Nothing is certain in life except death and taxes.
Nothing is more true, especially when navigating the complex and emotionally charged world of divorce. There are many tax implications that you need to watch out for both during the equalization process and after you and your partner have separated.
Here are a few things you need to know to make taxation work for you and make sure you reach the best settlement possible for your situation.
Consider the value of each asset after taxes
This may be the most important thing you do in your divorce settlement. When you are looking at equalization it is important to consider the value of each asset AFTER taxes because assets will be taxed differently.
For example, imagine you and your spouse own a house that is worth $400,000. Your partner also has non-registered investments totaling $100,000 and an RRSP that is worth $300,000. That comes to a total of $800,000 of which you are entitled to $400,000, or half. In this case the investments will be taxed at a rate of 20% while the RRSP will be taxed at a rate of 40%, leaving you with only $260,000 of the $400,000 once the money is withdrawn. As a primary dwelling your house is not taxable, therefore it’s value of $400,000 will stay intact. In this case it would make the most sense economically to opt for the house in the equalization process rather than the money that will be taxed upon withdrawal.
Do not cash in your RRSPs
Cashing in your RRSPs as part of your equalization payment will cost you a lot in tax and is not necessary. In Canada there is a law that dictates that one spouse can transfer their RRSP to the other spouse upon divorce internally, and without tax consequences. This counts as part of the equalization payment and will make sure that you are not taxed unnecessarily.
Change your marital status immediately with CRA
People often forget to change their marital status with Revenue Canada upon divorce or separation. All your credits and tax processing will be calculated with the marital status they have on record and therefore will remain the same if you don’t change it. This will have certain tax implications and you may end up owing money if you they don’t have the right marital status on file.
Contact everyone else to tell them of your status change
It may be the last thing you want to do but you need to make sure pretty much everyone knows that you and you ex are no longer a pair. Things like changing the beneficiary on life insurance, closing joint credit cards and bank accounts, telling your utilities and phone companies and reviewing loan ownership and other debts are integral for making a clean break from your spouse. Even if the divorce is amicable you don’t want anything to be tying you together financially in case things go sour. This is especially important in the case of beneficiaries. Most people would prefer that their life insurance or investments end up with their children or other family members rather than their ex.
Decide who is the primary caregiver for children
This is often one of the most difficult things to do when it comes to divorce or separation. The primary caregiver will be able to apply for the Canada Child Benefit on a single income and this could mean a greater payout. A single parent can also claim a child as a married equivalent which could lead to a large tax deduction. However, the requirements for this are very specific and it will need to be negotiated very closely in your agreement. If you are chosen to be your child’s primary caregiver make sure you let their school and doctor know, that way if the CRA ever comes knocking you will have some reliable sources to back you up.
You may be able to claim some legal fees
If you have to go through a lawyer to claim child or spousal support payments those legal fees are tax deductible. However, legal fees that you pay for a lawyer to prepare a separation agreement or facilitate disputes going back and forth based on family assets are not. If you are the person who should be paying spousal or child support payments your legal fees are not tax deductible either.
Taxes are no walk in the park at the best of times. Situations like divorce and separation make them even more complicated. Talking to someone like an accountant is highly recommended to make sure that you are taking advantage of all the benefits and avoiding all the pitfalls when it comes to taxation.