Tax Implications of Divorce for Ontario, Canada Residents
Tax Rules Made Simple
Most people aren’t turned on by tax law; even lawyers find the topic unduly complex and labyrinthine. But there are a few relatively-straightforward tax rules and specific principles about which separating and divorcing couples should be aware.
Legal fees that are paid to pursue child or spousal support are deductible from the recipient spouse’s income.
The concept – at least as tax principles go – it relatively straightforward. The Income Tax Act specifically allows that for the purposes of determining taxable income, a person can deduct any legal and accounting fees (which the legislation collectively calls “professional fees”) that are incurred in the pursuit of a claim for child or spousal support. The professional fees are deducted in the year in which they are paid. In this way, by deducting those professional fees from total income, the person receiving child/spousal support enjoys a reduced level of income tax liability. (Note that legal fees incurred by the paying spouse or partner are not deductible).
However, this tax rule comes with some rather finicky exceptions and clarifications. For example:
• Legal costs to quantify a spousal support entitlement, established under the Ontario Family Law Act, can be deducted from income.
• Legal costs in connection with determining child support are always deductible, whether the proceeding takes place under the Ontario Family Law Act or the Divorce Act.
• Legal costs to establish the entitlement to child or spousal support amounts under the Divorce Act are not deductible.
• In contrast, legal costs incurred to enforce a pre-existing right to either interim or permanent support are deductible.
Complicated? It can be. Always seek competent Family Law and tax advice in connection with the deduction of legal fees from income.
5 Things to Know About the Canada Child Tax Benefit
The April 30th filing deadline will be here soon enough, so it’s time to start thinking about individual income taxes, and all of the various components that go into providing the federal government with a financial “snapshot” for the past year.
For separated or divorcing spouses with children, one of those components is the Canada Child Tax Benefit (CCTB).
The Canada Revenue Agency (CRA) administers the CCTB, which is a monthly, tax-free benefit received on behalf of a child under the age of 18. Its purpose is to assist families with child-raising costs, and its value depends on family income, among other things. The benefit amount is either mailed out by cheque, or – if the recipient requests it – can be direct deposited to an account held with a financial institution.
For parents who are separated or divorcing, the question arises as to how the CCTB is calculated and which of the parents is entitled to receive it. Here are the most important points to know:
1. Eligibility is determined by the Income Tax Act.
Once a CCTB application form is filled out by one or both parents, the Act’s stipulated eligibility requirements are applied to determine which parent is entitled to the benefit. The dollar-amount of the CCTB is calculated with reference to the applicant’s income for the previous year (together with the income of any cohabiting spouse or common-law partner, if applicable).
2. Usually, the custodial parent receives the CCTB.
Where the child splits time between different residences, the parent with primary responsibility for his or her care receives the CCTB. The CRA will make this determination, after reviewing the circumstances and assessing which parent provides the majority of the child’s care and upbringing. To do so, the CRA will refer to a number of specific legislated factors, and will consider the provisions of any existing court order.
3. If custody is shared equally, then each parent may be entitled to the CCTB for 6 months of the year.
The CRA currently does not split the benefit entitlement into periods of less than half-year, no matter what the actual custody and living arrangement may be. Furthermore, for CCTB purposes, spouses are only considered separated if they have lived separate and apart for 90 days or more.
4. Only one parent is eligible for the CCTB in any given month.
The monthly CCTB amount cannot be shared or pro-rated between parents, no matter how the child’s actual living arrangements are structured.
5. Eligibility for the CCTB ends when the child turns 18.
It may also end if the custody of the child changes, or if the parents fail to meet other eligibility requirements (particularly those relating to family income).
Note that the CCTB received by an eligible parent may include an amount for the Child Disability Benefit (CDB), which is an additional monthly benefit for qualifying families of children with several and prolonged mental or physical impairment. It also incorporates the National Child Benefit Supplement (NCBS), which is the federal contribution to the National Child Benefit, a program aimed at assisting low-income families with children.
Taxation of Support Payments
- Support payments are amounts paid to a spouse, a former spouse or the parent of the payor’s child
- The Tax Rules differ between spousal support and child support
- Support payments are defined as payments made when parties are living apart, paid on a periodic basis and which are made for the maintenance of the recipient or for a child of the marriage
- All support payments which are not specifically defined as spousal support will typically be considered as child support for tax purposes
- If spousal and child support are payable but the full amount is not paid, any payments made will be treated first as child support and only any remaining amount will qualify as spousal support
Tax Treatment of Spousal Support
- Eligible Payments made in a particular calendar year will be deductible in determining the income of the payor
- Payments deductible by the payor will be taxable to the recipient
- Spousal support payments paid by an estate are not taxable to the recipient or deductible by the estate
When are Support Payments Deductible?
