Navigating Divorce: Financial Planning & Tax Considerations

Divorce and separation can be an extremely emotional and difficult time in your life. To make matters worse, these life changes can lead to unwanted financial stress. Nevertheless, there are important factors which need to be addressed from a tax and financial perspective such as who gets what property and how to split up financial assets. While it will be important to evaluate changes in your tax returns for the immediate future and next few years, there is also opportunity to engage in tax planning around long-term assets such as real estate and retirement.

Because assets and property will need to be assessed and divided between the two spouses, the first step will be evaluating household income along with the value of what is owned vs. what is owed.

‘Marriage’ by Tax Definition

Marriage is defined in the same manner for tax as it is in other areas of the law. The tax rules applicable to married couples also generally apply to common-law partners. For tax purposes, a couple is considered “common-law” if they cohabitate in a conjugal relationship and have been living together for at least 12 months or have a child together.

For tax purposes, a married couple is considered married until they are legally divorced. However, there are other tax rules that may apply during a period of separation. In the case of common-law partners, the end of the relationship is not always as clear. Generally, two people will no longer be considered common-law if they are living separate due to a breakdown in their relationship for a period of at least 90 days.

If you were privy to any tax credits or benefits as a married or common-law couple, they would have been determined with your marital status when you filed your last return, you need to notify the Canadian Revenue Agency (CRA) when your marital status changes. Once you do this, they will recalculate your benefits or credits. You can also apply to receive a credit you didn’t apply for when you were married because of your change in status. Depending on your employment status, you may also be required to file a new working income tax benefit (WITB) application.

First Steps When Financially Preparing for a Divorce

The courts will require full disclosure of income, assets and debt. Full disclosure means all of your financial information must be up to date, complete and truthful. In order to prepare for proceedings, some good first steps include:

• Ensuring your bookkeeping and tax returns are up to date;
• Filing unfiled tax returns;
• Preparing copies of bank statements, tax returns, loan documents and any other financial documentation; and
• Gathering documents related to real estate, along with all information relating to who is on the title to each property.

It’s important to communicate honestly and openly with your tax professional throughout the proceedings of your divorce. If you and your spouse already have an accountant or tax professional who prepares your tax returns, that individual will have a conflict of interest in providing both of you tax and financial advice. Similar to the fact that each spouse would hire their own attorney, having separate tax advisors frees up any conflicts of interest when it comes with providing professional advice. It’s also important to remember that tax professionals can only advise clients on tax and financial matters. Any legal matters should be directed to your attorney.

Divorce & Tax Planning

Two of the key issues when addressing wealth and tax planning are asset settlement and financial support.

Asset Settlement

Property Assets

When you separate, you may be required to divide up assets. Generally, you’ll be able to transfer assets between the two of you without tax consequences. Capital property (most assets) can transfer at adjusted cost base (ACB) so that the recipient spouse inherits the current ACB of the property without tax exposure on the transfer. If you transfer your family home or cottage to one person, important steps need to be taken in order to make sure you’re not liable to pay capital gains taxes. This usually involves preserving the home’s principal residence status or choosing which property to designate as your principal residence. In the case where one spouse takes the primary residence and the other the cottage home, one spouse may be receiving a property with a significant embedded tax liability. This liability should be calculated and included in the negotiated value of the settlement. Other property, like shares and / or rental properties, can be transferred tax-free in some instances, if proper tax planning is done.

Pension Assets

Canada Pension Plan credits earned by both spouses during marriage can be combined and split without any immediate tax. Other pension plan assets can often be split without tax, however it’s important to meet with a tax and legal professional in your province to discuss this, given that family and pension law operate on a province to province basis.

RRSP Assets

Registered Retirement Savings Plan (RRSP) assets can transfer directly to the other spouse’s RRSP without a tax hit. The rules are the same when it comes to assets in a Tax-Free Savings Account (TFSA). In the case of a TFSA, the transferor doesn’t receive a reinstatement of contribution room.

Financial Support

The amount of financial support owed from one spouse to the other depends on a number of variables. On the whole, the tax rules surrounding support are as follows.

Dependent Children

As a general rule, only one parent can claim the amount for an eligible dependent (AED). When deciding the terms of a separation or divorce, who is going to claim the AED is usually established. However, if there is a disagreement and both parties try to claim the AED, neither spouse will receive the credit. With that being said, if you have two children and share custody and access, each parent is may be able to claim one child. Arrangements like this however, require careful planning and clear documentation in both the custody and support agreements.

If one parent has custody of children, then the Universal Child Care Benefit (UCCB) will be paid to that parent. With shared custody, you can apply to split the payment equally. The UCCB is taxable and if you’re single at the end of the year, you have the option of reporting the income yourself or in the hands of your dependant.

As for child-care expenses, you can claim expenses incurred by you for the period your child resided with you. In the case of tuition, textbook and education credits, a student can transfer these credits to either parent, but not a portion to both, which will require agreement between both spouses.

Spousal

With a legal separation agreement, you are able to deduct your spousal support payments from your income to help reduce your taxable income. It’s important to note that lump sum payments or payments made outside of the separation agreement or court order are not tax deductible. Furthermore, legal fees paid by the recipient of child or spousal support relating to obtaining such support may also be tax deductible.

In Conclusion

Divorce and taxes aren’t exactly two topics anyone is clamouring to discuss. But if you are going through a divorce or have recently finalized one, tax challenges unique to your relationship are bound to come up. MNP’s Tax Services team can help you and your family lawyer create an effective tax strategy designed to mitigate stress, minimize exposure and facilitate better outcomes for everyone, positioning you for a strong financial future.

For more information, contact Mark Ritchie, CPA, CA at 403.359.7102 or [email protected].