Family breakdown can have income tax consequences that should be considered in the resolution of property, child and spousal support and custody issues.
Tax law is complicated and constantly changing. Canada Revenue Agency (CRA) can be very strict and uncompromising in its approach to issues affecting separated families and care should be taken, and proper accounting and legal advice obtained in all situations.
Note: The information in this section is for general information only and may not be up-to-date as tax laws and their interpretations seem to change with considerable frequency.
Taxation of Spousal/Partner Support and Child Support
Spousal or partner support payments are treated differently than child support payments by CRA.
Prior to May 1, 1997, payments of periodic spousal and child support pursuant to an agreement or court order that was properly made, that is, one which met the criteria set out in the Income Tax Act were tax deductible from the income of the payor and included as income for tax purposes in the hands of the recipient.
After that date, this provision only applied to spousal support payments.
The theory behind this provision was to give a break to separating families and to make more money available for the payment of support. Canada’s graduated tax system, based on the presumptive scenario of the payor having a higher income and, therefore, higher marginal tax rate than the recipient, shifts the tax burden to free up more funds for the payment of spousal or partner support.
An example (the figures and rates in this example are arbitrary and for illustration purposes only):
a. The Pre-Separation Scenario:
The payor earns $150,000 annually and, therefore, at a tax bracket of, say, 50%, or $75,000, will have $75,000 per year in disposable income, that is, cash available to spend after he/she has paid their income tax.
The payee earns $50,000 per year and, therefore, at a tax bracket of, say, 25%, or $12,500, is left with disposable income of $37,500 after payment of tax.
The family’s net disposable income, before separation, was $75,000 + $37,500 = $112,500.
b. The Post-Separation Scenario:
Assuming the court orders, or the parties by written agreement provide, that the payor will provide $1,000 per month in spousal or partner support, or $12,000 per year, then:
Payor will end up with $150,000 – $12,000 = $138,000 less the 50% of that for tax, $69,000, leaving $69,000 to spend.
Recipient of support will end up with $50,000 + $12,000 = $62,000 less 25% for tax, $15,500, leaving $46,500 to spend.
The separated family’s disposable income after the payment of support and application of the tax consequences is now $69,000 + $46,500 = $115,500, that is, $3,000 more. Of course, the separated family probably needs more money, given the establishment of a second household and the loss of some economies of scale.
Using this type of analysis, the courts often order, or the parties often agree to take those calculations into account and provide for a higher amount of spousal support.
Child support is now payable from after tax disposable income and is tax free in the hands of the recipient.
Child Care Expenses
Daycare or child care expenses incurred to allow the parent to work, pursue a business activity or obtain education are deductible subject to limitations and maximums. The child care expense limits rose to $8,000 in 2015 for children under 7, and to $5,000 for children ages 7 to 16.
Where the parents are cohabiting, CRA requires the deduction to be taken by the lower income parent.
Where the parents have separated or divorced, the deduction is available only to the custodial parent.
Where the parents have shared custody, the parties may share the deduction to the extent that they each pay.
It is important to consider the tax implications on the payment of child-care or daycare expenses because those expenses will usually qualify as "special or extraordinary expenses" under Section 7 of the Guidelines. The non-custodial parent who contributes to the cost of daycare is only required to share the “net” cost of that expense, that is, the required share of the amount that the custodial parent pays after taking the tax implications of such payments into account.
Canada Child Benefit
The Canada Child Tax Benefit (CCTB) and the Universal Child Care Benefit (UCCB) were replaced, effective July 1, 2016, when the Canada Child Benefit (CCB) came into force. Claims for the CCTB and UCCB prior to that date can still be made.
The new CCB is available to families for their children under the age of 18, with payments of up to $6,400 annually for each child up to the age of 6 and up to $5,400 for each child between the ages 6-17. The amount payable is subject to income limitations and, where the parties are separated, may be paid to the primary parent or 50% of the amount each parent is eligible to receive in a “shared custody” arrangement.
The government requires that each parent file a tax return, whether or not there is income to declare, to qualify for the CCB. The amount is payable based on the income reported and is subject to annual adjustment in July. Where the parties have separated, CRA looks only to the income of the custodial parent.
Amount for Eligible Dependent
The Amount for Eligible Dependent (AED), formerly known as the “equivalent to spouse” credit is a claim that can be used as a tax credit in place of the spousal or partner credit that is available to intact families. It can be available to allow one of the parties, for example, to apply this credit to a child in his or her custody.
The AED is available only under strict conditions, some of which are:
NOTE: the claim can only be made by one of the parents. If both make the claim CRA will deny it to both. At Fishman Beley, we recommend that the parties enter into an agreement respecting this credit, which CRA will honour to allow one of the parties to make the claim. Often, parents will agree to alternate the claim yearly.
Education and Tuition Credits
A student may be eligible to claim a credit for tuition and some other expenses for university or college. In addition the student may be able to claim an education credit depending on the province in which the student resides (approximately $100 per month) for each month of enrolment.
This credit, to the extent it is unused by the student to eliminate his or her liability for tax, subject to maximums, may be transferred to a spouse, parent or grandparent as the student may choose.
Particularly, where the parents are paying the child’s education costs, this is something to be considered carefully, noting that an agreement between the parents may not bind the adult child who must consent to his/her parent taking advantage of the tax savings.
How this credit is used may affect the amount a parent has to pay for post-secondary education as a special or extraordinary expense.
Tax Deductibility of Legal Fees
In certain circumstances, legal fees associated with marriage/relationship breakdown are deductible, namely, where the fees are incurred:
NOTE: Legal fees incurred for custody litigation, to obtain a divorce, relating to the division of property or to establish, enforce or collect payment of a lump sum amount instead of periodic support are not deductible. The payor does not have the right to deduct legal fees.