One major advantage of having a professionally-prepared family law agreement is the possibility that, with advance planning and careful drafting, obligations under the agreement can be structured to minimize the tax liabilities of one or both parties.
A recent case from the Tax Court of Canada illustrates the degree to which such family law agreements can be tailored to take into account the unique circumstances of your family, while still taking advantage of tax deductions drafted in more conventional terms.
One of the most common tax issues arising from the end of a relationship is the payment of spousal and child support, which may have the effect of significantly reducing a payor spouse’s take-home pay. Under subsections 56.1(4) and 60.1(4) of the Income Tax Act, payments “paid as an allowance on a periodic basis for the maintenance of a former spouse” are deductible from the payor spouse’s income. However, this deduction comes with Canada Revenue Agency (“CRA”) strings attached.
For example, the payments must be made according to the terms of a “Written Agreement” signed and dated by both parties. Payments rendered in the two years before such an agreement has been executed may be deducted, but only if the agreement is drafted so as to acknowledge the amounts paid.
Furthermore, the CRA imposes five conditions on the form and structure of payment before it will allow a deduction to be claimed:
- The payment is a specific amount made to the recipient according to a court order or written agreement.
- If the recipient is the payer’s current or former spouse or common-law partner, the payer is living separate and apart from the recipient at the time the payment is made because of a breakdown in the relationship. Otherwise, the payer must be the legal parent of a child of the recipient.
- The payment is made to support the recipient, the child of the recipient, or both. The recipient can use the payment at their discretion.
- The payments are payable on a periodic basis. The timing of the payments must be set out in the court order or written agreement.
- The payments are made to the recipient or to an agent enforcing the collection of the amount.
However, there is still room for flexibility within these conditions. In Ross v. The Queen, the payor was a lobster fisherman, a highly seasonal line of work. He and his wife, both represented by counsel, entered into a separation agreement in which the husband’s support obligation, instead of the more conventional monthly payment schedule, took the following form:
The Spousal support shall be made on the following schedule:
- A lump sum of $20,000 to be paid upon the wife signing this agreement in good faith;
- The [family’s] 2011 Jeep and title shall be delivered to the wife by the husband no later than 5 (five) days after this agreement is signed by both parties;
- A lump sum of $10,000 to be paid no later than January 1, 2017. (at para 3)
When the husband tried to deduct these payments from his income taxes, a CRA agent refused the deduction. The taxpayer appealed this refusal to the Tax Court of Canada.
The Tax Court reasoned that, although the payment structure was unconventional, the ultimate question of whether he qualified for the deduction needed to be decided in light of “particularity of the… circumstances of the spouses.”(at para 18). It was clear to the Court that the parties had considered the highly seasonal nature of the husband’s work and income, and had therefore structured their agreement “specifically to accommodate the seasonal ability of Mr. Ross, the payor, to pay without default or tardiness” (at para 19). In other words, the agreement showed that the parties had negotiated the timing of the support payment obligation to fit their own financial and life circumstances, rather than to disguise transfers of money as spousal support payments. The Tax Court allowed the husband to claim the deduction and awarded him appeal costs.
The above case illustrates the range of options which may be available to parties negotiating family law agreements, as well as the importance of ensuring an agreement is professionally prepared so as to maximize tax advantages. If you have any questions about tax agreements in family law matters, or about family law agreements in general, please contact a member of the Family Law Group.
If you have (or someone you know has) questions about tax agreements in family law matters, or even family law agreements in general, you are encouraged to reach out directly to anyone in our Family Law group for more information. With over 85 years of combined experience, families trust us to help them navigate the complex legal framework and processes involved with separation and divorce, including child and spousal support, and how to best situate you financially at the end of the process.
This piece appears as part of a special four-part article series where our experienced Family Law team will explore some of the most important aspects of taxation for BC families when it comes to legal fees, structuring family agreements, optimizing tax obligations, as well as navigating separation and divorce. Learn more about this limited series and what topics are coming up next HERE.