"Can I deduct legal fees at tax season?" - BlogBite

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Question: Can I deduct my family law legal fees on my tax return?

Answer: you can, but only in specific circumstances. If you are either the recipient of or are pursuing entitlement to either child or spousal support, you have a shot at deducting for tax purposes legal fees related to establishing, quantifying, varying or enforcing those support payments. At tax season and on request, your family law lawyer will give you a letter confirming the total amount you paid in connection with these steps in the immediately preceding calendar year. You will have to submit that letter with your tax return.

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Support and related income considerations

When support (either child or spousal) is an issue in a family law case, there are a number of questions which need to be addressed before the actual support calculation is made.  

For example, in the case of child support, is a young person over the age of 18 still eligible to receive child support?  If so, in what form is that support to be paid? To whom? 

On the issue of spousal support, is the potential support recipient making best efforts to contribute to his or her own support based on their current ability to do so?

The income of the potential payor is a key question to address in any consideration of support obligations.  “Income for tax purposes" is not necessarily “income for support purposes” in family law.  In other words, simply because Canada Revenue Agency accepts a potential payor’s representations of his or her income for tax purposes does not mean that a family law Judge will do the same. 

Family law spreads a much wider sweep over a potential payor’s income sources to determine the true extent of his or her ability to pay support.  

The Child Support Guidelines, which technically apply to the calculation of child support but have now been wildly accepted as applying to spousal support calculations as well, permit the inclusion in income for support purposes of a wide variety of income sources.  The intent of the legislation is to ensure that financial dependants receive support based on all sources of the payor's actual income but also on sources which are available to the payor, even if he or she chooses not to tap into them. 

By way of one example only, income earned by a business which is not paid out to a shareholder but could be is vulnerable to being included in his or her income for support purposes.  Personal expenses run through the business are also vulnerable to being added back to the payor’s income for support purposes.

Incomes over $350,000 and the Spousal Support Advisory Guidelines

You may have heard about Child Support Guidelines (both federal and provincial). They are mandatory in their application. On a daily basis, both before the Courts and in the context of out-of-court negotiations about child support, they are used to calculate amounts payable by parents, one to the other, based on their respective incomes for child support purposes, the children's residential arrangements, the children's activities and many other relevant factors. 

What about spousal support? How are those amounts calculated?

Setting aside for the moment the issue of entitlement to spousal support (being the preliminary issue which needs to be determined), we now have the Spousal Support Advisory Guidelines, which came about after years of government-sponsored studies on appropriate spousal support levels and fair methods of calculating them. The SSAGs, as they are known, are not mandatory in their application. Rather, they are a guideline. They remain "advisory" to the Court - hence the use of the word in the title.

The SSAGs have many very interesting features and deserve a lot of comment. There will be future postings in this blog about them. 

For the moment, I comment on whether or not they are applicable to incomes (in the payor's hands) of over $350,000. The Guidelines themselves say that they "may not apply" in such situations but increasingly, Courts have applied them, particularly to incomes materially in excess of $350,000. One of the arguments made is that if the parties were still together, all of the income available would be used for their benefit - there would be no artificial "cut-off" after $350,000. So why should the same scenario not apply once the parties are separated, assuming the spouse claiming spousal support is able to establish entitlement in the first place? 

For more information on this issue, and for a more in-depth discussion on how the law may apply to the specific circumstances of your case, speak to a family law lawyer.

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Imputing Income for Support Purposes

If you live in Ontario and are involved in a family law matter, you may have heard about the possibility of someone (perhaps you) being imputed with income. What does this mean?

The Child Support Guidelines (both at the provincial and federal level) give the Court the power to make a finding that a payor of child support should be treated, for the purposes of a court case, as if he or she were making an income which is not actually being received by that person.

There are a number of scenarios in which this may take place. By way of one example only: a parent claims that he or she cannot pay support because they are jobless and yet, that parent cannot provide a persuasive reason for their being unemployed. Plainly put, if a parent deliberately tries to avoid their child support obligations by being without employment, that parent risks being imputed with income by the Court, usually based on their historical ability to earn a particular level of income.

Imputed income is an interesting but complex area of family law and I encourage you to speak to a lawyer about your particular scenario to see if the concept is relevant to your case.

Lump Sum Spousal Support

5 points to ponder when considering lump sum spousal support (not in order of importance - the level of importance of each of these points will depend on the particular circumstances of your case):

1. Lump sum spousal support is generally a one-time payment, as opposed to "periodic" (for example, monthly) payments;
2. A true lump sum support payment is neither taxable in the hands of the recipient nor tax-deductible to the payor;
3. Is is generally accompanied by a comprehensive release of spousal support, which is meant to make this payment final and non-variable;
4. It should be calculated with care and be based on factors including the length of the relationship (not just marriage), the parties' roles in relationship, whether child support is paid and in what amount, and the life expectancy of the payor and recipient;
5. When calculating the right amount of the lump sum, do not forget to consider the unique tax treatment of these payments  - ie: take into account that the sum will have no tax consequences for either party. The payor will make the payment using net dollars (money on which he or she has already paid tax) and the recipient will receive the payment on a tax-neutral basis as well. For example, when calculating what lump sum three years of periodic payments would represent, it is not appropriate to simply multiply the amount of support payable per month by 36 months. This is because periodic payments have different tax consequnces to both the payor and recipient.

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Income and support obligations

For the purposes of determining a payor's support obligations (assuming he or she has any), income is not just money they "bring home".  For both child and spousal support, it is the gross income of the payor which is used to determine the extent and amount (we call this "quantum") of their payments.

The Federal Child Support Guidelines (and their provincial counterpart) give judges broad powers to "tag" various forms of income for support purposes. For example, if you are a business owner, you should not assume that it is only the income on which you are taxed by CRA which will determine how much support you pay. As I tell my clients often, in this area of the law "what is good enough for the tax man may not be good enough for a family law judge" meaning that over time, family law in Ontario has carved out special rules relating to income for support purposes. Areas which are vulnerable to consideration under the heading of "income" include (but are not limited to) salaries paid to non-arm's-length parties, personal expenses deducted (even if such a deduction is accepted by CRA), earnings left in the company and not drawn out without a valid explanation and bonuses. In certain circumstances, even cashed RRSPs can be considered income for support purposes.

If you would like more information, I suggest you consult a lawyer in your area but in any event, as a first source, you should turn to the specific wording of the Child Support Guidelines and their companion Schedules.

The ebb and flow of the tide...

Child/Spousal Support and CRA

Periodic child support payments, unlike spousal support, are made in Ontario on a tax-neutral basis. This means that they do not form part of the income of the recipient and are not deductible to the payor. 

The preceding statement must be approached with some caution because there are some payments made by parents, effectively being child support, which do have tax consequences. For example, daycare expenses can have tax consequences to the payor, and favourably so. Depending on the age of the child, either all or some of those expenses may be deductible for tax purposes. Again, depending on the child's residential arrangements, a parent may deduct those expenses (while the other parent does not) and in such a case, the deduction may affect the way the amount owing by the non-deducting spouse is calculated in the first place. By way of a simple example, if the annual cost of daycare is $5,000, in calculating at what proportion the parents will share the expense, one must consider which parent will take the tax deduction and in what amount.

Periodic spousal support, on the other hand, is taxable as income in the hands of the recipient and tax-deductible to the payor. A different tax treatment applies to lump sum spousal support payments.