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Legal and Accounting Fees – Deductibility for Divorce and Separation

Income Tax legislation related to whether or not legal fees and accounting fees can be deducted related to divorce and separation are somewhat confusing. The quick answer is that, subject to very specific rules, someone entitled to receive taxable support may deduct legal and accounting fees to obtain, increase or defend the receipt of that support, including costs to collect arrears. A payer of support may not deduct fees.

You may wish to read publication P102 Support Payments published by the Canada Revenue Agency (CRA). This publication is available by telephoning CRA (1-800-959-8281) or on the CRA web site .  A more thorough document from CRA is their Income Tax Folio, S1-F3-C3, Support Payments (paragraphs 3.78 and subsequent) available on their web site.  Interpretation Bulletin IT-99R5, Legal and Accounting Fees is out of date with respect to deductibility of such fees.

Fees related to child and spousal support

Court decisions confirm that there is an existing property right to receive child and spousal support.  Costs to enforce this right can be deducted.  This means that fees incurred to obtain or increase support payments will be deductible. What if you are unsuccessful? The guidance in CRA publication P102 Support Payments states that fees are deductible by recipients who “try to get an increase in support payments.” They state that legal and accounting fees are deductible by the recipient even where the claim for support was unsuccessful as long as the claim was made in good faith and not frivolous, with a reasonable chance of success (Income Tax Folio S1-F3-C3).

Fees paid by the payer to defend against a requirement to pay support, or to reduce the amount of support payments, will not be deductible. These are not fees to enforce an existing right to income and are considered personal expenses. The law allows fees paid to obtain child support to be tax-deductible, even though child support itself is not taxable under current legislation. This is not a typical scenario in the Income Tax Act.  The exception exists because child support is not included in the technical definition of “exempt”  income. With respect to spousal support, if the support is taxable, the related fees will be deductible.

Individuals (and their legal counsel) are not allowed to agree between themselves as to whether they need to report spousal support as income. I have seen legal agreements stating that the payer agrees not to deduct monthly support and the recipient will not include it in income for tax purposes. This is not an option.  If the amounts qualify as spousal support, the recipient must always report it on their tax return – that is the law.

For deductions, the payments must qualify as support

To claim fees, it is very important that the amounts qualify as “support.” Generally, the amount must be paid on a regular periodic basis, and not be a lump sum payment. It must also be for maintenance of the spouse or child(ren), and not as a payment for division of assets or for other services.  There are certain other qualifications also.  (See Income Tax Act subsection 56.1(4) and the aforementioned Income Tax Folio, S1-F3-C3, Support Payments). If the fees are paid to obtain a lump sum payment in lieu of periodic payments, the fees will not be deductible with one exception. This exception is when legal actions are taken to collect arrears, and the arrears are paid in one amount. However, fees to obtain a lump sum payment in lieu of ongoing support payments are not deductible.

Spousal support payments received from a US resident that would be taxable if received from a Canadian resident are generally non-taxable to a Canadian resident on their Canadian tax return based on the Canada-US tax treaty.  However, such payments still qualify as “support” in accordance with the Income Tax Act, and, consequently, the professional fees to collect such support payments are still tax-deductible.

As a final matter, you should not confuse payment of support with periodic payments related to division of assets. Sometimes, the lump-sum payment for equalization of assets is paid in instalments over a period of time. These amounts are not support payments, are not taxable to the recipient or deductible to the payer.  Related legal fees are not deductible.

More specific information is available from the CRA web site .

How much of your total fees are deductible?

The general rule in the Income Tax Act is that only amounts paid to earn income are tax-deductible. Consequently, professional fees for equalization of assets, establishing custody and parenting plans, and for obtaining a divorce decree are not deductible. However, fees to obtain child or spousal support are a different matter, as discussed above.

Obviously, professionals need to tell their clients what portion of their fees relate to child or spousal support services. If this is not clearly reported on the billing, you need to contact your lawyer or financial advisor and get that breakdown in writing. This deduction is often verified by the Canada Revenue Agency, so be prepared by having your paperwork ready.

When (in what year) are these fees deductible?

The fees are deductible when they are “incurred”, not when paid. The Canada Revenue Agency have indicated that they consider the term “incurred” to mean when the bill is provided to the client. If the court case carries on for three years with a billing provided at the end of the case, all of the fees would be deductible in that final year, regardless of when the bill is paid.

