British Columbia Family Law Blog

12.8 Non-Taxable Payor Income

Both formulas produce a "gross" amount of spousal support, i.e. an amount that is deductible from taxable income for the payor and included in taxable income for the recipient. As we noted in Chapter 6 on Income, some payors have incomes based entirely on legitimately non-taxable sources, usually workers’ compensation or disability payments or income earned by an aboriginal person on reserve.¹¹⁸ In these cases, the payor is unable to deduct the support paid, contrary to the assumption built into the formulas for determining amount.

Some of the recipients may pay little or no tax on the support income received, due to their low incomes, but that is not our concern here. Nor are we concerned with payors who earn income tax-free by working "under the table" or by understating their income for tax purposes. Here we are concerned with payors who legitimately receive their income on a non-taxable basis.

What warrants this non-taxable exception is when the non-deductibility of the spousal support poses a problem for the payor’s ability to pay, as the non-taxable payor is unable to pay the gross amount of spousal support that would be required of a payor with the benefits of deductibility.

Under the without child support formula, ability to pay will usually only become an issue in longer marriage cases, marriages of 15 years or more. In these longer marriage cases, the 50/50 net income "cap" will simplify the use of this exception, as the upper limit on spousal support will be equalization of the spouses’ net incomes. A simple example helps to explain why.

Example 12.6

Donna and Jeff have been married for many years, with two adult children. Later in his career, Jeff experienced became unable to work and Jeff now receives a disability pension of $37,500 per year, non-taxable. Grossed up, his disability pension would be worth $50,000 per year. Donna works part-time on account of health issues and earns $10,000 gross per year.

Under the without child support formula, if Donna and Jeff have been married for 25 years and using the gross income difference, spousal support would be $1,250 to $1,667 per month, indefinite (duration not specified). But Jeff cannot deduct any amount for the spousal support paid, even though Donna will have to include it as taxable income.

In this final version, we have added a net income "cap" under this formula, so that the upper end of the range for support would leave both Jeff and Donna with 50 per cent of the net income. This net income calculation takes into account Jeff’s inability to deduct his support and Donna’s payment of tax on that support. The "cap" would kick in at $1,318 per month (using Ontario tax rates), well below the formula’s upper limit of $1,667 monthly (if Jeff’s income were taxable, the "cap" would still take effect, but much higher, at $1,575 per month).

That would only leave a narrow range of $1,250 to $1,318 per month if we applied the "cap" literally. Practically, the non-taxable exception would mean that a court or the parties will likely have to go lower than $1,250 per month in most cases, in consideration of Jeff’s ability to pay.

What if Donna and Jeff were married for 20 years? Using the gross income difference, the range would be $1,000 to $1,333 per month, indefinite (duration not specified). The net income "cap" would only have a small impact here, as it would limit the upper end of the range to $1,318. Ability to pay concerns for Jeff’s position would be much diminished and this non-taxable exception may not be required.

The problems are actually more serious at higher income levels, especially where the support recipient has to pay a higher rate of tax. If the payor receives $68,388 non-taxable, the equivalent of a grossed-up income of $100,000 and the recipient earned $30,000 per year, the net income "cap" has an even greater impact than it does for Donna and Jeff. Most cases of non-taxable income involve low-to-middle incomes rather than such higher incomes.

Because the with child support formula already uses net incomes for its calculations, the basic formula automatically adjusts for the non-deductibility of support. The result is that the whole range under this formula is reduced downward, but it is important to be aware of the reduction and the amounts involved. Another example can help, if we go back to the familiar example of Ted and Alice.

Example 12.7

Ted and Alice have been married for 11 years and have two children aged 8 and 10, as in Example 8.1. Alice still earns $20,000, but Ted now receives a non-taxable disability pension totalling $56,900 per year (grossed-up, this would be equivalent to $80,000 of employment income). This means that Ted still pays $1,159 per month in child support and there are no section 7 expenses. When Ted earned $80,000 per year in employment income, the spousal support range was $474 to $1,025 per month, using Ontario rates. Now that Ted receives a non-taxable disability pension, the range is reduced to $380 to $797 per month. The difference in the two ranges reflects the effect of Ted being unable to deduct the spousal support for tax purposes.

It might be possible to make an exception here, to increase spousal support above the upper end of the automatically-reduced non-taxable range, pushing up towards $1,025 per month, in order to improve the financial situation of the recipient and the children. At $1,025 per month, however, almost 61 per cent of the family’s net disposable income or monthly cash flow would be left in Alice’s household.

The important point is to appreciate how much the basic with child support formula has reduced the range for amount when the payor’s income is non-taxable, in order to make the necessary judgment about whether an exception should be made, to increase spousal support above the calculated range.

In every one of these non-taxable exception cases, it is necessary to balance the tax positions of the spouses — the reduced ability to pay of the payor spouse, who can’t deduct the support paid, and the needs or loss of the recipient spouse, who still has to pay taxes on spousal support and only receives after-tax support.