SEPARATION, DIVORCE AND TAXES

Summary

Article
The common areas that can benefit from tax planning are:

Property transfers – If property is transferred between spouses as part of the separation agreement, or as settlement of rights arising from the marriage, it can be transferred at the original cost, without tax consequences for the spouse transferring the property. Otherwise, if the property is transferred after the marriage breakdown, there may be capital gains tax to pay, or recapture of Capital Cost Allowance to add to income.

RRSPs – If transferred as part of separation or divorce agreement, RRSPs are taxable only when the spouse who receives them withdraws the money from the RRSP, and then in that spouse’s hands, not the original contributor. Normally, when a spouse contributes to a spousal RRSP, and the other spouse then withdraws funds from the RRSP, the original contributor reports some or all of the income on their tax return if contributions have been made in the past 3 years to any spousal RRSP. However, when the money is withdrawn from a spousal RRSP after the marriage breakdown, this does not occur - the spouse withdrawing the money pays the tax. If a spouse is continuing to make spousal RRSP contributions pursuant to a separation agreement or divorce settlement, the payments can be deducted from income as RRSP contributions, if the spouse has sufficient RRSP room in the year.

Child care expenses – Child care expenses can only be deducted if the child lives with the parent making the payment, and to the extent of those costs. If each parent pays 50% of the cost for a child, and both parents have joint custody, they can only claim 50% of the costs each. If there are two children, and each parent has sole custody of one child, each could claim child care expenses for the child they have custody, to the extent they actually paid the expense.

Equivalent to spouse – Only the parent who has custody of the child and whom the child lived with during the year can claim the equivalent to married credit. If both parents have joint custody, if they agree in writing as to who can claim the credit, that parent can claim the credit if the child lived with the parent in the year. If there are two children, each parent can claim a different child if they have an agreement to that effect, and if the child actually lived with the parent.

Married amount credit – The married amount can be claimed in the year of separation by the spouse with the higher income, but not thereafter.

Deductibility of Support payments – Support payments can be deducted by the payer in certain circumstances:
• The amount is paid as alimony or an allowance for the support of the spouse, not children.
• The spouses are living apart at the time the payments is made and were separated due to a divorce, judicial separation, or written separation agreement.
• The amount is paid pursuant to a decree, order, judgment of a competent tribunal or written agreement.
• The recipient has discretionary use of the funds.
• The amount is payable on a periodic basis.
• Payments to third parties that are clearly for the benefit of the spouse are generally deductible.
• Any amount deductible to the payer is taxable to the recipient.

Problem areas:
• If payments are made prior to the actual date of a court decree will the payments will only be deemed paid pursuant to the decree if the decree or agreement specifies that they are to be considered to be so paid.
• Lump sum payments will usually not be deductible, neither will payments that release the payer from future obligation.
• Payments of amounts in excess of that required to maintain the spouse in the manner to which they are accustomed are likely to be denied.
• Any payment not clearly designated as spousal support will usually be deemed to be child support, and thus not deductible.
• If payments are less than the required or agreed amount, and include both child support and spousal support, only the amount in excess of the agreed child support amount will be deductible.
• If the payer is claiming a tax credit for the spouse, or the eligible dependant (child), the payer cannot also deduct the payments to the spouse.

In certain circumstances, payments for child support are deductible for the payer and taxable for the recipient. Child support payments made pursuant to written agreements and court ordered settlement made prior to May, 1997 are deductible provided that:
• The agreements have not been changed or varied after May, 1997 such that the amount of child support is changed.
• The payer and the recipient have not filed an election with Canada Revenue Agency to have the post 1997 rules apply.
• A new commencement date has not been specified in an agreement

Information provided by
Mark Allan, CGA, CFE
J. A. SMITH & ASSOCIATES INC.
2147 Bowen Road
Nanaimo, British Columbia, Canada V9S 1H8

If you would like more information on any of these topics, contact Mark at (250) 751-3383, 1-800-343-6133 or at J. A. Smith & Associate's web site at www.jasmith.com.

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