Article content material

Among the many challenges of separation and divorce is figuring out whether or not spousal and little one assist can be payable, and, if that’s the case, how a lot and for a way lengthy. For anybody going by way of this course of, it’s vital to take the tax penalties into consideration when structuring a separation settlement.

Article content material

The Revenue Tax Act distinguishes between spousal assist and little one assist, with totally different tax guidelines for every. Spousal assist consists of any quantities paid on a periodic foundation, beneath a courtroom order or settlement, for the assist of a former partner or common-law companion. Baby assist, then again, consists of any assist funds that aren’t particularly recognized in that order or settlement as being just for the previous partner’s or companion’s use. In each circumstances, the previous spouses or companions should be dwelling aside after the breakdown of their marriage or relationship.

Article content material

If the courtroom order or separation settlement solely supplies assist for a partner or companion, then the funds are totally taxable to the recipient and tax deductible to the payor. To make sure tax deductibility, the order or settlement should be registered with the Canada Income Company. To take action, the previous spouses or companions ought to full CRA Kind T1158 Registration of Household Assist Funds and embrace a replica of the order or settlement.

Article content material

If, then again, the order or settlement is solely for the assist of youngsters, the funds are neither taxable to the recipient nor tax deductible to the payor, so there isn’t any must register the settlement with the CRA.

If the settlement comprises each spousal and little one assist, and it clearly signifies a separate quantity for a partner or companion, then this portion of the funds can be deductible and taxable. However how formal does the settlement should be for the assist funds to be tax deductible? A current tax case handled this particular situation.

The case concerned a taxpayer who received married in 2006, and legally separated on Dec. 8, 2010. In March 2011, the couple entered a separation settlement, signed by each events. The couple selected to arrange the separation settlement on their very own with out utilizing attorneys. Within the part coping with spousal assist, the settlement acknowledged: “Get together 1 shall pay spousal assist to social gathering 2 within the quantity of $3,500 month-to-month commencing Dec 8/10 and ending Dec 8/14.”

Article content material

The dispute with the CRA, nevertheless, concerned the 2018 taxation yr as a result of the taxpayer continued to make spousal assist funds past the 2014 finish date of their settlement. On his 2018 tax return, he deducted spousal assist funds of $42,000 (12 instances $3,500), whereas his ex-spouse included the $42,000 on her return as revenue.

The CRA reassessed the taxpayer and denied his deduction for spousal assist on the idea that the funds didn’t fall inside the definition of “assist quantity,” as a result of, within the CRA’s view, the spousal assist funds weren’t made by the taxpayer pursuant to a written settlement.

The decide reviewed the 2011 separation settlement and known as it “flawed from the outset.” He famous the signatures of the spouses weren’t witnessed, and there was a handwritten clause on the backside of the contract stating the settlement was “topic to approval by authorized counsel.” There was no indication such approval was ever obtained.

Article content material

Nonetheless, the truth is that the 2 separated spouses honoured the phrases of the written settlement, with the taxpayer paying $3,500 monthly in spousal assist all through the time period of the settlement and for a number of years thereafter.

The taxpayer took the place that the March 2011 separation settlement, regardless of not being correctly up to date after 2014, constituted an settlement in writing beneath which he made assist funds in 2018.

The CRA argued the assist funds in query weren’t made pursuant to a written settlement. The beforehand present separation settlement had expired in 2014, and, subsequently, no settlement obliging the taxpayer to pay spousal assist existed in 2018.

The decide famous in his evaluation that there was quite a lot of litigation regarding the situation of whether or not assist funds had been made pursuant to a written settlement. As to why a written settlement is critical, he quoted a previous determination of the Federal Courtroom of Attraction that concluded: “The rationale for not together with separated spouses concerned in funds made and obtained pursuant to a verbal understanding is quickly obvious. Such a free and indefinite construction would possibly effectively open the door to colourable and fraudulent preparations and schemes for tax avoidance.”

Article content material

The decide then turned to the details of this case, which he famous “is clearly not a fraudulent scheme.” The events agreed in 2011 in writing to an quantity to be paid as spousal assist. They “incorrectly ignored” the necessity to replace the contract in 2014 as a way to correctly replicate the taxpayer’s continued assist obligations.

However for the reason that two events continued to think about themselves certain by their 2011 separation settlement by way of the 2018 taxation yr, such conduct helps the conclusion {that a} “assembly of the minds continued to exist regarding spousal assist obligations.” In different phrases, the assist established within the 2011 separation settlement was handled by the events as persevering with to be in drive as much as, and together with, 2018.

Article content material

The decide, “guided by the plain that means of the phrases of the act,” concluded the funds had been, certainly, made pursuant to the phrases of a written settlement. The funds glad the necessities beneath the Revenue Tax Act that the assist was “an quantity payable … on a periodic foundation for upkeep … beneath a written settlement,” and thus needs to be tax deductible to the taxpayer on his 2018 return.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Property Planning with CIBC Non-public Wealth in Toronto. Jamie.Golombek@cibc.com.

_____________________________________________________________

If you happen to favored this story, join extra within the FP Investor e-newsletter.

_____________________________________________________________