Divorce is never easy and can change a person’s life in various ways. Aside from the emotional toll, there are practical considerations when a marriage ends in Canada. One of these is taxes.
Benjamin Franklin is famous for saying that nothing is certain in life save for death and taxes. He made that statement after US Constitution’s ratification, but the same holds for Canada. While a simple divorce might mean an easy end to a marriage, that does not mean you end your relationship with the Canada Revenue Agency (CRA).
You should know that the dissolution of a marriage brings with it a slew of paperwork to formalize your status change. This article discusses some things you must understand about the impact of divorce on taxes in Canada.
|Key Takeaways: Divorce has numerous tax implications, including eligibility for benefits, capital gains exemptions, tax deductions, and transfer taxes. The Canada Revenue Agency requires notification of your status change before you file your next tax return. Ignorance of the impact of divorce on taxes in Canada can lead to unnecessarily high tax obligations or ineligibility for specific benefits.
You Need To Tell the CRA You Are Separated
The sole basis for divorce in Canada is the breakdown of a marriage. You must prove one of three things to apply for a divorce:
- Separation for one year or more
- Mental or physical cruelty
In most cases, Canadians use the one-year separation as evidence of the marriage breakdown. However, the government will not simply take your word for it. You must provide the CRA with proof that you have been living apart for a minimum of 90 days. The CRA might not recognize your separation claim if you are still paying bills together within that period.
Theoretically, you can continue to live in the same house during your separation if you lead separate lives financially. However, having children makes it more complicated as the assumption is you are sharing parenting duties. In that case, the CRA may require the spouses to have separate households. Official CRA recognition of separation has various points of significance.
Start date of separation
The first day of the 90 days is the effective date of your separation period. That means you must stay separated for a year to apply for a divorce starting that date.
The timely reporting of your change in marital status significantly impacts the family and child benefits you can claim. Child benefits are recalculated annually in July based on your income tax report for the previous year. GST/HST credits automatically recalculate when a child turns 19.
Canada Child Benefit
The other is claiming the Canada Child Benefit (CCB) for tax purposes. The CCB is a tax-free monthly stipend given to children under the age of 18. The purpose of this child tax benefit is to help families with child-rearing costs. The CCB payments will affect the income tax the parents must pay as it is a tax deduction.
In a recognized separation and official divorce, the CRA pays the benefit to the spouse responsible for primary child care. In shared custody cases, the CRA may split the payments equally, depending on the parenting arrangement. Generally, children residing at least 43 percent of the time with a parent entitle that parent to half the CCB benefits.
Goods and services tax/harmonized sales tax credit
The GST/HST or goods and services tax/harmonized sales tax is a federal value-added tax for consumer goods and services. Alberta, British Columbia, Manitoba, Northwest Territories, Nunavut, Quebec, Saskatchewan, and Yukon impose a 5 percent GST. Ontario (13 percent), New Brunswick, Newfoundland and Labrador, Nova Scotia, and Prince Edward Island (15 percent) use HST.
Eligible, low-income individuals can claim a GST/HST tax credit, a tax-free payment paid quarterly. How much you can claim for 2021 depends on the marital status plus the number of eligible dependents and children under 19.
Separated or divorced parents can claim the credit as single individuals. Parents with shared custody of a child can qualify for half of the credit for tax purposes. You can use a calculation sheet to determine how much you can get for 2023.
Tax status in subsequent filings
Separation does not necessarily lead to divorce. However, filing a return as “separated” means the CRA will assess your taxes as divorced. As soon as you get your divorce decree, you can file as “divorced,” but nothing much will change. Nevertheless, you should notify the CRA about your change of status before filing a tax return. You can call it in, do it online, or mail in a marital status change form.
You Can Claim Children as Dependents
Aside from the monetary family benefits you receive for your children, you may also be able to claim one as a dependent. That means deductions on your income tax filing which can significantly reduce the tax you pay. However, your home must be the child’s principal residence on record.
You can only claim a deduction for one dependent per tax filing. Typically, that means a spouse (or common-law partner) earning less than $13,808 annually for married couples. Failing that, you can claim one eligible child, parent, or family member with a physical or mental disability.
When you get a divorce, you lose any spousal tax deductions. Instead, you can claim it for a child who lives with you until they turn 18 unless they have a disability. However, you are not eligible for dependent deductions if you receive child support payments.
What about support payments and taxes?
Support payments in Canada are subject to CRA tax rules if they are in accordance with a court order or a written agreement. They are for the upkeep of either a child or spouse and are support payments if they meet the following conditions:
- It is a specific amount paid to the recipient periodically as set in the court order or written agreement
- The recipient can spend the payment in any way they want
- It is to support the child, recipient, or both
- The recipient is a current or former spouse living separately from the payer or the legal child of the payer
Suppose you have custody of your children after a divorce, and your ex-spouse pays child support. Typically, you don’t have to pay taxes, and your ex-spouse cannot claim it as a deduction.
On the other hand, if you receive spousal support payments, the CRA generally considers it as income and is fully taxable. Your ex-spouse can claim it as a deduction in their income tax return.
That sounds straightforward, but there are always exceptions to the rule. For example, you started paying spousal support in 2020 when you separated. You had a written agreement drawn up in 2022 for the same amount as spousal support. In that case, you can claim deductions for payments you made for the tax years 2022 and 2021 but not 2020. Your spouse also must pay income taxes on the support payments they received in 2022 and 2021 but not in 2020.
