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Bodnaruk Law

Tax Issues of Separation or Divorce

Understanding How Separation Affects Your Taxes

Divorce and separation in Alberta can create complex tax issues. Understanding how the Canada Revenue Agency (CRA) treats property division, support payments, and other financial changes is critical to avoid unexpected liabilities. This guide explains key tax considerations following a separation or divorce in Alberta, so you can protect your finances and stay compliant with Canadian tax laws.

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A taxpayer’s marital status can affect the amount of benefits and credits he/she receives as well as how they file their annual tax return. Taxpayers tick the box on their T1 Income Tax Return that indicates their marital status on December 31st of the year for which the taxes are being filed.

The Canada Revenue Agency defines separation to mean the taxpayer has been living apart from his/her spouse or adult interdependent partner because of a breakdown in the relationship for at least 90 days. Once the parties have been separated for 90 days because of a breakdown in the relationship, the effective date of the separated status is the day the couple started living apart. If the taxpayer files a return before the 90-day separation period is over and that period includes December 31st, he/she must enter the marital status as married or living as an adult interdependent partner, as applicable.

If, after filing the return, the taxpayer continues to live separately and apart from his/her spouse or adult interdependent partner and has lived this way for at least 90 days, the taxpayer must complete a marital status change form. The date of the start of the 90-day period is the date of separation. The taxpayer must also file an amended return to adjust their entitlement for any credits claimed, or to apply for credits they were not entitled to claim when the taxpayer was married or living in an adult interdependent relationship.

The CRA considers the date of separation as a question of fact to be determined on a case-by-case basis and will require more information or supporting documentation from a taxpayer when it has contradictory information on file. A Separation Agreement or a court order may not be considered sufficient proof of the date or fact of separation unless the separation agreement or order indicates different residential addresses for the separated parties. Often, the CRA will ask taxpayers to provide additional documentation proving their new relationship status, or request the taxpayer provide letters from two different third parties who have personal knowledge of their relationship status for the period under review.

The CRA may not consider taxpayers separated until separate residences are being maintained by both parties, but sometimes parties remain in the same residence and, when that is the case, the CRA may consider taxpayers as living separate and apart based on several factors, including:

  • whether the individuals have two distinct households within the home with separate bedrooms, and their meals are not taken together;
  • there is an absence of joint social activities, or joint activities only involve coparenting;
  • when the parties do not present themselves as a couple in public;
  • there is an absence of sexual relations;
  • each person runs their own separate household and makes independent financial decisions;
  • there is a valid reason the parties share the same residence (i.e., they have nowhere else to go, or for coparenting reasons); or
  • when one person adds a letter after the street number for the address of the residence to denote a separate residence.

You might be surprised to learn some legal fees for separation or divorce are tax deductible. Legal fees are NOT deductible when they are incurred to establish a right to obtain a separation or divorce or to establish decision-making responsibilities or parenting time with respect to a child.

Legal fees incurred to exercise a pre-existing right ARE tax deductible. This includes legal fees incurred by the recipient of support to:

  • collect late spousal or child support payments;
  • establish the amount of spousal or child support payments from a current or former spouse/partner or the legal parent of his/her child; and
  • increase the amount of spousal or child support, and/or to defend against the reduction of spousal or child support.

Clients can request a billing statement from their lawyer, which separates out the fees for legal services that are eligible for the deduction. Lawyers may also provide a letter outlining the total legal fees paid in the year with an estimate of what portion/percentage of legal fees related to deductible categories.

Deductibility of legal fees is not tied to the success in a claim for child or spousal support. For example, where a recipient unsuccessfully defends against a reduction in support and the support is reduced, the recipient is still entitled to deduct his or her legal fees.

After the breakdown of a marriage or adult interdependent relationship, the net income of each former spouse/partner is used to determine his/her entitlement to receive the Canada Child Tax Benefit (CCB) and the GST/HST credit. The parent who is primarily responsible for the care and upbringing of the child should apply for the CCB. When a child lives with one parent at least 60% of the time, that parent’s net income is used to determine his/her entitlement to receive the Canada Child Tax Benefit. When entitled, that parent will receive 100% of the benefit. A parent receiving child support remains eligible for the benefit. Child support is not part of the parent’s net income for the purposes of calculating entitlement to the Canada Child Tax Benefit.

When both parents share parenting of a child, each parent’s net income will be used to determine entitlement. If entitled, each parent will receive one-half (50%) of the amount he/she would have received if the child resided with the parent full time. This is the rule even though one parent may not be entitled to the benefit (net income too high) and the other parent would be entitled to the maximum benefit (because of a low net income). To receive the CCB, a parent must file their tax return on time every year. The Canada Child Benefit is not treated as taxable income and does not have to be reported as income on a parent’s income tax return or for child support determination purposes. Parents can contact the CRA online or by telephone to apply for the Canada Child Benefit.

