By Kathleen Wells, Wells Family Law

When the court orders that one spouse must pay the other spousal support, the order is usually forward-looking. The paying spouse is required to pay a certain amount of support for an express period of time. However, occasionally the paying spouse is ordered to pay a retroactive amount of spousal support as a lump sum payment. There are often questions about how taxes will apply to these retroactive lump sum payments; for example, whether or not the recipient spouse will have to pay income tax on the amount, and whether or not the paying spouse will be entitled to a tax credit on the amount, as is the case with regular periodic spousal support payments. These issues only apply to spousal support: child support is neither taxable in the hands of the recipient, nor tax deductible to the paying party.

Tax Benefits & Lump Sum Payments

Retroactive spousal support is paid in the form of a lump sum. In general, Canada Revenue Agency does not consider lump sum payments to qualify as a true support payment because they are not paid on a periodic basis. However, if periodic payments are owed pursuant to a court order or written agreement, and these payments are overdue and one large payment is being made to bring them up to date, the lump sum payment will be considered a support payment. In that case, the spouse paying the support must provide the spouse receiving the support a completed form from Canada Revenue Agency, Form T1198 “Statement of Qualifying Retroactive Lump Sum Payment”[1], for the recipient spouse to file with their taxes. However, this form only comes into play in certain situations:

  • The lump sum payment was at least $3,000;
  • The lump sum payment was made to bring the support payments up to date;
  • The paying spouse would otherwise be entitled to deduct the support amount; and
  • The recipient spouse is required to report the support amount as income.

Most of the time, lump sum spousal support payments are not tax deductible by the payor spouse; they are also not considered taxable income by the spouse receiving the payment. This is because whether or not the payment is either taxable or tax deductible can only be adjusted for the year that the order or agreement was made, and/or the year prior to the order or agreement. Essentially, if the court decides to order retroactive spousal support that goes back further than this one-year time period, the money will be handled differently for tax purposes.

Tax Treatment of Retroactive Spousal Support: Case Study 1

The Alberta Court of Appeal discussed the issue of the tax treatment of retroactive spousal support payments in Samoilova v. Mahnic [2].  At trial, the judge proposed a lump sum amount of spousal support. After the judge delivered his reasons, but before the judgment was entered as an order, the husband wrote the judge a letter pointing out that the retroactive support did not account for the fact that typically, periodic spousal support was tax deductible by the spouse paying the support and taxable in the hands of the recipient; a lump sum was neither. The trial judge summoned the parties back and subsequently reduced the spousal support he previously ordered by 30 percent. The wife appealed. The Court of Appeal stated that according to Canada Revenue Agency, in order for spousal support payments to be deductible, they had to be paid on a periodic basis. The trial judge came up with the number of 30 percent as the appropriate reduction of support based on averaging the marginal tax rates of the parties. The Court of Appeal determined that this decision was reasonable. They stated that retroactive spousal support awards may be paid by a lump sum and the lump sum reduced by a percentage to adjust for the lost tax deductibility to the paying spouse. [3]

Tax Treatment of Retroactive Spousal Support: Case Study 2

The Ontario courts recently revisited this issue in Verhey v. Verhey [4]. In the case, the wife had brought a motion to resolve the issue of the spousal support owing to her by the husband from the year 2013. The court was asked to consider whether the amount owing should be adjusted so that the wife would have the same after-tax benefit that she would have had if tax had been paid on the support, or if the husband should only be required to pay what he would have paid after tax if the amount had been deducted. There were three options before the court:

  • The husband’s after-tax cost (which was $7,458);
  • The wife’s after-tax benefit (which was $9,252); or
  • The midpoint between the husband’s after-tax cost and the wife’s after-tax benefit (which was $8,400). [5]

The court ruled that they must take a balanced approach, and considered what amount of a lump sum award would place both parties in the position they would have been in if the payment had been both deductible and taxable. The court determined that the appropriate method to be used was the midpoint of the parties’ respective tax rates. However, the court emphasized that it was important to consider all of the circumstances, including the receiving spouse’s needs and the paying spouse’s ability to pay, when making such awards.

Conclusion

The courts seems to be suggesting that a paying spouse can receive a tax benefit for a lump sum payment further back than one year.  A balanced approach dictates that the amount to be used should fall somewhere at the midpoint between the after-tax cost and the after-tax benefit in order to achieve fairness for both parties.

 


 

If you have questions about income tax benefits and retroactive spousal support, please contact Wells Family Law for a free consultation – we are Calgary-based divorce lawyers who are committed to a fast and effective resolution.

 

[1] https://www.canada.ca/content/dam/cra-arc/formspubs/pbg/t1198/t1198-18e.pdf

[2] Samoilova v. Mahnic, 2014 ABCA 65 (Alberta Court of Appeal).

[3] Ibid. at para. 28.

[4] Verhey v. Verhey, 2018 ONSC 1943 (Ontario Superior Court of Justice).

[5] Ibid. at para. 7.