Personal Finance

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Among the challenges of separation and divorce is determining whether spousal and child support will be payable, and, if so, how much and for how long. For anyone going through this process, it’s important to take the tax consequences into account when structuring a separation agreement.

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The Income Tax Act distinguishes between spousal support and child support, with different tax rules for each. Spousal support includes any amounts paid on a periodic basis, under a court order or agreement, for the support of a former spouse or common-law partner. Child support, on the other hand, includes any support payments that are not specifically identified in that order or agreement as being only for the former spouse’s or partner’s use. In both cases, the former spouses or partners must be living apart after the breakdown of their marriage or relationship.

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If the court order or separation agreement only provides support for a spouse or partner, then the payments are fully taxable to the recipient and tax deductible to the payor. To ensure tax deductibility, the order or agreement must be registered with the Canada Revenue Agency. To do so, the former spouses or partners should complete CRA Form T1158 Registration of Family Support Payments and include a copy of the order or agreement.

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If, on the other hand, the order or agreement is solely for the support of children, the payments are neither taxable to the recipient nor tax deductible to the payor, so there is no need to register the agreement with the CRA.

If the agreement contains both spousal and child support, and it clearly indicates a separate amount for a spouse or partner, then this portion of the payments will be deductible and taxable. But how formal does the agreement need to be for the support payments to be tax deductible? A recent tax case dealt with this specific issue.

The case involved a taxpayer who got married in 2006, and legally separated on Dec. 8, 2010. In March 2011, the couple entered a separation agreement, signed by both parties. The couple chose to prepare the separation agreement on their own without using lawyers. In the section dealing with spousal support, the agreement stated: “Party 1 shall pay spousal support to party 2 in the amount of $3,500 monthly commencing Dec 8/10 and ending Dec 8/14.”

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The dispute with the CRA, however, involved the 2018 taxation year because the taxpayer continued to make spousal support payments beyond the 2014 end date in their agreement. On his 2018 tax return, he deducted spousal support payments of $42,000 (12 times $3,500), while his ex-spouse included the $42,000 on her return as income.

The CRA reassessed the taxpayer and denied his deduction for spousal support on the basis that the payments did not fall within the definition of “support amount,” because, in the CRA’s view, the spousal support payments were not made by the taxpayer pursuant to a written agreement.

The judge reviewed the 2011 separation agreement and called it “flawed from the outset.” He noted the signatures of the spouses were not witnessed, and there was a handwritten clause at the bottom of the contract stating the agreement was “subject to approval by legal counsel.” There was no indication such approval was ever obtained.

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Nonetheless, the reality is that the two separated spouses honoured the terms of the written agreement, with the taxpayer paying $3,500 per month in spousal support throughout the term of the agreement and for several years thereafter.

The taxpayer took the position that the March 2011 separation agreement, despite not being properly updated after 2014, constituted an agreement in writing under which he made support payments in 2018.

The CRA argued the support payments in question were not made pursuant to a written agreement. The previously existing separation agreement had expired in 2014, and, therefore, no agreement obliging the taxpayer to pay spousal support existed in 2018.

The judge noted in his analysis that there has been a lot of litigation concerning the issue of whether support payments were made pursuant to a written agreement. As to why a written agreement is necessary, he quoted a prior decision of the Federal Court of Appeal that concluded: “The rationale for not including separated spouses involved in payments made and received pursuant to a verbal understanding is readily apparent. Such a loose and indefinite structure might well open the door to colourable and fraudulent arrangements and schemes for tax avoidance.”

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The judge then turned to the facts of this case, which he noted “is clearly not a fraudulent scheme.” The parties agreed in 2011 in writing to an amount to be paid as spousal support. They “incorrectly overlooked” the need to update the contract in 2014 in order to properly reflect the taxpayer’s continued support obligations.

But since the two parties continued to consider themselves bound by their 2011 separation agreement through the 2018 taxation year, such conduct supports the conclusion that a “meeting of the minds continued to exist concerning spousal support obligations.” In other words, the support established in the 2011 separation agreement was treated by the parties as continuing to be in force up to, and including, 2018.

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The judge, “guided by the plain meaning of the words of the act,” concluded the payments were, indeed, made pursuant to the terms of a written agreement. The payments satisfied the requirements under the Income Tax Act that the support was “an amount payable … on a periodic basis for maintenance … under a written agreement,” and thus should be tax deductible to the taxpayer on his 2018 return.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com.

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I’ve already made my 2023 tax-free savings account (TFSA) contribution … have you?

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The new TFSA dollar limit is $6,500 for 2023. And if you’ve never opened a TFSA before, the new cumulative limit could be as high as $88,000 if you’ve been a resident of Canada and at least 18 years of age since 2009.

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Making my contribution was as easy as electronically moving funds from my bank account to my TFSA, which provides a lifetime potential of tax-free investment income and unlimited tax-free gains on the funds’ growth. My intention is to use those funds in retirement, but TFSA funds can be withdrawn, tax free, at any time, for any purpose, such as buying a new car, a wedding reception or a down payment on a home.