The Child Disability Benefit (CDB) is a tax-free, monthly payment to families who care for a child under age 18 with a severe and prolonged impairment in physical or mental functions. To receive the CDB, a parent must be eligible for the Canada Child Benefit (CCB), and the child must be eligible for the Disability Tax Credit (DTC). A child is eligible for the DTC when a medical practitioner certifies that the child has a severe and prolonged impairment in physical or mental functions and the CRA approves the application. After separation or divorce, the parent with primary care of the child will receive the benefit. When both parents share parenting, the Child Disability Benefit may be split 50/50.

After a relationship breakdown, a parent with primary care of a child may be able to claim the Amount of Eligible Dependent (AED) credit for a child. For the parent to make an AED claim, the following conditions must have been met at some time during the year:

  • the child is under 18 years of age, or is older, and has a medical or physical disability;
  • the child lives with the parent for most of the year;
  • the parent is not making support payments for the child (unless the parents have shared parenting/shared decision/making); and
  • no one else is claiming the credit for the child or for anyone else in the household (there is only one eligible dependent credit allowed per household and only one eligible dependent credit allowed for a specific child).

In shared parenting situations, either parent may claim the AED credit. In that case, it is up to the parents to decide which one of them will make the claim. If both parents attempt to claim the AED credit on their T1 Tax Returns when there is only one child of the relationship, neither parent will receive the credit. When parents have shared parenting of two or more children, one parent may claim the AED credit for one child and the other parent may claim the AED credit for the other child if they qualify for the credit. A taxpayer is only allowed one AED credit per year, no matter how many children live with the taxpayer, and can only claim a child as an eligible dependent if he/she does not have a new spouse living with them.

The childcare expense deduction generally allows a parent to receive some tax relief for childcare expenses incurred so the parent can work, carry on a business, or undertake certain educational activities. After the breakdown of the relationship, when the spouses/partners have been living separate and apart for a full year, both former spouses/partners may claim childcare expenses that each paid in respect of a child. The allowable amount of the deduction will depend on the nature of the expenses, when they were incurred, and when the child was living with the parent claiming the expense.
Students at a university, college, or other eligible post-secondary institution may claim a tax credit for tuition fees, education amount, and textbooks. When a student does not have sufficient income in the taxation year to fully use the credit, he or she can carry it forward to another year or transfer the unused portion to a parent (among others). The student must designate the parent to whom he/she wishes to transfer the credit on the applicable form. The student may designate only one parent. Alternatively, the student may accumulate unused credits for future years.

A property that was a principal residence for every year that it was owned may be sold at a profit without any capital gains needing to be reported on a T1 General Tax Return. A property must be owned by one or both spouses/adult interdependent partners to be considered a principal residence for tax purposes.

According to the Income Tax Act, a couple may have only one principal residence in any given year. So long as the taxpayer has “ordinarily inhabited” the property at some point during the year and the property is not owned to gain or produce income, it can be designated as the principal residence by including the appropriate forms on the taxpayer’s Income Tax Return.

Tax issues relating to the designation of a principal residence most often arise for separating or divorcing spouses/adult interdependent partners when:

  • they own more than one property;
  • the time between the breakdown of the relationship and a court order or the signing of a written separation agreement is lengthy and property values have risen significantly; and
  • when one party remained in the principal residence and the other party bought a new home after marriage breakdown but before a court order or written separation agreement was in place.

Until there is a fully-executed Separation Agreement or a court order, the CRA requires both spouses/adult interdependent partners to designate the same property as their principal residence for the year. When the spouses/partners have been living separately and apart throughout the year and there is a fully-executed Separation Agreement or court order, each party may claim a different principal residence.

After separation, the CRA recognizes two households instead of one, and therefore, it is possible for each ex-spouse to own one tax-exempt principal residence.

Since no capital gains tax results from the sale or deemed disposition of a principal residence, the decision as to which property to designate as a principal residence can have significant tax consequences. The tax implications may be a factor in determining the fair distribution of assets of the marriage or adult interdependent relationship. A principal residence is considered a “personal-use property”, and there can be no capital loss claimed should it sell for less than its original purchase price.

The person who makes spousal support payments may deduct the amounts paid from income, generally reducing taxes owing. The person who receives spousal support payments must include the support payment amounts as income on his/her tax return, and that income is taxable. The reporting of spousal support income must be done even if the person making the payments does not take advantage of the tax deduction.

When there is a child (children), and a fully-executed agreement or court order indicating a global amount for support – without specifying the part of the amount that is for spousal support – the full amount is considered child support.

Child support payments are not deductible from income by the payor and are not included in income by the recipient.

Lump-sum spousal support payments are not deductible from income by the payor and are not included in income by the recipient.

To qualify as “spousal support” payments, the payor and the recipient of support must be living separate and apart due to a relationship breakdown at the time the payment was made. Spousal support payments have four additional characteristics:

  • the terms and schedule of payments are set out in a fully-executed agreement or court order;
  • the payments are made on a periodic basis (e.g. weekly, monthly, quarterly);
  • the payments are for the maintenance of the recipient; and
  • the payments are made to the recipient or an agent enforcing collection of the amount.

