Retroactive Spousal Support and Tax Implications
Child support is paid in “after-tax” dollars – the payor is not entitled to deduct, and the recipient should not be claiming, these payments on their income tax return. Spousal support, however, is tax deductible to the payor, and must be claimed as income by the recipient.
The issue of adjustment for tax plays a significant role when fixing amounts for retroactive spousal support. At present, the Canada Revenue Agency (CRA) generally does not permit payors or recipients to deduct or claim lump sum retroactive spousal support payments on their income tax return. According to CRA’s Interpretation Bulletin on the issue, in order for spousal support payments to be deductible they must be payable as an allowance for the maintenance of the recipient on a “periodic basis.” An amount paid as a single lump sum will generally not qualify as being payable on a periodic basis.
Given this, the Court, or counsel/parties negotiating a settlement, must factor in the tax adjustment, and reduce the lump sum payment accordingly. Generally, the Court will use the “mid-point” or average of the tax that would have been deducted and paid by the payor and recipient respectively, had the support been paid monthly. Using this “average” approach is equitable, but it can have significant implications for both payor and recipient, particularly where there is a significant gap in the tax rates of the parties.
Take, for example, a couple where the payor is earning an income of $500,000.00 and the recipient $50,000.00, with the Court determining that the payor owes 2 years of retroactive support at a quantum of $10,000.00 per month ($240,000.00 total).
Had the payor paid periodic monthly support of that amount, the net after tax cost to the payor of paying that support would be approximately $5,200 per month. The after-tax benefit to the recipient would be approximately $6,521.00 per month. On a lump sum retroactive amount, the Court will generally take the average of these two amounts, or an average of the parties’ tax rates, resulting in an overall discount to the lump sum down to approximately $140,652.00, which equates to approximately $5,860 per month over 2 years. As such, the payor ends up paying, and the recipient ends up receiving approximately $15,864.00 more or less than they would have paid/received had the amounts been paid monthly.
For this reason, it is generally advantageous to resolve interim spousal support issues early pending final resolution, to ensure both parties are receiving the full tax benefits available to them.