One element of your separation that may not have afforded much thought is how to deal with the various tax implications of the breakdown of a relationship.
Whether you are a recipient or payor of child or spousal support or transferring property as part of a settlement– here are some things to keep in mind to reduce your tax liability.
- Taxation of Spousal Support and Child Support
While child support is not tax deductible to the payor nor taxable to the recipient, spousal support can be if it has the appropriate characteristics. Firstly, a payment must be considered support per its definition in the Income Tax Act in that:
- The parties must be living separate and apart when the payment is made;
- The payments must be considered an allowance payable on a periodic basis;
- The payments must be made for the maintenance of recipients/the children of the marriage or both, and the recipient must have discretion as to how the funds are used;
- The payments must be made directly to the recipient spouse or be considered payments to third parties; and,
- Where payments are made to a spouse or former spouse…
- The parties must be living separate and apart by reason of the breakdown of their relationship; and,
- The payment must be made pursuant to an Order of a competent tribunal (which includes a Court Order or an arbitrator’s award) or by a written agreement.
If the spousal support payment fulfills this definition of support, to be deductible to the payor it must also have the following features:
- The payments are made pursuant to a Court Order or written agreement.
- That Court Order or written agreement must refer to the amount as “spousal support” or as a “spousal support amount”.
Keep in mind that a support amount that is not identified as being solely for the support of the spouse, former spouse or parent of the payor spouse’s child, will be treated as child support unless a portion of it is clearly identified as spousal support. Child support must be paid before the payor can claim a deduction for spousal support
It should be noted that a lump sum of spousal support (a single amount paid once or in installments over a specified period of time) is usually not tax deductible to the payor (nor taxable to the recipient).
- Property Transfers
There are several avenues to transfer capital assets from one spouse to the other tax-free. These assets include the matrimonial home, cottage, marketable securities, RRSPs, RRIFs, shares in public/private companies, rental properties, and even some life insurance policies.
The transfer of such capital property from one spouse or former spouse to another is deemed to occur at the original price the transferring spouse acquired it for if:
- The transfer takes place pursuant to a written agreement or settlement of marital property rights; and,
- Both parties are residents of Canada.
This means that capital gains on the property may be deferred until the recipient spouse transfers the asset to a third party. Note that this does not apply to non-capital property such as inventory.
- Beware of Income Attribution Rules
If one spouse owns property, the income from that property or the capital gains upon sale can be attributed back as the income of the other spouse for income tax purposes and should be properly dealt with in a Separation Agreement. Any income arising from the transfer of a property due to relationship breakdown between separated parties is included in the taxable income of the recipient. This automatic presumption is applied so long as the parties remain separate and apart. If the parties are not separated, the income will be attributed back to the taxable income of the transferor.
So if your spouse, whom you are separated from, transfers you property, any income from that property like rent is presumed to belong to you. If you were not separated from your spouse in that situation, the income would be attributed back the transferor spouse even though you now own the property. Parties may jointly sign an election form to reverse these automatic presumptions, but this must be filed with the Income Tax Return of the transferor spouse.
Overall, each separation will come with its own unique tax issues. Parties going through a separation should be aware of the general tax consequences outlined above. We remind you to contact a family law practitioner to properly assess the tax implications that will arise from your specific situation.