- The payments must be made pursuant to an order or written agreement
- The agreement or court order in place must refer to the amount paid as spousal support
- Payments must be periodic, the parties must be living apart and the payments must be for the maintenance of the recipient
Deducting Support Paid Prior to an Order or Agreement
- If support payments were made prior to an order or agreement being in place then they can still be deducted if made in the same year or in the year before the agreement or order was put in place
- Payments must be eligible as support payments
- Child support payments made prior to an order or agreement can be deducted as well in some circumstances
- The agreement or order must refer to these payments and the parties must clearly indicate that these payments are to be deductible to the payor and taxable to the recipient in the year in which they were paid
- Amended personal income tax returns for prior years will be necessary
Tax Treatment of Child Support
- Any monies paid as support prior to an agreement being in place or not specifically defined as spousal support will be considered Child Support
- Child support paid pursuant to an agreement or court order is not deductible by the payor or taxable to the recipient
Taxation of Lump Sum Payments
- A lump sum payment is a single amount of money generally paid at once or in installments over a specified period of time
- Lump sum payments are typically not tax deductible, but can be in certain situations
Deductible Lump Sum Payments
- A series of annual payments for spousal support pursuant to a court order or written agreement will be deductible
- Lump sum payment representing an advance of future support paid only for the purpose of secure the funds for the periodic payments will be deductible
- A Payment made on account of overdue periodic payments which were required pursuant to a court order or written agreement may sometimes be considered deductible
Income Averaging for Recipients of Lump Sum Arrears of Support
- Income averaging is available to person who have received lump sum payment representing arrears of support payments where at least $3,000 was owed which was on account of amounts owing in previous years
- This allows taxation to occur as if the money was received at the time when it was owed as opposed to having to pay tax on the full amount in one year
Taxation of Support Arrears
- Arrears payments will be deductible in determining the taxable income of the payor if they are made on account of spousal support
- Arrears payments which are deductible for the payor are taxable to the recipient
- Taking advantage of Income averaging options may be prudent when receiving a large arrears payment representing spousal support
Arrears Payments which may not be Deductible
- If a settlement is reached whereby a lump sum is paid which does not represent the total amount of outstanding payments then this amount may not be deductible
- Partial arrears payments made where both child support and spousal support are outstanding will not be deductible until child support amounts have been paid in full
Taxation of Third Party Payments
- Payments made by a 3rd party for the benefit of a spouse, former spouse or child can be deductible in determining the taxable income of the payor
- Payments deductible by the payor will be taxable to the recipient spouse
- Common third party payments include items such as tuition fees and rental payments
When will Third Party Payments will be Deductible?
- The nature of the 3rd party payment must be specified in a court order or agreement
- Both parties must agree that the 3rd party payments will be deductible
- The court order or agreement must specifically refer to the third party payments section of the income tax act
- The parties involved in the divorce must be living separate and apart
- The payments must be made solely for the maintenance of a spouse or former spouse if they are to be made after a court order or agreement is in place
- The payments may have been made for a dependent child if made before a court order or agreement was in place
When will Third Party Payments not be Deductible?
- The payment is in relation to a residence occupied by the payor
- The payment is in relation to the purchase of tangible property
Transfers of Property in Divorce
- Property transfers between related parties are general taxable even if no money changes hands
- In a divorce when capital property is transferred between spouses who are married by way of a settlement of martial property rights then the transfer may not be taxable
- To avoid taxation both parties must be residents of Canada
Tax Impact of Capital Property Transfer Between Spouses
- In a separation property is transferred between spouses by way of a rollover
- A rollover can be explained as a transaction in which property is transferred to one spouse and the government pretends as if they had purchased it (or purchased it alone) at the exact same time as when it was actually purchased
- spousal transfers of capital property are deemed to take place at the same cost as the original purchase for tax purposes so there will be no tax impact of transferring the property at that time
- when and if the property is sold, any gain, loss or recapture since the original purchase will belong to the spouse who now owns the property
- The transferor may choose to have the property transferred instead at its fair market value if they wish to take advantage of tax planning opportunities
Tax Impact of Non-Capital Property Transfer Between Spouses
- Non-Capital property transferred between spouses is taxable
- If property such as business inventory is transferred, then a sale at fair market price will be deemed to have occurred and the transferor must recognize any resulting gain or loss
Property Transfer and the Matrimonial Home
- Individuals can designate one home as their principle residence
- The gain on any sale of the principle residence is tax free
- Divorcing couples should take care in any transfer of the Matrimonial home that the receiving party is able to designate it as their principle residence
- This is most important in situations where there are two or more principle residences
Property Transfer and RRSPs/RRIFs
- All or part of one spouse’s RRSPs may be transferred to the RRSP of a spouse or former spouse without any consequences if the following conditions are met
- The transfer is made directly between the parties plans by direct deposit
- The parties must agree to sign certain CRA forms
- The transfer is made when the parties are living separate and apart pursuant to a court order or separation agreement
- The agreement must specifically require the division of property as settlement of martial rights
- An RRSP may be transferred to a spouse or former spouse tax-free in consideration for a lump sum spousal support payment if the lump sum is being paid to satisfy all future claims for spousal support
Tax Deductibility of Legal Fees
- Legal fees are typically not deductible unless paid in relation to obtaining, enforcing or varying a court order for spousal support
- Legal fees paid by a support paying spouse are never deductible
Legal Fees Paid by a Recipient-Spouse
Legal fees are deductible by the recipient of support in the year the fees are paid in the following circumstances:
- Fees paid to obtain an order for child or spousal support
- Fees paid to enforce an existing order for child or spousal support
- Fees paid to vary an existing order for child or spousal support
- Fees paid to defend a reduction of child or spousal support
Any legal expenses being claimed must be reduced by the amount of any costs awarded by the court which are received by the recipient spouse in the same year as the fees are paid