A Recent U.S. Tax Reform is Impacting Canadians Receiving Alimony
In this blog, find out how a recent shift in how the U.S. treats alimony payments has resulted in a difference in tax treatment between the U.S. and Canada on alimony paid and received.
After years of an unhappy marriage, John and Kathy decided to separate. Kathy moved to live in Colorado and John remained at his home in Ontario.
In January 2019, they finalized their divorce proceedings and Kathy was required to start making monthly alimony payments of $1,300 USD to John. The amount was agreed upon with the expectation that Kathy would get a tax deduction for the amounts paid.
To Kathy’s surprise, her U.S. tax advisor has now noted that because her divorce was finalized after December 2018, her alimony payments will no longer be deductible in the U.S.
Additionally, John’s Canadian tax advisor has noted that he will not be taxed in Canada on the alimony payments he receives from Kathy.
Kathy asked her tax advisor to explain why the treatment of the alimony payments had suddenly changed?
Her tax advisor provided her with the following summary:
“On December 22, 2017 the United States Congress passed “The Tax Cuts and Jobs Act”. This piece of legislation made numerous changes to the Internal Revenue Code (“IRC”), including repealing the deduction available Section 215 on alimony established or modified after December 31, 2018. It also modified paragraph 61(a)(8) of the IRC to eliminate the income inclusion for alimony received.
For Canadians, Article XVIII paragraph 6 of the Canada-U.S. Tax Convention (“the Treaty”) addresses the impact of these changes to Canadian residents.
In essence, subparagraph 6(a) states that the country in which the recipient of the alimony is resident has the right to taxation on the payments. Subparagraph 6(b) states that in spite of the rule set out by subparagraph 6(a), if the recipient of the alimony would not be taxed in the payer’s country of residence, than that same protection would flow through to the recipient’s country.
In short, in cases where alimony is paid by a U.S. resident to a Canadian resident, if the U.S. wouldn’t tax a U.S. resident on the receipt of the alimony, the Treaty will act to also prevent Canada from taxing its residents on alimony income received from the U.S.”
The impact of the reform on alimony tax:
This fundamental shift in the way the United States of America treats alimony payments has resulted in a difference in tax treatment on alimony paid and received between the United States of America and Canada.
For this reason, it is important that professional advisors establish the citizenship and residency of their clients in negotiating a divorce settlement and contemplate the impact that any post-2018 modifications to a settlement may have on the tax position of the payer and the recipient.
For further information or to discuss how this reform could affect you more specifically, contact the Cross-Border Tax Services Team at Davis Martindale who would be happy to help.