Breaking Up Is Hard To Do
WITH SEPARATION AND DIVORCE becoming an all too frequent occurrence in our society, it may be prudent to consider how the Income Tax Act affects parties who have experienced a marriage breakdown. This article will examine some of the issues that inevitably arise in these situations.
At the present time, until legislation is enacted to recognize same sex couples as being married, a spouse is defined in the Income Tax Act as being an individual of the opposite sex who cohabits with the taxpayer in a conjugal relationship and either (a) has done so for a period of twelve months or (b) is a parent of a child of whom the taxpayer is also a parent. Consequently, a spouse will include not only a legal spouse, but one who is "common-law" as well.
The term, former spouse does not appear in the Act and so must be given its ordinary meaning of a person who was at some previous time the taxpayers spouse. For income tax purposes, spouses who have separated, whether by written agreement or otherwise, are still considered to be spouses until such time that a divorce has terminated their relationship. As for a common-law spouse, he or she will become a former spouse when the couple no longer co-habit for some period of time due to the breakdown of their conjugal relationship.
The dissolution of a marriage carries both emotional and financial costs. It is beyond the scope of this article to consider the former, but the latter can be divided into two categories: alimony payments and property settlements.
Spousal support, or the payment of alimony, is an obligation assumed by one party to re-direct a portion of his pre-tax income to his spouse. These payments are deductible by the payer and taxable to the payee.
The only requirement of the Income Tax Act is that the frequency of payment is to be spelled out in the court order or written divorce agreement. Consequently, it is not uncommon for such payment arrangements to be for a stipulated period of time or until the death of one of the parties.
In contrast, property settlements are usually executed over a brief period of time and may include non-cash assets. They are neither taxable in the hands of the recipient nor deductible by the payer. They are not contingent upon subsequent events, and the recipient spouse is entitled to her share of the matrimonial assets even if she remarries immediately after the settlement has been negotiated.
Difficulties arise when complex and sizeable agreements have elements of both spousal support and property settlement. It is often advantageous for the spouse with the higher marginal income tax rate to wish to convert a lump sum property payment into spousal support. This can occur when the property settlement is being paid in equal installments on a periodic basis.
It becomes very important to distinguish between where support stops and property settlement begins. What is the difference between spousal support of $1,000 per month payable for ten years despite remarriage and a property settlement that pays the recipient spouse her share of $240,000 in monthly payments of $1,000 over ten years?
The distinction reflects the underlying difference between income and capital as defined in the Income Tax Act. There are subtle differences that separate legal form from economic substance.
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Associates. All rights reserved.