When you’re in the middle of your separation process you’re probably not thinking about your taxes, but you really should be. There are a number of tax implications that will arise coming out of your divorce, and it is important to be aware of them while you are creating your separation agreement.
Here is a small sample of some of the tax issues that will likely surround your divorce. You may want to seek the assistance of a Certified Divorce Financial Analyst (“CDFA”) to get a better understanding of all of the tax implications at play.
Changes to Your Marital Status
If you are married and you separate or divorce after December 31st, you will continue to file your tax returns with Canada Revenue Agency (“CRA”) as if you are married. Once you reach December 31st of the next year, you will begin filing your tax returns as “separated” until the time in which your divorce is finalized. Once you have received your divorce decree, you can begin to file your tax returns as “divorced”.
Regardless of your official legal status, Revenue Canada will not consider you as separated while you are still living under the same roof. You must be living separate and apart, at different addresses, for at least 90 days before you can update your Revenue Canada marital status to “separated”.
It is important to promptly inform CRA of any changes to your marital status because certain tax credits are calculated on the basis of total household income. Generally, your total household income will go down when you separate, which makes you eligible for benefits you weren’t previously eligible for.
Child support is not taxable if you are the recipient and not deductible if you are the payor.
Spousal support is taxable income if you are the recipient and deducted from your total gross income if you are the payor, as long as the spousal support payments are made monthly. This tax benefit does not apply if the payment is made as a lump sum or if there is a property transfer taking the place of regular spousal support.
Be wise with these calculations as the added income (support to you) could place you in a higher income bracket, causing you to be taxed at a higher rate, lose HST/GST tax credits or lose Canada Child Benefits. Consequently, paying support, may also conversely lower you to a new tax bracket, but also have implications on your ability to qualify for a mortgage.
Capital Gains Tax
The separation of assets often requires transferring assets from one spouse to another. The recipient of an asset needs to understand that they will typically be taxed at the time he or she ultimately sells or disposes of the asset, called a tax-deferred rollover. This tax-deferred rollover provision applies automatically unless the parties decide to transfer an asset at its fair market value, thereby triggering a capital gain upon transfer.
RRSP’s and TFSA’s
Your joint RRSP and TFSA accounts can be split with your spouse on a tax-free basis. Funds from one spouse’s account can be transferred to the other without penalty while you are still legally married. In addition, your RRSP’s may be rolled over to your spouse and defer the tax penalty, so long as you are living apart and have a separation agreement in place. You will want to account for what is called “notional tax” which is the tax amount that will be incurred when RRSP’s and TFSA’s are cashed in.
Any legal fees paid to a lawyer to prepare a separation agreement or to assist in the court process are not deductible with CRA.
When clients divorce or separate, they often transfer assets to their former spouses as part of a legal settlement. The question becomes, who is the income attributed to and who will pay the subsequent tax? There are many misconceptions about the attribution rules during separation and after divorce. Attribution is a set of rules that tax income or gains to one spouse even though the other spouse receives the income. When a relationship breaks down, attribution may or may not still apply on income and capital gains generated by the recipient spouse. It is very important to confirm this before you sign any Separation Agreement.