Divorce would be much simpler without children or money. In fact, that’s really all there is to argue about once the tears have dried. However, you cannot simply divide up the money and go your separate ways – the taxman wants his share. Here is what you need to know about divorce and taxes.
When deciding how to divide up the family assets, we include the future tax burden that has been incurred on that asset. For example, if a family owns an investment property for which capital gains are payable. The capital gains tax burden is taken into account when calculating the value of the asset when it is being transferred from one party to the other (if the property is being sold to a third party, then the capital gains actually incurred are those paid). If this tax burden is not taken into account then one person could end up paying the taxes on an asset that the other person received the benefit from. Don’t forget that capital gains are payable on portions of properties as well, such as basement suites in family homes.
This capital gains tax burden calculation occurs whenever there is an asset for which a capital gains are payable when it is cashed out, and is also applies to personal investment portfolios.
However, there are some investments that can be transferred without triggering such a tax burden. Spousal rollovers are available for TFSA, DPSP, RESP, RPP, RRSP, or RRIF accounts pursuant to a separation agreement or a court order. In such cases the transfer is made directly between the registered plans of the two spouses.
Businesses and Corporate Taxes
The future tax burden is also taken into account when valuing a company. It important to look at the tax consequences to the individual and to the business itself, as the sale of a company can trigger both. This can be a complicated calculation that is affected by the history of the company’s financial transactions and tax elections, the composition of the corporation, and the potential sale structure. An ill-conceived separation agreement could inadvertently value the business unfairly, or even negatively affect the viability of the business into the future.
Generally speaking spousal support is counted as income for the person who receives it, and is an income deduction for the person who pays it. I say generally, because there are some exceptions that I will discuss below. While the Canada Revenue Agency (CRA) asks how much child support was paid and received, these payments do not change your income.
When either child support or spousal support is paid, the CRA would like to see the actual payment made. Family finances can be complicated and people like to simplify matters, but if you owe $950 in spousal support it is generally not sufficient to just pay $650 and say that the $300 is what is owed to you from your spouse for the child’s skiing lessons. If you are tempted to get creative, just speak with your accountant and they’ll set you straight.
Payments to third parties can be considered part of a spousal support payment under certain circumstances. For example, this would occur when a spouse who wants to claim $950 in periodic spousal support payments pays $650 directly to their spouse and $300 to Tesla on behalf of their spouse for a car lease payment. In order for the payor to be able claim the $300 a month paid to Tesla as spousal support, and receive the appropriate income tax deduction, very specific language must be included in the agreement or order for the CRA to recognize that payment to Tesla as spousal support.
Some spousal support can be received tax-free. Periodic spousal support means that the payments are made regularly. It is most commonly paid every month, but it can be paid at any agreed upon schedule such as every two weeks or even every year. Lump sum spousal support is when the entire payment for spousal support is made at one time. While periodic support has income tax consequences, lump sum spousal support is not tax deductible. This means that when you are thinking about how much the lump sum payment should be, the lack of tax consequences should be taken into account. It’s not sufficient to simply add up the number of periodic payments that should be made and pre-pay it all at once, because that could lead to an unintended tax burden for the payor and a windfall for the recipient.
It is not uncommon for people to start paying spousal support voluntarily, especially in the initial months after the separation before lawyers are involved and the terms are finalized. There are many good reasons to this, but you should know that you generally won’t receive the tax benefit of making those voluntary periodic support payments unless they are pursuant to an order or an agreement. However, you are able to claim the tax benefit for the current year and the year prior if those terms are included in a subsequent order or agreement. Often the person who received spousal support tax free is not very keen on this, as they will be receiving a tax bill from the CRA.
The good news is that legal fees that were incurred to seek or obtain child support or spousal support are tax deductible.
Other tax issues
As you can imagine, this is not a comprehensive list of all of the places tax considerations need to be taken into account when resolving the terms of a separation. Every time money is involved, there is likely a tax consideration to be factored in, for everything from family debt to income imputation to special and extraordinary expenses.
Keeping it in the Family
Your lawyer will have many goals for how to resolve your separation, and one of those goals will be keeping as much money as possible in your family. We make sure that there are no inadvertent slips that result in the CRA getting more and you getting less.
Likewise, when reaching the terms of a final agreement, the tax consequences must be taken into account so that one person doesn’t end up paying for the other person’s share of the tax burden. No one wants to pay their ex’s bill to the CRA.
The lawyers at Connect Family Law work with a wide range of tax professionals and business experts who are able to assess the effect of different scenarios and the tax burden each will trigger. This means that when we get to the bottom line, everything has been taken into account. The best outcome is when you feel like you got a good deal, and your accountant agrees.