Unfortunately, divorce is a fact of life. There is a strong emotional element that often surpasses the attention given to the monetary or tax side of things. The reality is that divorce has a strong business component that may not receive the attention it should.
Below are some issues that are often overlooked resulting in unpleasant surprises when tax time hits.
Children or Adult Dependents
More often than not, parents are awarded shared or joint custody of children. This means that the children spend close to half their time with each parent. Generally, the spouse with the higher income pays child support to the other spouse. Child support received is not taxable income and child support paid is not tax-deductible.
It is obvious that if the higher income spouse was able to claim their spouse as an eligible dependent, after the first year of separation, that credit is lost. Often the newly single parents desire to claim one of their children as an eligible dependent. However, as soon as a person is legally obligated to pay child support, they may not claim that child as an eligible dependent.
The recipient of the child support is eligible to claim the related dependent credits for the child(ren). This treatment of eligibility for dependent credits can create a higher tax burden for the family unit after separation/divorce. Often the spouse receiving child support does not have enough taxable income to fully utilize the dependent tax credits.
Let’s assume that a family has two disabled children that require full-time care. One spouse works full time and one spouse provides full-time care to the children. The higher income spouse claims the spouse as an eligible dependent and claims the disability amount for the two children. Annually a significant amount of taxes paid are refunded.
After the marital breakdown, the parties share custody of the children. The higher-income earning spouse is required to pay child support. The other spouse continues to have no taxable income.
For the higher income spouse:
1) The eligible dependent credit is not available for the spouse or children
2) The child support is not deductible for tax
3) The disability credits for the children are no longer available
Overall, the family unit has the same amount of income but the loss of the eligible dependent and disability credits results in significantly higher taxes.
Although this may be the only option for this family unit, it is important to understand the impact of custody and support agreements. Note that each spouse may be eligible for the Canada Child Benefit (CCB) based on their individual incomes.
The loss of the tax credits to the family unit is somewhat mitigated by the increased CCB received by the lower-income spouse and the access to lower tax rates for any amount of spousal support paid. It is unlikely that this would fully compensate for the change in the family unit’s tax burden.
Although there is not a lot of flexibility in altering these types of arrangements, it is critical to understand the full impact on the cash in your pocket.
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Disclaimer: This article is intended for general information only and is not intended as legal opinion or advice. The views and opinions expressed do not reflect the official position of BNG Bossy Nagy Group or any other affiliate.
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