Taxes and Family Separation
Tax Treatment of Spousal Support
Provided that it meets the requirements in the Income Tax Act, spousal support is generally deductible from income for the payor spouse and is included as income for the recipient spouse for tax purposes. However, there a number of different payments that could constitute ‘spousal support’ and it is important to examine them carefully to determine their tax treatment.
What Qualifies As “Spousal Support”
- In many cases, it will be very clear what amount of money is being paid as spousal support pursuant to a written agreement or court order. However, in some cases, parties fail to apportion ‘support’ amounts as ‘child’ or ‘spousal’ and these designations (or lack thereof) can have some significant implications come tax time.
- In the case of orders made, or agreements entered into or altered after April 1997, only amounts that can be clearly identified as spousal support or payments for the benefit of the former spouse are considered spousal support. All other amounts are considered child support. In the case of these agreements or orders, only spousal support amounts are taxable/deductible. In case of orders made, or agreed to before May 1997, all payments for support are deductible to the payor and attributable to the recipient.
- As well, one must always remember that child support takes priority over spousal support. If a court order or agreement specifies that both spousal and child support, then any payments made by the payor will first be considered child support by the CRA. Once the full amount of child support has been paid, then the remainder of payments will be considered spousal support by the CRA. However, these rules do not apply when child support and spousal support are payable under different agreements or court orders.
The Basic Rules
- In order to qualify for the support tax treatment under the Income Tax Act, payments must be:
- Subject to the recipient’s discretion (the payments must be with ‘no strings attached’)
- Made on a periodic basis (lump-sum payments do not qualify for these rules)
- Paid for the support of the recipient; and
- Paid pursuant to a written agreement or Court order.
- While most support payments made pursuant to Court order or marital agreement meet these requirements, it is nonetheless important to receive legal advice to ensure that you are not running afoul of the Act or the CRA policy.
- Lump sum payments are not deductible by the payor or included in the income of the recipient. This isn’t common knowledge and, while it may play into the favour of support recipients, is certainly not the avenue to get preferable tax treatment as a payor. While the difference between ‘periodic’ and ‘lump-sum’ may seem clear, it (like most tax law formulae) is not. The following example should be illustrative.
- Parties A and B separate and enter into a separation agreement. If the agreement stipulated that the recipient would receive $12,000.00 in spousal support, payable in monthly installments of $1,000.00, this would most likely constitute a lump sum payment, and would not attract the special tax treatment. If the agreement stipulated that the recipient receive base spousal support in the amount of $1,000.00 per month, this would be a periodic payment.
- While the foregoing example is overly simplistic, it highlights the need for careful drafting and characterization of payments to ensure that parties reap the benefits of the special tax treatment. In order to avoid the CRA deeming periodic payments as lump-sum payments, it is important to consult a family law lawyer to ensure that the amounts are properly characterized.
Third Party Payments
- In most cases, spousal support will be paid directly to the recipient. However, there are situations where payments are made by the payor to a third party, which are in the nature of spousal support. In order for these payments to qualify, they must meet certain requirements under the Income Tax Act. To qualify, the payments must be:
- Made pursuant to a written agreement or Court order;
- The agreement or order must specifically refer to ss.56.1(2) and 60.1(2) of the Income Tax Act or contain sufficiently clear language confirming the parties’ understanding that the payments will be considered spousal support and will be taxable/deductible;
- Paid for the support of the recipient. If the payments are for specific living expenses, such as medical, rent or mortgage expenses, they may not be included in determining the amount of deduction available.
- Made in the current or immediately preceding taxation year.
- While the above list may make third-party payments seem straightforward, they are, in reality, complicated. And because of their susceptibility in being employed in tax evasion schemes, these arrangements are subject to special scrutiny by the CRA. If you are planning on incorporating a third-party payment arrangement into your separation, it is advisable that you consult a lawyer prior to entering into the agreement or order to avoid any issues come tax time.
Tax Treatment of Child Support
Like spousal support, there is a divergence in the tax treatment of child support payments depending on the date on which the order or agreement was made. If the order or agreement arose after April 1997, then the child support is not deductible by the payor and is not included in the income of the recipient.
For agreements or orders made before May 1997, child support is deductible by the payor and included in the income of the recipient, unless one of the following exemptions apply:
- Changes to the Quantum of Support – If the amount of support payable is changed after April 1997, then the child support will not be deductible/included in income.
- A New Court Order of Agreement – If 1) a new order or agreement is made after April 1997; 2) the previous order or agreement remains in effect; and 3) the effect of the new order or agreement is to change the overall amount of child support payable, the post-April 1997 tax rules apply to both orders or agreements.
- Express Terms – An order or written agreement may specify that child support payments made after a certain date (not earlier than May 1, 1997) will no longer be taxable and deductible.
- Election – If there is an order or agreement prior to May 1997 and a person wishes, they can make an election with the CRA that the post-April 1997 rules will apply to the payments.
Tax Treatment of Family Law Legal Fees
In certain circumstances, legal fees incurred in the context of family law litigation are tax-deductible. Under Lines 22100 and 23200 of your tax return, the following legal fee expenses can be deducted by a support recipient from their income:
- Legal fees incurred to establish entitlement to spousal or child support;
- Legal fees incurred to increase the amount of spousal or child support payable;
- Legal fees incurred to claim retroactive spousal or child support or to enforce arrears of support;
- Legal fees incurred to try and make child support non-taxable.
However, a recipient cannot claim a deduction for the following legal fees:
- Legal fees incurred to get a divorce or separation;
- Legal fees incurred to obtain an equalization of family property, or any other division of property;
- Legal fees incurred in relation to custody and access;
- For a payor spouse, there is no income deduction for legal fees associated with contesting or negotiating the amount of support payable.
How to Take Advantage of the Tax Benefits
The best way to ensure that any support arrangements are taxed in a preferential way is to speak with an accountant. They will review any marriage, cohabitation or separation agreement to ensure that it is structured to maximize any tax benefits. They can help you file your income tax return to make sure it is in compliance with the Income Tax Act, its regulations and CRA policy.