When there is a divorce or separation, family law will attempt to clarify responsibilities for support and the division of family assets.
The tax implications of transferring the assets will likely determine how the assets are to be divided to ensure that the individuals maximize their available cash and minimize taxes. Therefore, it is important to understand the tax implications and engage tax professionals early in the separation process to ensure all objectives are met. This article will discuss the tax implications of the following:
- Division of property
- Support payments
- Tax-deductible expenses
- Government credits
Division of property
Generally, when there is a transfer of property between two individuals, the transfer is usually done at fair market value. Any capital gains that arise from the transfer will be subject to taxation. However, in a divorce or separation, spouses or former spouses may transfer assets to one another on a tax-deferred basis using the spousal rollover. The spousal rollover is available when the transfer results from a settlement of rights arising from a marriage or common-law partnership. The adjusted cost base will remain unchanged when transferred to the former spouse.
In some circumstances, the property transfer between former spouses can be done at fair market value. To transfer the property value at fair market value, both individuals must file an election with the Canada Revenue Agency (CRA). The transfer at fair value may be beneficial when one party has significant capital losses that they want to utilize or if the individual wants to use their lifetime capital gains exemption.
Family home
For most individuals, the family home is the largest asset that is subject to division in a divorce. As discussed above, the family home can be transferred to the former spouse at cost or fair market value. An issue arises when the couple owns more than one property, and both properties are held for personal use. As the family can only designate one property as their principal residence, any other properties would be subject to capital gains when sold. If the divorce agreement is silent on who gets to claim the principal residence exemption (PRE), it will be the first of the spouses to sell one of the properties who can claim the PRE. This suggests that any good separation or divorce agreement should clarify how the PRE will be claimed upon a subsequent sale of a particular property.
RRSPs, RPPs, DPSPs & RRIFs
Upon the breakdown of a marriage or common-law partnership, an individual can transfer assets to their former spouse’s registered plan on a tax-deferred basis. However, once the assets are transferred to the former spouse, the receiving spouse will be liable for future tax obligations when the amounts are withdrawn.
Registered Education Savings Plan (RESPs)
RESPs are unique as the plan’s beneficiaries are the children and not the spouses. However, the subscribers (usually the parents) can control the funds within the RESP and can choose to withdraw the funds.
Former spouses can remain subscribers of the RESP after a divorce or separation. However, if the spouses do not wish to continue to be joint subscribers of the RESP, it can be split and transferred to another RESP on a tax-deferred basis. For the transfer of the RESP to be on a tax-deferred basis, the beneficiaries must remain the same.
Tax Free Savings Account (TFSA)
When there is a breakdown in a marriage or common-law partnership, amounts within a TFSA can be transferred directly from one spouse’s TFSA to the other’s TFSA without affecting the receiving spouse’s contribution room. However, the transfer must be done directly between the TFSAs by the financial institutions.
Canada Pension Plan (CPP)
CPP contributions made when a couple was married or were common-law can be equally divided during or after a divorce or separation. The contributions can be divided even though one spouse did not contribute to the CPP during the period.
Private pension plan
Funds in private (employer-sponsored) pension plans accumulated while the couple was married or considered in a common-law relationship may be included in family property (please check your provincial legislation) and be subject to division upon separation. Generally, the maximum amount that can be split between a former spouse is 50% of the value accumulated during the marriage. However, in some provinces, a judge can order that the allocation be greater than 50%.
Individuals who own a federally regulated pension plan can also assign up to 100% of their pension to an ex-spouse or ex-common-law partner. In addition, if a pension is being paid out during the time of separation or divorce, the former spouse may be entitled to receive up to 50% of the contributing spouse’s monthly benefits.
Support payments
Spousal support is taxable in the hands of the receiving spouse and deductible for the paying spouse when the following conditions are met:
- The amount is payable under an order of the court or written agreement (based on provincial laws);
- The amount of the support payment is specified and on a periodic basis for the maintenance of the receiving spouse;
- The receiving spouse has complete discretion to use the support payment as they wish; and
- The payer and the receiving spouse are living separately and apart.
Child Support payments are not tax-deductible for the paying spouse and are not required to be included in the receiving spouse’s income. However, child support payments negotiated and agreed upon before May 1, 1997, were tax-deductible.
Tax-deductible expenses
Legal fees
Legal fees incurred to get a separation or divorce, to establish custody of or visitation arrangements for a child are not tax-deductible. However, the legal fees incurred for the following are deductible for tax purposes:
- Fees incurred in relation to enforcing payment or defending against a reduction of spousal support
- Legal fees incurred to try to make child support payments non-taxable
Childcare expenses
Childcare expenses are typically claimed by the spouse with the lower net income while a couple is married. After a divorce, if the child is in a shared custody situation, where the child lives with each parent at different times in a year, both parents may be eligible for the childcare expense deduction. Each parent may only claim childcare expenses incurred for when the child resided with them and only to the extent that the costs were paid by them—provided that the expense was to enable that parent to earn an income or obtain an education.
Government payment and credits
Canada Child Benefit (CCB)
Upon divorce or separation, depending on which parent has custody of the child, the revised CCB can vary as it is now calculated based on that specific parent’s new adjusted family income. The maximum CCB in 2020 is $6,765 (for children under 6) and $5,708 (for children aged between 6 to 17).
If the parents share custody of the child, each will get 50% of what they would have received if they had full custody of the child, calculated based on their own adjusted family net income. The CRA will not split the CCB using other percentages or give the total amount to one of the parents.
GST/HST credit
If an individual is recently divorced or separated from their spouse or common-law partner, they may be entitled to the GST/HST credit once the CRA has been notified of the marital status change. The CRA will determine your eligibility (based on your income for the prior year) and inform you if you are entitled to receive the GST/HST credit.
Eligible dependent tax credit
The eligible dependent tax credit is a non-refundable tax credit of $13,229 (2020). An individual may claim the eligible dependant tax credit for a dependent child or other dependent relatives if the following conditions are met:
- You do not have a spouse or common-law partner, and you were not supporting or being supported by a former spouse;
- You supported a dependant during the year; and
- You lived with the dependant in a home that you maintained.
Summary
Transitioning through a divorce can be emotional and challenging for anyone. Engage tax and legal professionals early to develop agreeable tax-effective solutions that may benefit both spouses.
Dri Financial Group 