Non-Taxable Income and Spousal Support

In a recent case released by the Alberta Court of Appeal, the Court had to address whether to gross up a party’s non-taxable income for the purposes of determining appropriate spousal support.

In Tancowny v. Tancowny, 2018 ABCA 307, the parties entered into a consent Divorce Judgment in 2015, wherein the husband’s obligations for spousal support were set out.  As at that time, it was deemed that the husband’s pre-tax income for spousal support was $148,800.  Subsequent to the Divorce Judgment, the Husband began collecting short term disability, and then transitioned to earning the whole of his annual income from non-taxable long-term disability payments in the amount of $87,350.52.   Because the Divorce Judgment used the phrase “gross income”, the hearing Justice grossed up the husband’s income by 38% to $120,543.72 per year.

On appeal, the Court held that it was appropriate to gross up the husband’s non-taxable income to gross taxable levels so as to compare “apples to apples” in respect of the original pre-tax income that the husband was earning at the time of the Divorce Judgment.  In so doing, the Court confirmed the hearing Justice’s reasoning that this would result in the “same percentage drop in cash in pocket money available to the appellant and in spousal support to the respondent.”

However, what was completely overlooked by the both the hearing Justice and the Court of Appeal are the tax implications when a payor is receiving income from a tax-free source.  Because spousal support is tax-deductible by the payor, the gross monthly payment made by a payor is not the true amount of support that the payor ultimately pays.  Once the tax deduction is accounted for, the true net payment made to the recipient is less than the gross amount awarded in any Order or Judgment.  However, when a payor is receiving tax-free income, they lose the ability to deduct spousal support payments from their income at year end.  As a result, should their tax-free income be grossed up to a notional “pre-tax” amount, such as was done in Tancowny, the payor will end up paying a greater amount of “real support” than had they actually earned the grossed-up income as taxable income.

As an example, to use the numbers from Tancowny:

a)      Payor 1 earns gross income of $120,543.72 per year as taxable income, and is ordered to pay $3,462.75 per month in spousal support. However, because they are able to write off their support payments on their income taxes, the actual out-of-pocket, net support that they pay will be some amount less than $3,462.75.

b)      Payor 2, like the husband in Tancowny, earns $87,350.52 per year as tax-free income, which, when grossed-up, is equivalent to a taxable income of $120,543.72. As a result, they are also ordered to pay $3,462.72 per month in spousal support.  However, because they receive non-taxable income, they have no ability to write off their support payments.  Therefore their actual out-of-pocket support is the full amount of $3,462.72.

This recognition of the prejudice to payors earning non-taxable income has been recognized by the Spousal Support Guidelines, which begs the question of how it was overlooked by the Courts at both levels, particularly given the Courts’ historical reliance on the Spousal Support Guidelines.  Regardless, any parties involved in spousal support payments who receive income from non-taxable sources need to be cautious and attentive to ensuring that the loss of the tax-deduction is accounted for.

Recipients of spousal support should be no less attentive, particularly if they are required to report their spousal support payment on their income tax when the payor receives support from a non-taxable source.  This is because the actual support received by the recipient, once taxed, will be less than the support ordered in any Order or Judgment.  If allowances are made for a payor who receives non-taxable income, such as a decrease in the amount of support ordered to account for that loss, that must be balanced against the decrease in the support received by the recipient that will still be taxed.

Spousal support is not a simple matter and has many aspects and factors that must not be overlooked.  The lawyers at Mincher Koeman LLP are experienced and knowledgeable in respect of the complexities of spousal support and the many considerations that must be looked at when determining spousal support.  If you need assistance with your spousal support, contact us at (403) 910-3000 or at reception@mincherkoeman.com.