By Steve Ranot, C.A., C.B.V., C.F.E.

Spousal Support and Child Support (where pursuant to a written agreement or court order prior to May 1997) is taxable to the recipient. Where an agreement calls for support of say $3,000 monthly and the payor in a particular year is in arrears for one month, the recipient must include $33,000 (11 months x $3,000) in income and the payor can only deduct this same amount. If the arrears is corrected in the following year, the payor and the recipient must each deduct and include $39,000 (13 months x $3,000) respectively.

The Income Tax Act does not require or permit either party to accrue support payments. These are taxable/deductible only on actual payment. This gives rise to an issue raised by family law lawyer Mr. Jack Straitman which may require attention. Consider the following situation:

Jacob earns $200,000 per annum and is required to pay support to Rachel of $5,000 per month. During 1995, Jacob fell into arrears and paid Rachel six monthly payments. In 1996 Jacob made eighteen payments to eliminate the arrears. Rachel had no other income in either 1995 or 1996 and is the custodial parent of Joseph and Benjamin.

Based on the actual tax rates in effect for 1995 and 1996, Rachel would have paid $17,799 in 1995 income taxes and $17,574 in 1996 for a total of $35,373, if this support had been received on a timely basis. Instead, as a result of the actual payments, Rachel paid $5,030 in 1995 and $33,177 in 1996 for a total of $38,207. The excess tax cost of $2,834 arose as most of Rachel’s additional arrears support income in 1996 was taxed at the highest marginal rate while the support income not received in 1995 would have been taxed in a lower income tax bracket.

Jacob on the other hand, is virtually unaffected from an income tax standpoint as his taxable income has allowed him to remain at the highest marginal tax rate throughout.

In order to remedy this situation, Rachel may have to commence an action for damages against Jacob, the costs of which may persuade her to do otherwise.

A clause in written agreements to deal with this issue may prevent the need to commence a costly action. The clause would include the payment of interest on arrears, the provision for payment of any incremental tax costs resulting from the arrears and a designation as to who will calculate those costs.

This clause may eliminate one more headache for clients and their legal representatives.