No matter what you choose to do with your TFSA funds, keep in mind that one of the biggest benefits of the TFSA, beyond the tax-free income and growth, is the flexibility to recontribute any withdrawn funds back to your TFSA, beginning the following calendar year. You’re also able to transfer funds from one TFSA to another, but it must be done via a direct transfer, rather than a withdrawal and recontribution.

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Taxpayers who don’t appreciate the nuances of the TFSA recontribution or transfer rules, however, could find themselves in trouble with the taxman for overcontributing. That’s exactly what happened in a case decided in late 2022.

The taxpayer’s troubles began in early 2020, when, needing to move closer to his young daughter after separating from his wife, the taxpayer withdrew $50,000 from his TFSA with the intention of making an offer on a new home. He said he did this before actually finding a home because “in a hot housing market in which there were often bidding wars for the same home, a competitive bid necessitated that funds be in hand for an offer to be accepted within a very short period of time.”

The taxpayer quickly realized the housing market was simply “too hot for his financial wherewithal,” so he did what he assumed was “the reasonable thing to do” and deposited the same funds back into his TFSA on Feb. 6, 2020. Unfortunately, the taxpayer’s TFSA contribution room for the 2020 taxation year was only $10,000, such that the redeposit of $50,000 triggered an overcontribution for the month of February of about $40,000.

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But things became even more complicated later that month when the taxpayer, in an attempt to consolidate two TFSAs into one account, transferred that same $50,000 from the TFSA into his regular savings account and then into a second TFSA on the same day.

From the taxpayer’s perspective, he was simply transferring funds from one TFSA to another. But from the Canada Revenue Agency’s perspective, the transfer via the savings account on Feb. 20, 2020, triggered a second TFSA contribution of $50,000 for the month of February 2020.

In the end, what was “simply an honest mistake” caused a massive 2020 overcontribution in the eyes of the CRA to the tune of $112,000. (The taxpayer made $22,000 of additional TFSA contributions during the rest of 2020).

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Under the Income Tax Act, there’s a penalty of one per cent per month for each month there is a TFSA overcontribution. As a result, the taxpayer in July 2021 received a notice of assessment from the CRA, charging him a penalty tax of $6,270, along with $332 in penalties and interest.

The act, however, allows the CRA discretion to grant relief, and states that a CRA officer may waive or cancel the penalty tax if the excess arose through “reasonable error” and is corrected by the individual “without delay.”

The taxpayer wrote to the CRA to request it cancel the assessment, arguing that “he was not aware that redepositing the same funds that were withdrawn during the same taxation year would constitute additional contributions.”

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The taxpayer’s request was denied by the CRA in September 2021 on the basis that even though his TFSA overcontribution was unintentional, it did not consider the taxpayer’s misinterpretation of the contribution rules to be a “reasonable error,” since the taxpayer had, back in 2013, already been granted relief on a TFSA overcontribution.

In October 2021, the taxpayer submitted a second request for the CRA to cancel the assessment, which was again denied. The taxpayer then took the matter to Federal Court, where the judge’s role is to determine whether the CRA officer’s refusal to exercise their discretion to deny the taxpayer relief was “reasonable.”

As in prior cases, a reasonable decision is one that is “based on an internally coherent and rational chain of analysis and that is justified in relation to the facts and law that constrain the decision maker.” Generally, a CRA decision is not set aside unless it contains “sufficiently serious shortcomings … such that it cannot be said to exhibit the requisite degree of justification, intelligibility and transparency.”

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Arguing one’s general ignorance of the law is not, by itself, sufficient to demonstrate an error was reasonable. Rather, “reasonable error” is limited to situations where the overcontributions occurred for reasons outside the taxpayer’s control, which can include bank errors, physical disasters, civil disruptions, a serious illness or accident, or distress.

The judge was sympathetic towards the taxpayer, but nonetheless concluded he was a “repeat overcontributor” and did not make a reasonable error in overcontributing in 2020, thus the CRA officer’s decision to deny him relief was rational.

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“The threshold for the determination of a reasonable error is high as our tax rules are based on a self-reporting system that relies on taxpayers to understand or be informed of the law and to take reasonable steps to comply with (it),” the judge said. “For TFSA purposes, taxpayers are responsible for being aware of their contribution limits and for ensuring that their contributions comply with applicable rules.”

In the end, the judge simply felt the excess TFSA contributions were made by the taxpayer because of his misunderstanding of the rules, and not, therefore, the consequence of a reasonable error, which may have warranted relief.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com.

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Given the high inflation we experienced in 2022, many of the important tax figures have been substantially increased for 2023. Here are the new numbers, along with a few other changes that launch on Jan. 1.

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Inflation adjustment factor: Most (but not all) income tax and benefit amounts are indexed to inflation. In November 2022, the Canada Revenue Agency announced the inflation rate to be used to index the 2023 tax brackets and amounts would be 6.3 per cent.