Even if these characteristics are not met, the following three types of payments may (in limited circumstances) be considered support payments that are taxable in the hands of the recipient and tax deductible in the hands of the payor:

  • payments made before the date of the court order or written agreement;
  • specific purpose or third-party payments; and
  • lump-sum payments for retroactive support.

Spousal support payments made before a fully-executed agreement or court order may be deducted by the payor and will be taxable for the recipient when:

  • the written agreement or court order states that any amount previously paid is considered to have been paid under the written agreement or court order;
  • the support payments have all the required characteristics of support payments; and
  • the support payments were made the same or prior year as the order or agreement.

The payor may ask the CRA to reassess a previous year’s tax return in consideration of the fully-executed agreement or court order.

Specific purpose payments and payments made to a third-party for the benefit of the spouse or child, or for a specific purpose that benefits the spouse or child, may also qualify as support payments if they are payable under a court order or agreement. An example is a payment to a landlord for rent, to a maintenance company for property upkeep, or to cover insurance. The third-party payments must be set out in a written agreement or court order and must be paid to for the recipient’s expenses for a specific purpose. Where the amounts are payable directly to the support recipient to cover specific expenses, they are specific purpose expenses. Where the amounts are payable to a third party to cover these expenses, they are third-party payments. These payments are considered a support payment when the recipient has discretion as to how the payments may be spent.

For instance, reimbursement for an expense a support recipient has already paid may be used as the recipient sees fit. If the recipient has the discretion to change maintenance or insurance companies, or move to a new rental property, these may be classified as support payments. The recipient may choose a less-expensive option and retain the rest. When the recipient does not have discretion about how the payments may be spent, they may not be considered a support payment unless the agreement or court order specifically states that the recipient will include the third-party payments in income and the payor may deduct them.

Spousal support amounts received must be included in the recipient’s income in the year it is received. A recipient cannot delay cashing a support cheque to delay reporting support as income. Support payments are taxable to the recipient if:

  • the order or agreement clearly states the amount to be paid for the current or former spouse or common-law partner; and
  • all payments for child support are fully paid for the current and previous years.

An order or agreement must specifically designate payment amounts as spousal support to the recipient. Without this designation, support payments will be considered non-taxable child support and do not need to be reported in the recipient’s income.

A lump-sum support payment from one former spouse/adult interdependent partner to the other is not usually tax deductible for the payor; however, a lump-sum payment made by one former spouse/adult interdependent partner to the other to make up for missed periodic spousal/ partner support payments (arrears) is tax deductible by the payor, when the support payments are set out in a fully-executed Separation Agreement or court order. The payor can claim this payment on his/her T1 Return in the year it is paid. A lump-sum payment must have these elements to be a Qualifying Retroactive Lump-sum Payment (QRLSP):

  • the payment is for at least $3000.00, not including interest;
  • it is paid by a former spouse/adult interdependent partner to the other former spouse/ adult interdependent partner;
  • it is a payment to cover missed periodic payments (arrears) for spousal/partner support;
  • the support payments are set out in a fully-executed Separation Agreement or court order, which was in place at the time the support payments were missed; and
  • it applies to missed support payments for one or more previous years.

When the recipient receives a QRLSP, the recipient must report the whole payment at line 128 of his/her T1 Return in the year it is received. At the request of the recipient, the CRA will review the impact of taxing the QRLSP as if the payments had been received in the year(s) in which they were supposed to have been paid. When that is to the advantage of the recipient, the CRA will recalculate taxes owing for those years.

At the end of a marriage or adult interdependent relationship, a pension beneficiary may transfer (roll over) current or future employment pension benefits to the other spouse or partner as part of a settlement without the transfer being taxed as a withdrawal of pension benefits.  This is done via a T2220 tax-free spousal roll-over. The eligible applicant must apply for a division of pension benefits. Pension benefits can be divided as part of a division of family assets to a maximum of 50% of the value of the pension benefits accumulated during the period of the relationship.

After a relationship breakdown, a former spouse or partner has a right to split the former spouse’s or partner’s CPP credits provided cohabitation requirements and application deadlines are met. The split has an impact on the Record of Earnings for each former spouse or partner and therefore, on the amount of CPP pension benefits that may be received on retirement. A spouse or partner has a right to ask for a split of the other spouse’s or partner’s CPP credits after a relationship breaks down. This right cannot be negotiated away except in British Columbia, Alberta, Saskatchewan, and Québec. In those four provinces, separating or divorcing spouses or partners can agree NOT to split CPP credits in a Separation Agreement or court order.

Provided the requirements are met, all or part of the funds in one former spouse’s or partner’s RRSP or RRIF may be transferred to the other former spouse’s or partner’s RRSP or RRIF without any tax consequences. Generally, taxes are withheld on any amounts withdrawn from an RRSP or a RRIF; however, separating spouses may transfer holdings in an RRSP or RRIF without having taxes withheld. Taxes will become payable when the receiving spouse or partner withdraws funds from the RRSP or RRIF.