Since 1992, common law relationships have been treated the same as legal marriages.
Spousal and Child Support
There must be a written agreement stating the amounts and dates of both spousal and child support and it must be signed by both parties. The tax treatment of spousal and child support changed as of May 1, 1997. For agreements entered into, or amended, after that date, child support is no longer deductible by the payer or taxable to the recipient. Tables have been derived by the government as guidelines to appropriate child support. Spousal maintenance, however, continues to be deductible / taxable between the parties.
(Update February 2005): The government is in the process of establishing a table, or algorithm, as a guideline for determining the amount of spousal support. Note that this is a guideline only, and not binding.
Deductibility of legal fees is another complex issue. Currently, the basic rules are as follows:
Non-deductible legal fees are those incurred to:
- Obtain a separation or divorce
- Obtain custody of, or visitation rights to, children
- Defend against an application to increase child support
- Apply to reduce child support
Deductible legal fees are those incurred to:
- Obtain child support
- Enforce an existing right to either spousal or child support
- Defend against a decrease in either spousal or child support
Eligible Dependent Credit (aka Equivalent to Spouse Credit)
This credit is available to an unmarried person if there is a child who is wholly dependent on that person for support. If there is joint support of a child, only one person can claim the credit. If there is joint support of more than one child, then each of the couple may claim one child. These rules apply both in the year of marital breakup and subsequently.
Registered Pension Splitting
It is important to consider provincial Pension Benefits Legislation when considering how a RPP is to be split on marital breakdown. In BC, if pension payments are split 50/50, each person reports his or her share as taxable income. If, however, pension entitlement is considered part of the net family assets for purposes of equalization, the person ultimately receiving the pension would pay tax on the full amount. The pension may be split and half its current value transferred to the non-pension-holding spouse. In this case, it must be transferred to a locked-in RRSP which cannot be accessed until age 65.
Canada Pension Plan benefits can be split between former spouses. The pension benefits accumulated during the marriage can be combined and split equally. In this case, the rules for legally-married and common law couples differ. There is no time limit for legally married spouses to apply for the split. It can be done any time until the CPP is drawn. Common-law spouses, however, must apply by the end of four years after the common-law relationship ends.
There is something else to consider when contemplating a CPP split. Everyone is entitled to eliminate the lowest 15% of their contribution years in calculating their benefit entitlement. In addition, anyone who stayed home to care for children under age 7 and therefore had low, or no, earning years, can eliminate those years from the calculation as well. Given these individual adjustments, it is entirely possible that it is not in someone’s best interests to apply for splitting CPP. Calculations should be made!
RRSP / RRIF Considerations
An RRSP or RRIF may be transferred to a former spouse without tax consequences if the following conditions are met:
- the spouses are living apart
- the transfer is either: ordered by a decree, order or judgment of a competent tribunal, or
- contained in a written separation agreement relating to a division of property in settlement of marital property rights
- the transfer is made directly between plans
On marital breakdown, a spouse may withdraw funds from a spousal RRSP without triggering income attribution to the contributing spouse’s tax return, provided the spouses are living apart. In this case, there does not need to be a formal separation agreement.
Transfer of Non-Registered Investments
Investments such as stocks, bonds and mutual funds may be transferred to a spouse or former spouse in settlement of marital property rights without immediate tax consequences. Both parties must be Canadian residents at the time of the transfer. The transfer is made at the adjusted cost base of the transferor. The receiving spouse needs to understand that this transfer at cost has not eliminated the tax liability, but only deferred it and, more importantly, transferred it to that spouse. Therefore, the value of the transferred asset to the recipient in the asset division needs to bear in mind the deferred tax payable when the property is sold.
Separating parties are not required to transfer assets at cost in a break-up. Instead, they may elect to transfer the asset at fair market value. The spouse surrendering the asset must bear any tax cost at that time. The receiving spouse gets a “fresh start” with the asset at its fair market value. In the right circumstances, it may be smarter to fall deliberately into this tax liability. For instance, the spouse surrendering the asset may be in a favourable tax bracket to bear a capital gain.
Income attribution does not apply to separated couples. If any transactions prior to separation gave rise to such attribution, that will cease on separation.
Family Homes and Marital Break-up
Real estate is often the core asset of a family’s net worth and the centre of a family’s life. When a marriage breaks up, real estate tax issues may need particular attention in the separation settlement. Remember that a domicile which has been used solely as a principal residence, and not as a rental property, enjoys tax-free capital appreciation, as long as the owners own no other residence concurrently.
In a marital break up, various scenarios may unfold for the family home. The simplest one is that the house is sold and both parties move to new places. Often, however, the custodial parent remains in the home to raise the children in their familiar environment. In this situation, different scenarios may ensue. First, the house may devolve to one party or the other as part of the overall asset division. In this case, the tax implications are simple. The partner who gives up the interest in the home faces no taxable event, thanks to the provisions for tax-free principal residences. The house remains a tax-free asset for the acquiring spouse as long as the building remains a principal residence, not a rental property.
Second, the house may remain a joint asset, with the departing spouse maintaining an equity interest until the house ultimately is sold and the equity is shared. In this case, a tax problem may develop if the departing spouse subsequently acquires a new residence. Now that person has two properties, and only one can qualify as a tax-free principal residence. So, when the former family residence is sold, there may be taxable gains, the determination of which can be quite complicated (See the article “Home, Sweet Hearth” on our website).
Other issues can arise in the second case, too. If the remaining spouse assumes responsibility for the mortgage payments, then over time the mortgage principal will drop and the owners’ equity will rise. It may be unfair for the departing spouse to enjoy an increasing value of equity in this situation. The solution here is that both parties acknowledge the mortgage balance at the time of divorce. At the time of sale, the ensuing principal reduction would be credited to the remaining spouse’s net equity and the rest of the net proceeds shared equally.
Another issue is: who enjoys the future potential for increase or decrease in the value of the home? One answer is that both parties will share that risk equally. Alternately, the departing spouse’s equity is fixed by an appraisal at the time of departure and credited with an imputed bank rate of return until the house is sold. The remaining spouse bears the risk of the house appreciating.
Finally, various repairs may be needed to maintain the home’s re-sale value and use. Both parties need to set out some general principles in advance as to who shares what.
The remaining spouse may need to rent out a portion of the home (e.g. a basement suite) to strengthen the family finances. The rent collected is taxable and various costs are deductible. Those costs specific to the rental unit are fully deductible. Other costs including mortgage interest, insurance, utilities, etc are pro-rated by the proportion of the rental space to the family space.
There is frequently a mortgage on a family home. If the departing spouse is coming off the title on the house, the remaining spouse will need to qualify alone for the mortgage.
A family cottage also may be involved. The general rules provide one tax-free residence per couple (since 1982). Thus, the family cottage likely is a taxable property for the couple. If the couple sells the property, then regular capital gains issues exist. However, if one spouse will take title to the property, the general rules permit the asset to transfer at cost, with the resulting afore-mentioned deferred tax problems for that spouse.
If the transfer is elected at fair market value, then some tax implications will occur on the transfer and the receiving spouse will get a “fresh start”.
If the receiving spouse doesn’t own another residence, the cottage now could convert to being a tax-free principal residence for that person.
These tax issues are very complex and depend upon the specific facts.