Refresher on the logic behind income and other gross ups
Fifteen months and counting into the worldwide pandemic experts have commented on the noticeable increase in separations and divorce, particularly among parties who may have been struggling even before the pandemic.
This increase has created an even greater need to reasonably determine the separating parties’ incomes for child and spousal support purposes. While many think of “income” as coming from employment and reported on a T4 slip, this is not always the case. “Income” may come from many different sources. One aspect of that income determination is identifying a reasonable dollar amount where the available resources are non-taxed or unreported. This often requires that dollar amount to be “grossed up.”
In the context of child and spousal support calculations, “grossing up” an amount usually means converting a number from a cash-based amount to a pre-tax amount so that it may be used in a specific type of calculation. There are two types of gross ups that may be necessary:
- converting a cash source of income to a pre-tax equivalent; and
- converting non-taxed child support to the equivalent gross amount as if it were tax deductible.
The latter is required when applying one of the “gross income” formulas found in the “Spousal Support Advisory Guidelines” (SSAG). This would be the case where the formula determines the suggested spousal support range by looking at a percentage of income before any tax considerations, but adjusts the available income by child support considerations.
Quick and dirty gross ups are often done by simply increasing the cash amount by a marginal tax rate. While this approach may create a “pre-tax” number, it rarely creates an equivalent pre-tax number. An equivalent pre-tax number is one that does not change the person’s bottom line or cash position. It should simply substitute the cash amount for a pre-tax amount that leaves the person no better or worse off than they were to begin with. Ideally this is what support calculating software should do when a gross up is required, and in fact it is exactly the approach taken by the ChildView software program.
Why should the focus be on cash? With respect to child support, the answer is that child support, like most other obligations, is paid with after tax dollars (ie: cash). Even though the Child Support Guidelines look at a concept of “gross income” in setting the base table amount of child support, the resulting support is paid with after tax dollars. It follows that the amount of resources the person has before the payment of the child support obligation, is a fixed amount; therefore, the determination of this bottom line should not change whether a component of it is grossed up or not.
With respect to grossing up a non-tax deductible child support amount when applying certain SSAG formulas, the need is to subtract apples from apples. Subtracting a cash amount from the pre-tax income amount would result in a meaningless number.
When doing an income gross up for child support purposes, the first thing to consider is what is trying to be accomplished. In this case, the goal is to determine how much the gross amount of income would be if the non-taxed or unreported source of cash was taxed as a particular type of taxable income, such as employment income. While applying a marginal tax rate might be easy, it does not necessarily produce an equitable result. It ignores many of the interrelationships in the Income Tax Act, such as the interplay between income and the significant family benefits paid out by the governments, including the Canada Child Benefit (CCB).
Therefore, for the income gross up to achieve the desired result of representing a pre-tax equivalent of the original cash amount, the amount of money or cash in the person’s pocket should not change. If a person has $30,000 in their pocket at the end of the day, grossing up part of the input should not increase that $30,000, regardless of whether the original cash amount or the substituted grossed up amount is used in the cash analysis.
A cash analysis considers the person’s gross (ie: pre-tax) amounts of income, adds any non-taxed or unreported cash and deducts the cash outlays, such as income taxes, Canada Pension Plan (CPP) contributions and Employment Insurance (EI) premiums where applicable, medical expenses and anything else needed for the tax and benefit calculations that require the payment of money. It is this bottom line that should not change when a grossed-up amount is substituted for the non-taxed or unreported cash in the analysis.
An equitable gross up requires an understanding of the interrelationships within our income tax system of taxes, credits and government benefits. As noted above, these complexities go beyond a consideration of tax rates alone. Different sources of income may have different tax effects. Employment income has a different tax effect than Canadian dividends, for example. Employment income is considered “earned income” in determining the amount of child care expense that may be deducted; whereas Canadian dividends are not. Employment income may be pensionable and insurable thereby triggering CPP and EI contributions and the related non-refundable income tax credits. Canadian dividends do not.
Further, taxed sources of income impact the amount of most government benefits a person may receive whereas cash sources do not. In a family situation, the most prevalent government benefit is the CCB and the related provincial and territorial programs. These government initiatives are needs-based and amounts are usually clawed back based on the person’s adjusted family net income. This impact needs to be factored into the calculation of the grossed-up income if the person’s bottom line is to be maintained.
When a gross up is done using the ChildView software, all the complexities mentioned above are automatically taken into consideration. Income gross ups are done using the integrated ChildView Gross Up Calculator. With the input of the cash amount and the choice of original source and desired conversion, the correct amount of pre-tax, source specific income for the particular party is calculated. These results may be automatically used in the support calculations generated by the software, and the calculator’s report provides full discloser of the gross up. ChildView’s method recognizes that different individuals have different tax and benefit situations that will drive the pre-tax amount and that different types of income have different tax effects.
This same gross up method is used when automatically converting non-taxed child support to the equivalent tax deductible amount in ChildView’s Spousal Support Advisory Guideline Calculator. Full discloser of this gross up is provided within the SSAG calculator.
Income determinations may be challenging but support software should be party neutral. No favours are done for the family when an income determination method is used that inflates one party’s resources beyond what they really have available.
Susan Roberts is president of ChildView Inc.