Marital breakdowns can be some of the most difficult, emotional experiences for individuals to face. Among the many issues to consider are the financial elements related to the division of Net Family Property (i.e. equalization of net assets) along with Spousal and/or Child Support obligations.
In this article, we will provide an overview of some of the most common concepts related to calculating income for support purposes.
Some of the most common questions when it comes to marital breakdowns include:
- Who will be obligated to pay spousal support (i.e. alimony), if any?
- How much will the spousal support obligation be?
- What is the difference between spousal and child support?
- How much will the child support obligation be, if any?
Spousal support and child support are two different types of support that may be required after a marital breakdown. These forms of support are applicable in different situations and have different tax treatments. Before the amount of either type of support can be determined, it is important to determine the applicable income of the payor.
Income Calculations in both child and spousal support can become complicated depending on several factors. For example, for some individuals, annual income is as simple as employment income. For others, owning a business personally or through corporate holdings can make the income calculations more complex. As a result, it is common that a family lawyer will reach out to a qualified expert witness with specialized knowledge in this area. This often involves the engagement of a Chartered Business Valuator (CBV), or other professionals who possess the requisite experience and expertise.
Spousal Support
Marriages and other similar partnerships can be viewed as economic partnerships. It is common for one spouse/partner to have more income than the other, such that when the partnership breaks down, the higher-earning spouse may have to pay support to the other. Spousal support payments are tax deductible for the payor spouse and are included in the taxable income of the recipient spouse.
Child Support
Child support is paid to the primary caregiver by the other spouse. The purpose of child support is to cover the costs of care and raising of the child. Marital or common-law status is not a requirement for child support eligibility. Furthermore, child support payments are not tax deductible for the payor and are not included in the taxable income of the recipient.
Calculating Income for Support Purposes
The Divorce Act includes the Federal Child Support Guidelines (“Guidelines”), which provide guidance on how to calculate income for support purposes. The calculation can be relatively simple for individuals who work as employees, whose only source of income is their salary or hourly wages. If this is the case, their Guidelines income can often be calculated using Total Income Line 15000 (formerly Line 150) of their personal income tax returns. However, this analysis can become complicated when one or more of the following factors, amongst others, apply to the individual:
- Own a business through one or more corporations.
- Is a partner in a business.
- Earns income from self-employment.
- Deducts employment expenses from their taxable income.
- Does not report a portion of income on their personal tax return.
- Earns a significant amount of investment income or rental income.
With the use of tax optimization strategies, self-employed individuals can lower their taxable income and consequently their tax liability. As a result, the calculation of income for support purposes may differ dramatically from what is shown on their personal tax return. A Calculation of Income Report pursuant to the Guidelines is prepared to assist the Court in determining the total income available to a spouse, beyond what is reported on their personal tax return. Common considerations include the following:
- Owners of corporations have discretion to leave earnings within their company, resulting in income not appearing on their personal tax return.
- Income splitting between family members is used to reduce income and avoid paying tax at the top marginal rates.
- Business owners may deduct personal expenses within their business lowering their taxable income.
- Shareholder loans to/from the business may impact the amount of available funds in a business.
If any of the above are relevant, adjustments to Line 15000 may be required, and they could significantly alter the calculation of income. Common adjustments include, but are not limited to, the following:
- Inclusion of a portion or all of the pre-tax income (or losses) of privately held corporations.
- Adding income-splitting amounts (e.g. salary or dividends) paid to a spouse, child, or other related parties.
- Adding personal expenses deducted from the business/corporate income.
- Adding unreported income (e.g. cash payments).
- An income tax gross-up (discussed further below).
Income Tax Gross-up
Certain types of income have preferential (i.e. lower) tax treatments compared with employment income. For instance, consider dividends and capital gains. Other benefits, like personal expenses or unreported income, are not subject to any tax. As a result, the Guidelines suggest that this income may be “grossed-up” (i.e. increased) to account for the tax savings on income or benefits that are taxed at a lower rate or not taxed at all.
Summary
The items described above commonly lead to adjustments, but they do not represent an exhaustive list of potential items that can impact the calculation of income under the Guidelines. Once the income under the Guidelines has been calculated, usually for three calendar years, the legal process and the discretion of the Court will determine the specific support obligations, which can be higher or lower, depending on specific case factors.
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