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Increases to the tax-bracket thresholds and various amounts relating to non-refundable credits take effect on Jan. 1, 2023. But increases for certain benefits, such as the GST/HST credit and Canada Child Benefit, only take effect on July 1, 2023. This coincides with the beginning of the program year for these benefit payments, which are income tested and based on your prior year’s net income, to be reported on your 2022 tax return due this spring.

Tax brackets for 2023: All five federal income tax brackets for 2023 have been indexed to inflation using the 6.3-per-cent rate. The new federal brackets are: zero to $53,359 (15 per cent); more than $53,359 to $106,717 (20.5 per cent); more than $106,717 to $165,430 (26 per cent); more than $165,430 to $235,675 (29 per cent); and anything above that is taxed at 33 per cent.

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Each province also has its own set of provincial tax brackets, most of which have also been indexed to inflation, but using their respective provincial indexation factors.

Basic personal amount (BPA): The BPA is the amount of income an individual can earn without paying any federal tax. The government in December 2019 announced an increase in the BPA annually until it reaches $15,000 in 2023, after which it will be indexed to inflation. As a result, the increased BPA for 2023 has been set by legislation at $15,000, meaning an individual can earn up to this amount in 2023, before paying any federal income tax.

For taxpayers earning above this amount, the value of the federal credit is calculated by applying the lowest federal personal income tax rate (15 per cent) to the BPA, making it worth $2,250. Because the credit is “non-refundable,” it’s only worth the maximum amount if you would have otherwise paid that much tax in the year.

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But higher income earners may not get the full, increased BPA since there is an income test. The enhanced BPA is gradually reduced, on a straight-line basis, for taxpayers with net incomes of more than $165,430 (the bottom of the fourth tax bracket for 2023) until it gets fully phased out when a taxpayer’s income tops $235,675 (the threshold for the top tax bracket in 2023).

Taxpayers in that top bracket who lose the enhanced amount will still get the “old” BPA, indexed to inflation, which is $13,521 for 2023.

CPP (QPP) contributions: The Canada Pension Plan contribution rate for 2023 is 5.95 per cent (6.4 per cent for the Quebec Pension Plan) with maximum contributions by employees and employers set at $3,754.45 ($4,038.40 for QPP) in 2023, based on the new yearly maximum pensionable earnings of $66,600 (with a $3,500 basic exemption.)

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For self-employed Canadians who must contribute twice the amount, the maximum CPP contribution for 2023 will be $7,508.90 ($8,076.80 for QPP), up from the 2022 amount of $6,999.60 ($7,552.20 for QPP).

The CPP hike is part of a multi-year plan approved six years ago by the provinces and the federal government to increase contributions and benefits over time.

EI premiums: Employment insurance premiums are also rising, with a contribution rate for employees of 1.63 per cent (1.27 per cent for Quebec) up to a maximum contribution of $1,002.45 ($781.05 for Quebec) on 2023 maximum insurable earnings of $61,500.

Tax-free savings account (TFSA) limit: The 2023 TFSA contribution limit will increase for the first time since 2019 to $6,500 (from $6,000). The cumulative TFSA limit is now $88,000 for someone who has never contributed to a TFSA, and has been a resident of Canada and at least 18 years of age since 2009.

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RRSP dollar limit: The registered retirement savings plan dollar limit for 2023 is $30,780, up from $29,210 in 2022. Of course, the amount you can contribute to your RRSP is limited to 18 per cent of your 2022 earned income, which includes (self)employment and rental income, less any pension adjustments, up to the current annual dollar limit.

Old Age Security (OAS): If you receive OAS, the repayment threshold for 2023 is set at $86,912, meaning your OAS will be reduced in 2023 if your taxable income is above this amount.

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First Home Savings Accounts (FHSA): Legislation to create the new tax-free FHSA was recently passed, paving the way for it to be launched as early as April 1, 2023. This new registered plan gives prospective first-time homebuyers the ability to save $40,000 on a tax-free basis towards the purchase of a first home in Canada.

Like a RRSP, contributions to an FHSA will be tax deductible, but withdrawals to purchase a first home, including from any investment income or growth earned in the account, will, like a TFSA, be non-taxable. The new legislation confirms that a first-time homebuyer can use both the FHSA and the existing Home Buyers’ Plan to purchase their first home.

Multigenerational Home Renovation Tax Credit: Jan. 1 also marks the beginning of this new credit, which is equal to 15 per cent of eligible expenses (up to $50,000) incurred for a qualifying renovation that creates a secondary dwelling to permit an eligible person (such as a senior or a person with a disability) to live with a relative.

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Anti-flipping rules: Finally, new anti-flipping rules for residential real estate are scheduled to come into force on Jan. 1, and are designed to “reduce speculative demand in the marketplace and help to cool excessive price growth.”

The principal residence exemption will not be available on the sale of your home if you’ve owned it for less than 12 months (with certain exceptions). Instead, the gain will be 100-per-cent taxable as business income.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto. Jamie.Golombek@cibc.com

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