Another exception is for third-party payments. For instance, your written agreement specifies that you pay your spouse’s rent directly to the landlord. The agreement also states that your spouse can receive the support payment in full. In that case, you can claim the rent as a deduction in your tax return.
One way a recipient can avoid paying taxes for spousal support is to get it as lump sum payments. You can agree to release your ex-spouse from overdue amounts or future support for a specific one-time payment. In this case, it is not a support payment. As a result, you don’t have to pay taxes.
You Must Pay Taxes on Assets
One of the most potentially contentious issues in a divorce is the division of assets. Most people don’t consider the tax implications of getting property the same way a divorce lawyer does, but you should.
When dividing property in a separation or divorce, you must include the tax obligations that come with it. If you don’t, one spouse may end up paying all the taxes.
Generally, dividing family property means a transfer of assets together with the tax burden of capital gains taxes. However, you should know critical tax rules before you start wrangling over who owns what.
You can minimize capital gains taxes for property and other assets if the transfer results from a settlement. A rollover transfer is at cost, meaning there is no capital gain, so there are no taxes to pay on either side.
However, you cannot use the rollover rule if the transfer happens as a court order. Additionally, if you sell the property to a third party, you must pay capital gains taxes.
There are assets you can transfer on a rollover basis, even if it happens because of a court order. These include the following accounts:
- Registered retirement savings plans (RRSP)
- Tax-free savings accounts (TFSA)
- Registered pension plans (RPPs)
- Deferred profit savings plan (DPSP)
This rule is when an individual transfers ownership of an asset to a spouse at less than fair market value. The income from that asset is taxable for the transferor’s account under spousal attribution rules. One example is the gifting of stocks. Any dividends accruing from these “gifts” are income for the transferor and taxed accordingly.
However, the CRA automatically suspends the rule when the spouses separate or divorce. This means the recipient must now pay taxes on the income accruing. You can choose to file a joint election not to report capital gain during the separation period.
Tax on split income
One strategy to reduce income taxes as a business owner in Canada is through income splitting. This tactic involves allocating income to family members earning less, typically through giving out loans or building a family trust.
However, the CRA expanded the Tax on Split Income (TOSI) rules in 2019 to discourage people from taking advantage of Canada’s progressive tax laws. It imposes the highest marginal tax rates (currently 33 percent) on gains from income splitting with some exemptions.
One of these exemptions is when the spouses separate. If an existing loan or family trust exists, the income derived is exempt from TOSI under specific conditions.
Tax Consequences for a Business
It is not atypical for married couples to go into business together and continue working together after a divorce. However, when you divide the business in a separation agreement or divorce, there are tax implications.
Capital gains exemption
Canadian tax laws allow eligible parties to claim a cumulative lifetime capital gains exemption. (LCGE). The LCGE helps business owners avoid paying taxes on part or all of the profit from selling a business or its shares up to a specific amount.
Spouses owning a small business typically qualify for the LCGE when separating or divorcing. However, the manner and circumstances of the sale or transfer require careful consideration to avoid losing the LCGE. Consult a qualified family lawyer to understand how to divide your business to your best advantage.
Divorcing couples should consider a related-party butterfly transaction to divide their business assets. It allows married business owners to split the business into two companies without paying taxes when the marriage breaks down. The tax benefit only applies to non-arm’s length parties, such as spouses. Another term for this transaction is, fittingly, corporate divorce.
Divorces can be expensive, especially if it involves children and property. Fortunately, the CRA allows you to claim legal expenses for obtaining child and spousal support as deductions on your income tax. The write-off does not include legal fees for separation agreements and property division negotiations, but it helps.
|Did you know? A non-arm’s length transaction generally refers to deals between individuals related to each other.
Consult Nussbaum Law About Divorce and Taxes
Getting a divorce is stressful enough without having to consider how it will affect your taxes. However, you should keep that in mind to avoid paying more taxes than you should. Most people don’t understand tax laws, so this quick guide should give you some idea of what to expect.
If you live in Ontario, make it easy on yourself by hiring an experienced divorce lawyer from Nussbaum Family Law. We can support and guide you in making informed decisions on critical issues like property division and child custody. Our lawyers consider the tax implications when negotiating the terms of a couple’s agreement. Knowing you are getting competent legal advice can provide you with the peace of mind you most need during this time.
Find out more about what Nussbaum Law can do for your divorce and taxes in Canada by booking a free consultation!
Divorce and taxes in Canada are complex issues. Contact Nussbaum Family Law for qualified legal advice on what to expect when filing your next tax return.
FAQs on Divorce and Taxes in Canada
What is the tax rate for married and single people in Canada?
Married and single people in Canada generally have the same federal tax rates, starting from 15%. However, each province or territory may impose income taxes on top of the federal tax, and the income tax brackets and rates can vary. Ontario, for example, charges an income tax between 5.05 to 13.16 percent.
What is a separation agreement?
A separation agreement is a domestic contract setting out the terms and conditions of living apart as stated in Part IV of the Family Law Act. It can be the basis for the divorce terms regarding property division, child support, parenting time, and other matters.
Is income sprinkling legal in Canada?
Income sprinkling or splitting is legal in Canada if you follow TOSI rules. However, it is only an effective strategy for lowering tax bills if you meet specific conditions.