On the other hand, if the lawyer and financial professionals bill every year throughout the negotiations, the fees would be deductible on a year by year basis. The problem in that situation is knowing whether the fees will result in a successful claim for support. Often, until negotiations are concluded, one does not know for certain whether support will be received.  If it is received, the fees will only be deductible if the support itself meets the official definition of support.  For example, is spousal support taxable to the payer and deductible to the recipient; is child support paid on a regular periodic basis for maintenance of the child.  It may be necessary to amend prior year tax returns depending on the outcome.  If the fees are deductible but were not previously claimed in the year they were billed, then you should request an amendment to the early year’s return.  If you claimed fees in a prior year, but determine that they are not deductible, a correction should also be made.  If CRA verifies your deduction before your case is settled, they may disallow your claim until a final determination can be made.

In some cases, your fees may exceed all of the other income you receive. If this creates a loss on your tax return, it can be carried back three years (use form T1A) and/or forward to the future for up to twenty years. For correct processing by the Canada Revenue Agency and by your own computer software, ensure your fees are reported on the right line.  They should be reported on Schedule 4 as a carrying charge, and deducted on line 221 of your return.

Shared Custody – a Special Situation

As I noted above, only the recipient of support may deduct fees. An interesting situation arises in shared custody cases, which is when each parent has custody of the same child(ren) between 40% and 60% of the time. Child support for shared custody is normally calculated by determining the amount that each parent will pay to the other parent. In such a situation, both parents will be recipients (as well as payers) of support.  You would think that both should be able to claim their legal and accounting fees. However, this is not how the Canada Revenue Agency and the tax courts see it.

As noted above, child support for shared custody is normally calculated by determining the amount that each parent will pay to the other parent. For convenience, and for easier enforcement, the parents normally agree to offset the two payments. As a result, the higher income parent will make a set-off payment to the lower income parent. Based on several court cases, the CRA has indicated that only the recipient of the set-off payment will be able to claim legal fees.  Even if two separate cheques are written, one by each parent to the other, only the person receiving the higher amount will be able to deduct his or her fees.  As referred to earlier, the ability to deduct legal fees is based on that person’s “existing property right”.  The CRA’s interpretation of court decisions is that only the person receiving the net benefit has this right and can claim the fees.

The rules for claiming fees are not consistent with the rules for claiming the eligible dependant tax credit for the children.  The Income Tax Act (subsection 118(5.1)) provides that when each parent must pay support to the other parent, in a shared custody situation, then they will treat the situation as if both parents are paying support amounts.  This is the case as long as the child support agreement provides for separate payments.  This particular rule has nothing to do with deductibility of legal fees; it only relates to the eligible dependant claim.  Legislation for the eligible dependant credit is based on who has an obligation to pay child support, whereas the deduction for legal fees relates to who is deemed to have an existing property right to receive support.

Split Custody – Another Situation / Another Interpretation

Split custody arises where there are two or more children, and each parent has sole custody of at least one child.  In such cases, a similar situation for payment of support may arise as in shared custody discussed above.  Each parent will owe money to the other for support.  The difference in this situation is that 100% of the support for one child is only being paid by one parent – it is not a shared scenario for the same child.  In accordance with the Tax Court case, Rabb v. The Queen, 2006 TCC 140, the CRA interpretation is that both parents will be able to claim their legal fees for split custody arrangements, even in set-off situations.

Concluding Remarks

Legal and accounting fees can be substantial – tens of thousands of dollars in cases where spouses and their advisors will not cooperate to reach an agreement within a reasonable amount of time. While a portion of your fees may be deductible, it will be far better for both parties to be emotionally balanced and open to fair negotiations. Speak with a family professional to help you deal with your emotions, and to help you with a parenting plan for your children in their new environment. Then, hire legal and financial advisors who understand family law (such as lawyers specializing in family law and Chartered Financial Divorce Specialists).  Ensure they want to negotiate a fair solution, as opposed to those who insist on “getting you more” (at your expense) even when the proposed settlements are reasonable. It may sound biased coming from me, but I recommend that you obtain financial advice before finalizing any agreements to ensure you understand the long-term cash flow issues, as well as the tax treatment.

Blair Corkum, CPA, CA, R.F.P., CFP, CFDS, CLU, CHS holds his Chartered Professional Accountant, Chartered Accountant, Registered Financial Planner, Chartered Financial Divorce Specialist as well as several other financial planning related designations. Blair offers hourly based fee-only personal financial planning, holds no investment or insurance licenses, and receives no commissions or referral fees. This publication should not be construed as legal or investment advice. It is neither a definitive analysis of the law nor a substitute for professional advice which you should obtain before acting on information in this article. Information may change as a result of legislation or regulations issued after this article was written.©Blair Corkum