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Divorce and Taxes

CRA Tax Status & Divorce: Separation Date

The CRA and Family Law have different definitions on what is considered to be a separation date. For example, under a Family Law’ definition a couple living in the same house, with a number of qualifying circumstances, can be considered separated. This is important for property division.

However, it’s after you physically move out to a different address and stay there for 90 days that you can be considered separated according to the CRA’ definition. Refer to the link: http://www.cra-arc.gc.ca/bnfts/mrtl/menu-eng.html.

This is important to know what is your CRA tax status as it directly affects your Canada Child Tax Benefit entitlement, dependent credits and tax deductions.

 

  • CRA Tax status “Married”

Thomas is earning $100,000/yr and his wife Sandra is earning $30,000/yr., as a married couple they don’t receive any of the CCTB and have no dependent credits.

For the time being, they have not yet decided how to split their matrimonial home and they continue to live under the same roof. They have separate bank accounts, don’t communicate with each other and consider themselves as separated.

Thomas and Sandra file their income taxes separately as Sandra detests the idea of going to the same accountant as Thomas uses. She thinks they both can plot against her.

Both tell their respective accountants that their status is “SEPARATED” and this triggers a retroactive payment of Canadian Child Tax Benefit to Sandra. Looks like good news. But shortly afterwards – just as Sandra have spent newly found fortune – she receives a letter from CRA asking to pay it all back. Why?

Well, the issue is that the CRA received Thomas’s return and eventually something got synchronized in such a way that it became evident that couple lives in the same house. Under this condition, no one is qualified for CCTB. The same goes for dependent credit, childcare deduction, etc.

It is an honest and such an easy-to-make mistake. But, having the same accountant would have caught this issue at the time of filing.

 

  • CRA Tax Status “Separated” 

Derek and Mary were living separately and apart for over a year. The couple has shared custody of both their children. Because the separation agreement was still in the works, they thought their CRA status was “MARRIED”.

By having them file the RC65 (CRA marital status change form) and certify that they lived separately an apart for the past 16 months, we triggered the tax reassessment. Not only both parents got their retroactive share of CCTB but also had their dependent credit applied.

Dependent credit entitlement in the situation of a shared custody is a big issue that largely depends on a proper wording of the respective clause in the separation agreement. Advice from a divorce financial professional is worth thousands of dollars of future tax savings.

The total was $8,070; of which $3,890 was dependent credit for both and $4,180 retroactive child tax benefit. This was a huge relief for both parties and allowed them to pay off mounting credit card debt and left cash on hand to finalize their separation agreement.

RRSP

RRSP & Divorce; hidden wealth

As a financial advisor, I could never agree with ubiquitous RRSP propaganda in Canada. I always spent time educating my clients about the pros and cons of this program. However, when it comes to a property division due to a divorce, registered retirement savings plans represents a huge opportunity for spouses with different marginal tax rates. So huge, that you sometimes wish to divorce just for the sake of it.

The trick is that there is NO attribution rule on spousal RRSP rollover (not to confuse with spousal RRSP), if it is done pursuant to a court order or written separation agreement using CRA Form T2220 (check: http://www.cra-arc.gc.ca/E/pbg/tf/t2220/README.html).

In my practice as a divorce financial analyst, I always make sure to show clients all possible tax savings that divorce-driven RRSP split can have. Whether done by tweaking your existing accounts or creating the new ones, this valuable opportunity should never go unnoticed. After all, thousands of dollars can be saved on both ends of a separating union.

Spousal RRSP to fund equalization payment in Divorce:

Thomas is earning $100,000/yr (43.41% MTR) and his wife Sandra works part-time in the local town library earning $30,000/yr (20%).

Thomas has to pay Sandra an equalization payment of $25,000 pursuant to a Separation Agreement; however he has no cash and does not want to sell his stocks as it will trigger a capital gains tax.

Thomas has room on his RRSP and decides to do a spousal RRSP contribution to Sandra at the grossed up rate or her current marginal tax rate to make it fair. This comes to $31,250. This way after 20% tax, Sandra would be netting $25,000.

To make things more interesting to Sandra, Thomas is making a $35,000 RRSP contribution and Sandra is happy to accept it. Thomas’s MTR of 43.41% allows him to phase out the deduction into several years to get just that; 43.41% tax deduction or $15,193, what in turn makes his cash outlay for equalization payment $19,806.

Also, he secures an RRSP loan with the bank at (!) prime rate, which makes it so much more attractive than drawing his credit cards to the ground, incurring 18% cost and downgrading his credit score.