Globe and Mail

A little co-operation with ex can pay off

When transferring assets, file simple election jointly to avoid getting stuck with tax.

Tuesday, February 23, 1999
TIM CESTNICK
Special to The Globe and Mail

If you're going through a separation or divorce, you are probably experiencing enough injury without having to worry about the added insult of excessive taxation.

But make no mistake: There are issues you should be thinking about to put you in a better tax situation after the split. In fact, a little co-operation between you and your ex could mean tax savings for both of you.

Here is my top-five list of issues deserving your attention:

Transfers of property.

If you're not careful, you could be in for a nasty tax surprise after you transfer assets to your spouse as part of a separation or divorce. But by filing a simple election jointly with your former spouse, you'll avoid the tax bill.

Why? If you transfer an asset to your former spouse and he or she subsequently realizes capital gains on the asset, you could be left holding the tax bill on those taxable capital gains.

The rules work so that the spouse who originally owned the property will still shoulder the tax bill -- unless both spouses jointly elect to avoid this attribution of the capital gains.

As an aside, you'll be glad to know that any property transferred to a spouse pursuant to a court order or in settlement of rights that arose out of the marriage will change hands at the adjusted cost base (typically the original cost) of the property for tax purposes. The result? No tax to pay on the transfer.

What about income generated on those assets after the transfer? That income (but not capital gains) generally will be reported by the spouse now owning the asset. That's because the attribution rules no longer apply to pass the tax bill on that income to the spouse who was the original owner.

It's those capital gains realized after the transfer that you've got to watch for -- and the joint election should look after the problem.

Equivalent-to-married credit.

Once you've split from your spouse, you may be entitled to a tax credit that you haven't claimed before. It's known as the equivalent-to-married credit, and you could be eligible for it if you're separated or divorced (those who are single and widowed also may claim it) and you're supporting another family member living with you under the age of 18. The age requirement can be ignored if the dependent person is your parent or grandparent, or suffers from a physical or mental infirmity.

Keep in mind, though, that in the year you separate or divorce, you can claim either the married credit in respect of your ex-spouse or the equivalent-to-married credit for a dependant -- but not both.

One-income status.

If you happen to have children under 18, you may be able to collect the Canada Child Tax Benefit more easily than when you were married. It's true that the benefit, paid by the federal government monthly to qualifying families, won't make you rich, but it's better than a kick in the pants.

Why does it get easier to collect after a split? Your benefits are based on the combined incomes of you and your spouse -- and could be clawed back quite quickly as a result.

But when a marriage falls apart, the parent with whom the kids will be living can make a special election to permit the benefits to be based on the income of that parent alone -- ignoring the income of the estranged spouse.

You must make this election within 11 months of the marriage breakdown. But going for it could put hundreds more dollars in the pocket of the spouse living with the kids.

Preserve pre-May, 1997, agreements.

Here's a situation where co-operating with your ex could save the family significant taxes.

The 1996 federal budget changed the way child-support payments are taxed. It used to be that the payer could claim a deduction for payments made, and the recipient was taxed on those payments.

But things have changed. For any new support agreements entered into after April 30, 1997 -- or when the amounts in an existing agreement are varied after that date -- new rules apply.

They prevent a deduction by the payer, and the recipient is not taxed on the payments.

Is the family really better off here? Not really. Only Revenue Canada wins. That's because the deduction claimed by the paying spouse typically provides tax savings that are greater than the tax bill owed by the spouse reporting the money as income.

Why? Because the paying spouse is usually in a higher marginal tax bracket than the recipient spouse. This is a net benefit to the family (albeit the paying spouse enjoys the savings).

But under the new regime, this net benefit is lost and Revenue Canada enjoys the windfall.

Here's a good compromise: Preserve your pre-May, 1997, agreements so that the deductibility of the payments remains with the payer (and the payments will be taxed in the recipient's hands), then arrive at an understanding that the paying spouse will consider using those tax savings for the benefit of the child.

Principal residence exemption.

Your principal-residence exemption allows you to sell your principal residence at a profit without paying any tax on the gain. The problem, of course, is that each family is entitled to only one exemption.

This is a problem especially when more than one property is owned by the family -- perhaps a cottage in addition to the home.

Oddly enough, separation or divorce provides an opportunity to multiply the exemption because you will be considered to be your own "family" after your marriage breakdown -- and you'll be entitled to your own exemption.

Here's the plan: Consider giving one property to each spouse when splitting the spoils. This way, both properties eventually can be sold with the gains sheltered from tax by a principal-residence exemption.

Tim Cestnick is the author of Winning The Tax Game and president of WaterStreet Group Inc., a tax-education and consulting firm based in Toronto.

Copyright © 1999 The Globe and Mail