With emotions running high and a new reality to get used to, separations are difficult enough without taking into account how you may be taxed on the transfer of property and payments.
The Canada Revenue Agency ("CRA") has specific rules in place that may reduce your tax burden in such circumstances.
If you are looking to minimize the amount of tax payable, here is our quick guide to tax deductions, exemptions, or deferrals in family law matters.
Child and Spousal Support Payments
Child support payments are non-deductible for the payor when tax season comes along and are not included in the recipient's yearly income, meaning the recipient does not pay taxes on the amount of child support received.
The opposite, however, is true for spousal support payments made on a periodic basis. Spousal support payments are deductible from the payor's income, meaning the payor can deduct the amount from their income to reduce their taxes paid. The payments are then included in the recipient's income each year, meaning the recipient pays tax on the amount of spousal support received.
Spousal support payments that are made through a lump sum payment are treated differently for tax considerations than periodic payments. They are treated much like child support payments, in that they are not deductible for the payor and are not included in the recipient's income. However, the total of the lump sum amount must be discounted for tax and net present value to reflect how the lump sum amount is taxed differently from periodic payments and to take the time value of money into account. The amount that will be discounted is often calculated by taking the different tax rates of the payor and recipient into account, along with the present value of the future payment of spousal support.
Other Tax Deductions, Exemptions, or Deferrals
Some of the property transfers or payments that are deductible, tax-exempt, or tax-deferred include the following rules for payors or recipients:
- A payor can transfer RRSP contributions to their former spouse on a tax-deferred basis (see the RRSP transfer form);
- The transfer of a principal residence can be done on a tax-free basis;
- A payor transferring capital property through a spousal rollover to a former spouse can defer the taxes payable until the property is disposed of;
- A taxpayer can deduct childcare expenses where there is no supporting person or when the taxpayer has the lower income; and
- A recipient can deduct legal fees in certain circumstances, such as those incurred to establish support payments or when seeking an increase in support payments.
For these transfers or payments to occur on a deductible, tax-exempt, or tax-deferred basis, the parties must make these transfers or payments while they remain married prior to divorce.
Although separating your finances may seem complicated, we can help your finances stay mess-free. If you or someone you know has questions about tax consequences during separation or divorce, you are encouraged to reach out directly to anyone in our Family Law group for more information. With over 85 years of combined experience, families trust us to help them navigate the complex legal framework and processes involved with separation and divorce, including child and spousal support, and how to best situate you financially at the end of the process.
This piece appears as part of a special four-part article series where our experienced Family Law team will explore some of the most important aspects of taxation for BC families when it comes to legal fees, structuring family agreements, optimizing tax obligations, as well as navigating separation and divorce. Learn more about this limited series and what topics are coming up next HERE.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.