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.
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