Separation can be taxing, both emotionally and financially, and is a time when surprises are generally unwelcome. Knowing the effects that separation will have on your income tax return, as well as the tax consequences for actions taken while in the process of separating (such as transferring assets), is essential to ensuring your economic stability.
Explained in this article are the most common areas of separation and divorce that attract taxes, and how to take advantage of the opportunities available to minimize those taxes paid.
For the purposes of tax considerations during separation or divorce, there are a few central definitions that are necessary to know:
(1) “Spouse” – Is a person you are legally married to.
(2) “Common-law Partner” – Is a person you are not legally married to, but have lived with in the same home for at least 12 months in a marriage-like relationship with no periods of separation spanning longer than 90 days. This designation can also be found in circumstances where your partner is the parent of your child (either by birth or adoption), or if they have custody of your child, and your child is wholly dependent on them for support.
If you are legally married, physically separating from your spouse will not end the marriage, you must obtain a legal divorce. If you are in a common-law relationship, separation will be established in the eyes of the Canada Revenue Agency (“CRA”) once you have been living separately and apart for 90 days.
Canada Child Tax Benefit
The Canada Child Tax Benefit (“CCTB”) is a tax exemption program available for qualifying families upon application to the CRA. If you have previously applied for the CCTB while married, this will be another area of tax concern upon separation or divorce.
Designation of child custody as “shared” or not is important when considering which parent will be able to claim the CCTB. If the child spends their time more or less equally between both parents, the custody arrangement is considered to be “shared”. If the child spends their time mostly with one parent, it is likely that this parent will be considered to have “full” custody of the child.
Only one parent can claim the CCTB on their tax return, and who gets to claim the benefit will largely depend on the custody arrangement.
If you currently have full custody of your child, you will be the parent who is eligible to claim the benefit. However, in the event of shared custody arrangements, you may have to split the CCTB with your ex-partner. The determination of whether or not the custody you have over your child is shared or full, and how the CCTB will be split, is made at the CRA’s discretion.
You can avoid leaving this determination to the CRA by making sure a fulsome separation agreement is drafted between you and your ex-partner and includes a provision addressing which parent will be claiming the CCTB on their return.
In more complicated custody scenarios, for instance, if the child spends the school year full-time with one parent, and the summers full-time with the second parent, the parents can each apply for the CCTB during their parenting period. This means the parent who has full custody during the school year would not receive the CCTB during the summer and would need to re-apply when the child is returned to their care in the fall.
Spousal support ‑ deductible or not?
The next area of tax concern is the manner in which spousal support payments are made. Whether or not the payments are made in a lump sum, or on a regular monthly basis (known as periodic payments) can drastically affect the tax implications for both parties involved.
Lump sum payments, in general, are not tax-deductible to the partner who is paying them (the payor), and are not tax inclusive for the partner receiving them (the recipient).
The payment is considered to be a part of what is known as an equalization payment common to the end of a long-term relationship. Simply put, it is considered to be money that has already been taxed.
Periodic payments, however, are tax deductible for the payor and are considered taxable income for the recipient.
If you are receiving or paying spousal support payments on a periodic basis, in order for those payments to be taxable or deductible, there are certain requirements that must be met:
- Any child support payments involved must be fully paid and up to date.
- The spousal support being paid must be pursuant to a written agreement or court order, and the agreement or order must clearly state the amount that is to be paid to the recipient. You can make an oral agreement regarding support payments, but these will not be taxable or deductible.
- The payments must actually be paid to the recipient.
- The spousal support order or written agreement must be registered with the CRA.
If an ex-partner pays spousal support in an indirect way, such as covering the mortgage payments on the family home, there is no guarantee that this form of support payment will be taxable or deductible. If you have received or paid support payments before a formal agreement or order was made, those payments may be deductible or taxable if the payments were made in the same year of the agreement or order, the payments were periodic, and the agreement or order refers to the prior payments made.
Upon separation or divorce, it is common for ex-partners to purchase new housing and the manner in which spousal support is paid and received can have a huge impact on mortgage qualifications. In order to avoid any uncertainty, as stated above, having a comprehensive separation agreement drafted by legal representation that clearly states the structure of the spousal support payments is the best course of action.
Filing taxes after separation or divorce
In Canada, partners must always file separate tax returns, however, on those individual tax returns you will indicate who you are married to (legal marriage) or who you are living with if the living arrangement has surpassed the 12-month threshold (common-law).
In the event that you are legally married, but have not yet legally divorced you have two filing options to choose from, and these indications will appear on your tax return forms:
- Married Filing Jointly; or
- Married Filing Separately.
Generally, there are more tax benefits to filing jointly as opposed to separately (such as large standard deductions), but those benefits also come with risks.
If you file jointly with a spouse you have separated from but are still legally married to, you are jointly and severally liable for all of the taxes, interest and penalties due on your ex-partner’s tax return. Inversely, they will be jointly and severally liable for yours. You will both be liable for each other’s underpayment of tax that may be due as a consequence of the returns you have filed, and if your ex-partner fails to pay the tax due you will be on the hook for the outstanding amount.
If you are the partner who has primary care over the child, has paid for more than half of the cost of keeping the family home, and has lived in the family home for more than half a year is what is known as “Head of Household Filing Status”. This status can provide you with a higher standard deduction after separation, and you can be taxed at a lower rate. To find out more about this option, it is highly recommended that you seek legal advice as to the particulars of your circumstances.
Informing the CRA of a change in marital status
December 31st is the most important day to keep in mind when filing your first tax return after separation or divorce. If your marital status has changed after December 31st of the year you are filing taxes, you will still file your return as though your marital status has not changed.
This is inclusive of both legal marriages and common-law relationships. This single date can drastically affect the taxes you pay for the year you are filing for if, for instance, the taxes you pay are much lower as a couple in contrast to what you would pay as a separated individual.
It is important to note you are not considered separated in the eyes of the CRA until 90 days of living separate and apart have come and gone and are only required to inform them of the separation after those 90 days.
With housing costs on the rise, it is becoming more common for separated spouses to continue to live in the same home and share parenting and financial responsibilities. If this is the situation you find yourself in, even if you have separated as a couple, the CRA will likely not consider you separated for tax purposes. There are loopholes to this rule, including if the house you share with your ex-partner has separate living quarters, but the CRA will ultimately have the discretion to make this determination.
How do you maximize your tax opportunities during separation or divorce?
Navigating the tax opportunities and pitfalls during separation or divorce can be overwhelming, and seeking legal advice to help clear the fog is your best defence to ensure you aren’t on the hook for large tax payments. Proactively drafting a separation agreement that addresses the abovementioned topics can significantly improve the chances that you won’t encounter surprise taxes during an already tumultuous time.
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 situation 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.