aimed at a one-off payment, not at a periodic payment replacing ongoing income. "Global compensation" — an overall sum in respect of the injury itself. The more the sum is split and expressly attributed to heads of loss that are in substance a replacement of income, the more the capital character erodes and the harder the question becomes.

The practical conclusion is not purely a tax one: how the settlement agreement or judgment is drafted directly affects the tax charge. That is worth checking before signing, not after.

The disability exemption under section 9(5)

Alongside the exemption on the compensation itself, there is a broader exemption on a disabled person's personal-exertion income — section 9(5). In brief: it is aimed at a person determined to have 100% medical disability, or at least 90% on a weighted calculation of impairments to different organs, and its size depends on the period determined — a period of 365 days or more attracts a far higher exemption ceiling than a period of between 185 and 364 days.

The determination of disability percentages for the exemption relies on the laws listed in the section — among them the Disabled Persons Law, the Nazi Persecution Disabled Persons Law, the Hostile Action Casualties Allowances Law and the relevant chapters of the National Insurance Law. A person for whom no percentage was determined under one of these is assessed by a dedicated medical committee.

This is a broad subject in its own right, and it is covered at length — including the procedure and retroactive refunds — in a dedicated article on the site of Yad Otefet, a related company of our firm specialising in realising medical entitlements. ← Full article on the section 9(5) exemption (Hebrew)

Retirement grant — the exemption and its ceiling

A capital grant received on retirement is exempt under section 9(7a) up to an amount equal to one month's salary for each year of employment, based on the final salary, and subject to a ceiling set and updated annually. Where the grant exceeds that, the Director of the Tax Authority has power to exempt the excess — in whole or in part — having regard to the length of service, the level of pay, the terms of employment and the circumstances of the retirement.

The words "circumstances of the retirement" are not decoration. Retirement on health grounds is precisely the kind of circumstance for which that power exists, and it is considered on its merits.

Spreading the tax under section 8(c) — the tool it is most costly to miss

A large sum received at once falls entirely into a single tax year and pushes its recipient into the higher brackets. Section 8(c) allows, on the application of the taxpayer or their heirs, the income to be treated as though received over several years:

• Salary or pension arrears — in the years to which they relate, but no more than six tax years ending in the year of receipt;
• Redemption of accrued leave — in equal annual parts over up to six tax years, but no more than the years of employment;
• A retirement grant or capitalised pension — in equal annual parts over the years of employment for which the grant is paid, or the period in which the pension right accrued, and no more than six tax years ending in the year of receipt.

And in addition — sometimes this is the main point — the Director may permit a spread over a different period, including over future years, on conditions he sets and which may include an advance payment. Spreading forward is materially different from spreading back: it is especially relevant to someone whose expected income in the coming years is low — for instance a person who has left the workforce following the injury.

What to check — a checklist

1. Who is paying? National Insurance, a private insurer, an employer, or a third party following a tort claim — each has a different treatment;
2. Capital or periodic? A one-off sum in respect of the injury, or a monthly payment replacing a salary;
3. Was tax withheld, and at what rate? Check the payslip or the payer's annual certificate;
4. Has a tax coordination or reduced-withholding certificate been applied for, where the payment is taxable;
5. Has entitlement under section 9(5) been examined? It applies to personal-exertion income, including to a taxable benefit;
6. Has spreading under section 8(c) been considered — backwards, and forwards too;
7. How is the agreement drafted? In a settlement or judgment, the attribution of sums affects the tax;
8. Has an annual return been filed? Without one no refund is received, even where it is due.

← Read our full guide: National Insurance for the self-employed and controlling shareholders

This article is provided for general information only and does not constitute professional advice or a substitute for personal advice. The tax charge depends on the specific circumstances of each payment and each taxpayer. For any question, please contact us and we'll be glad to assist.

Best regards,
Hager-Alperowitz & Co. — Certified Public Accountants