We all get married for life but unfortunately that is not always the case and when children are involved, the matter becomes more complicated. The rules surrounding alimony and child support are ever changing due to legal cases brought in front of the courts so depending on what you and your spouse decide to arrange can make the difference to everyone's overall financial situation.
Child support agreements entered into after may 1997 will result in tax free income to the recipient and thus accordingly, the amount is not deductible by the person making the payments.
Alimony, on the other hand is taxable to the person who receives the income and is thus also deductible by the person who pays the support. This is a very important matter as the income paid to you as alimony will be added to all your other income and then be taxed at the rate applicable to your total income. For example, if you earn $21,000 from your job and $24,000 in alimony, you will be taxed on $45,000 of income. The problem is that your work has only deducted enough tax based on you earning only $21,000 and thus with the addition of the alimony, you are now in a totally different and much higher tax bracket! This can be a nasty surprise come tax time.
The good news with alimony income received is that the amount is classified as earned income and thus will increase your RRSP limit. As such, if you are able to contribute to your RRSP, then this might be a great way of reducing your overall income and thus save you taxes.
The opposite also applies to those who pay alimony. If you earn say $60,000 and pay $24,000 in alimony, you will only be taxed on $36,000 of income. Rather than waiting for your refund in the new-year, you can apply to have less tax taken off by your employer so you have use of the extra income now. Your RRSP limit is not affected when you pay alimony so in this example, you would earn RRSP room based on your income of $60,000.
In order for any of the above rules to apply, your alimony payments must be in accordance with a written agreement and must be made on a periodic basis. As such, a lump sum payment is not subject to the above rules. This is important to note when you are deciding whether or not you want to be paid out or if you would rather receive a monthly income amount.
If you are entitled to receive alimony and child support but only receive a portion of what you are entitled to, payments are applied firstly to overdue child support and only when all the child support has been paid do you have to report (and the person paying can claim) alimony income.
Payments to children and spouses not resident in Canada may also be affected by these rules so be sure to speak with your professional tax advisor before you enter into any agreements.
This article was written by Gabrielle Loren -- a partner with Loren & Company, CGA's located in North Vancouver, BC and can be reached at firstname.lastname@example.org, at 604-904-3807 or check out their website at www.loren.bc.ca