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Tax and alimony - almost as complicated as marriage itself?

In today's society of quick fixes and convenience, it seems, easier to terminate a marriage than adopt a puppy. In turn, marital breakdown is increasingly more common. Although each household's situation is different, one spouse will usually be required to make alimony and/or child support payments to his/her family. These issues are complicated and emotional for all parties involved; it is unfortunate to see them reduced to dollars and cents. Dollars and cents, of course, attract the tax authorities.

Despite matrimonial support payments being so common, their tax treatment can be complex and is worthy of consideration. The complexity is mainly due to broadly worded statutory provisions (which were significantly amended in 1997) that have led to conflicting court decisions. Perhaps unsurprisingly, the tax implications of a particular post-marriage arrangement are sometimes overlooked when determining the conditions of a Separation Agreement or Divorce Order. It is not uncommon for Family Court judges to criticize counsel for ignoring the relevant tax issues; Tax Court judges have even criticized Family Court judges for granting Orders which simply do not comply with the Income Tax Act. A detailed discussion of the taxation of support payments is beyond the scope of this article. However, the reader will hopefully come away with a general understanding of the tax treatment of support payments, including an awareness of certain payments which are not deductible to the payer.

The General Scheme

Support payments made to a spouse or former spouse are generally deductible to the payer if the following five conditions are met (note that "spouse" now includes same sex and common law partners):

* The amount is payable or receivable as an allowance on a periodic basis. The question of whether a payment is made on a periodic basis will often arise when a lump sum payment is made for periodic payments that have fallen into arrears. Judicial decisions on this issue have been very inconsistent. This issue is very fact specific and is beyond the scope of this article.

* The amount is solely for the maintenance of the recipient spouse (not children).

* The recipient has discretion as to the use of the amount. See the discussion on third-party payments below.

* The recipient and the payer are living separate and apart.

* The amount is receivable under an order of a competent tribunal or under a written agreement.

When amounts are deductible to the payer, they are generally included in the recipient's income and taxed accordingly.

Child Support Amounts

Child Support Amounts are not deductible to the payer (nor included in the recipient's income) despite the fact that all of the above five criteria (except #2) are met. The definition of Child Support Amount is extremely broad and includes basically any amounts that are not identified in the Order or Agreement as being solely for the support of the spouse. It is therefore essential that the Order or Agreement be carefully drafted if the payer and recipient wish to receive a certain tax treatment.

Third-Party Payments

Amounts paid to third parties on behalf of the recipient spouse that are not expressly contained in the Order or Agreement are generally non-deductible to the payer because they do not meet the "discretion as to the use of the amount" (test #3 above). However, if the would-be recipient directs the payer to make a payment on his or her behalf to a third-party that would have otherwise met the above five conditions, then it may be deductible to the payer (judicial decisions are not entirely consistent on this issue).

Certain other third-party payments made under the Order or Agreement may be deemed to have been payable to the recipient and therefore meet the above five conditions. These amounts include payments made under an Order or Agreement to third parties for things such as tuition, medical expenses, etc. However, expenditures made to third parties for the recipient's acquisition of tangible personal property will not be deductible to the payer. Therefore, if Ms. X makes Mr. X's car payments under a Separation Agreement, they will not be deductible to her. Also, there are certain restrictions with respect to payments for the acquisition or improvement of a personal residence. Again, careful drafting will be required to prevent third-party payments from being classified as Child Support Amounts and therefore non-deductible.

Amounts Paid Before An Order or Agreement is Completed

Timing can become an issue when a payer spouse has made payments prior to an Order or Agreement coming into effect. The Income Tax Act may consider these early payments to have been paid and received under the Order or Agreement if two conditions are met:

* The Order or Agreement provides for the amounts to be considered payable or receivable pursuant to the Order or Agreement; and

* The payment was made in the year the Order or Agreement was made, or in the prior year.

The importance of careful drafting when preparing an Order or Agreement is again apparent with respect to these amounts.

It is always advisable to retain legal counsel in the unfortunate event of a marital breakdown. Tax is only one of a great many (legal and non-legal) issues that must be addressed and this article has only scratched the surface. Tax consequences may result from many other types of payments or events which arise in a marital breakdown, for example: legal costs for obtaining a divorce, legal costs for enforcing support payments, property settlements, interest charges, pension plans, RRSPs, child care expenses, and withholding tax. While this article is by no means intended to be comprehensive, hopefully it has provided a general overview of the tax treatment of support payments.
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Author:Kirby, Richard
Date:Dec 1, 2002
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