Tax implications of divorce, Part 1

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This is Part 1 of a two-part series. Read Part 2 here.

Clients navigating separation or divorce often seek guidance from their advisors about the short- and long-term effects on lifestyle and finances. Advisors may face complicated issues and conflicts of interest in advising clients.

Here are tips to help clients manage the division of assets and support matters.

Division of assets

Assets acquired and debts incurred during a marriage are included in determining family property and distributed equally when the marriage ends. Rules for common-law partners differ across the country.

Certain assets may be excluded from property division, such as exempt property—acquired from a third-party gift or inheritance before the relationship, or as an award for damages. The value of the exempt property at the time of marriage or on the date acquired is exempt from a distribution. The spouse claiming property exemption must demonstrate why the property is exempt as well as its value. Growth of exempt property during the relationship can be divided in a manner the court deems fair.

Absent agreement among the parties, division dates differ across provinces. Most jurisdictions, including Ontario, use the separation date as the division date. Alberta uses the settlement date or the trial date.

Paper trails are key when excluding property. Clients should keep statements, purchase and sale agreements, receipts, separation agreements, tax returns and notices of assessment. Proving exemptions means proving property value on both the date acquired and the division date, and proving it was kept separate from family property. Exempt property should be in its original form or be traceable into an asset that currently exists. If the exempt property is sold, the sales proceeds must be traceable into an existing asset. If tracing isn’t possible, the exemption is lost.

For example, if an inherited house valued at $250,000 on inheritance (exempt property) is subsequently sold, exempt status of $250,000 remains if a new home is purchased with the original home’s sale proceeds.

Clients must notify the CRA of their status change (using Form RC65 Marital Status Change) once separated more than 90 consecutive days. This proves the timing of the separation and triggers the agency to process changes to credits and payments.

Defining common-law

Definitions for income tax purposes work in parallel with provincial family law definitions of spouse, dependant, common-law partner, family or marital property, and exempt property. However, rights to property and support on relationship breakdown, particularly for common-law partners, vary by province according to applicable provincial family law. The definition of common-law partners for family law purposes is different than for tax purposes, and also varies by province. For example, Saskatchewan and British Columbia require co-habitation of at least two years for common-law status. Alberta, Manitoba and Ontario require three years.

Support matters

Where not specified, payments between former spouses/partners are presumed to be child support payments. Children have the right to support from both parents, and the federal Divorce Act publishes guidelines for appropriate support in different circumstances.

Support payments can be determined by agreement or court order, but the guidelines should be considered. Even though provincial law governs divorce, most provinces have adopted the federal guidelines or similar ones. Separation agreements/court orders must be registered with the CRA in cases where spousal support must be paid.

Since 1997, spousal support payments are treated differently than child support payments for tax purposes. While child support payments for arrangements struck after this date are neither taxable to the recipient nor deductible to the payor, spousal support payments generally are both. Generally, common-law partners and married partners have equal rights to support. Lump-sum payments are generally not considered support payments as they’re not paid on a periodic basis.

Parenting time is the amount of time a child spends with each parent. In a primary parenting situation, one parent has more than 60% of parenting time. The primary parent typically claims tax credits for the child, including the eligible dependant, GST/HST and disability tax credits.

In shared parenting, each parent has at least 40% of parenting time. Both parents typically pay child support, and benefits and credits are shared if certain conditions are met.

Canada Child Benefit (CCB). This tax-free monthly benefit for eligible families raising children under age 18 is typically paid to the primary caregiver. In shared parenting arrangements, each parent may apply for the benefit. If they qualify based on their own incomes (or family income where repartnered), each parent is entitled to half the amount they would otherwise qualify for if they were not in a shared parenting arrangement. For example, if Parent A would have qualified for $700 a month in a non-shared parenting arrangement, she would qualify for $350 in a shared parenting arrangement. No option exists for parents to agree, or for the court to order, that the lower-income parent in a shared parenting arrangement receive the full benefit.

Clients submit Form RC66 to the CRA to apply to share benefits, and they must file a tax return annually to receive the CCB.

GST/HST credit. In shared parenting arrangements, each eligible parent may receive one-half of the GST/HST credit for each child under age 19.

Eligible dependant credit. The credit is available where a client supports an eligible dependant and doesn’t live with a spouse.¹ Claiming the credit saves between $2,000 and $3,000 in tax annually depending on the province or territory.

A primary parent who receives child support may claim the credit for one child. A parent paying child support to a primary parent can’t claim the credit for any child they pay support for. The credit is zero where the dependant’s income exceeds a certain amount.

In shared parenting where both parents are legally required to support the child, both parents are eligible to claim the credit. However, if the parties can’t agree on who will claim the amount, neither parent may claim it—unless there is more than one child and each parent can claim for one of the children.²

Legal fees. Fees incurred to establish or increase taxable/deductible support payments are generally deductible for tax purposes, as are fees paid to enforce child support orders or defend applications to reduce support amounts.

Childcare expenses. For intact families, childcare expenses are generally deducted by the lower-income parent. For those separated or divorced, childcare expenses are deductible by the primary parent. The contributing parent paying a support amount in respect of that child can’t deduct childcare expenses. In shared parenting, each parent may deduct expenses to the extent each parent paid. Also note that if a client repartners and the new partner is the lower-income earner in that household, the new partner claims the childcare expense.

Part 2 will examine the tax impacts of settling different types of property as well as estate planning considerations.

Rebecca Hett, CPA, CGA, TEP, is vice-president, Tax, Retirement and Estate Planning at CI Investments.

Editor’s note: This article was updated on April 25, 2019 to include additional context.

1 ITA Sections 118(5) and 118(5.1).

2 In shared parenting where there is more than one child, for each parent to be eligible to claim the eligible dependant credit in respect of one child, the separation agreement must state that each parent pays the other their required portion of child support.