Taxation of Divorce & Separation
Separation turns routine tax returns into minefields of questionable deductions and property transfers. Custom-written for CPAs advising clients through relationship breakdowns and preparing returns for separated individuals.
Hugh Woolley
Learn which support payments are actually deductible, how to execute property divisions without triggering tax, and when attribution rules stop applying. You will understand how to advise clients on structuring agreements that preserve tax benefits, handle the year-of-separation return properly, and avoid the conflicts of interest that emerge when you've served the whole family.
Your client hands you a separation agreement and asks: "Are these payments deductible? Can we transfer the house without tax? What about the cottage?"
You scan the agreement. Monthly payments of $3,000 for spousal support. Property division transferring the family home to one spouse, the cottage to the other, RRSPs being split. The agreement was signed three months ago but payments started six months before that. Are the early payments deductible? Does the house transfer trigger a capital gain or does it roll over? If both spouses owned both properties, who gets to claim which one as principal residence? And if you've been doing tax returns for both of them for years, can you even advise on this or are you in conflict?
This session shows you what to look for in separation agreements and how to handle the tax filings correctly:
- Payments are only deductible if the agreement says they're periodic, for maintenance, and the recipient has discretion over how to use them
- The agreement can validate payments made up to one year before it was signed, but not earlier
- Property transfers between spouses roll over automatically at cost unless you elect out on the return
- When couples each own property after separating, the first spouse to file their principal residence designation wins
- Attribution of income stops the year after separation, but capital gains keep attributing until divorce unless both file an election
- Legal fees for establishing or collecting support are deductible, but fees for getting the divorce or dividing property are not
You need to know when you can help both parties and when you cannot. If they want you to prepare both returns and advise on the agreement, you are in conflict the moment their interests compete. One wants to maximize deductions, the other wants to minimize income. The separation creates competing interests that put you in an impossible position unless you choose a side or step back entirely. You also need to recognize what makes support payments deductible. Agreements drafted by family lawyers often use language that sounds like support but fails the tax test. If the payment releases the payor from future obligations, it is a capital payment and not deductible even if the agreement calls it support.
The material walks through real scenarios you will encounter in practice.
Seminar Snapshot
This program will help you understand the taxation of divorce and separation, spot issues, and identify valuable planning opportunities. Learn at your own pace with instant access.
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Taxation of Divorce & Separation
Course Syllabus
Relationship Status and Professional Conduct
Understanding when relationships begin, end, and create tax consequences
Conflict of Interest Considerations
- CPA professional conduct rules when accounting firms serve entire families
- Recognizing conflict of interest situations arising from competing interests
- Options: acting for one party, acting for family company while both get independent advice
- Documenting conflict management techniques and disclosure requirements
Meaning of Spouse and Common-Law Partner
- Legal marriage requirements and recognition of foreign marriages
- Common-law partner definition: 12-month cohabitation or parent of partner's child
- Deeming rule continuing relationship until separation conditions met
- Extended definition under subsection 252(3) for void or voidable marriages
Conjugal Relationship Factors
- Question of fact determined by circumstances (M v. H Supreme Court case)
- Shared shelter, sleeping arrangements, sexual behavior, personal conduct
- Services provided, social activities, economic support, children
- Molodowich factors adopted by courts
Separation for Tax Purposes
- Living separate and apart for 90 consecutive days due to relationship breakdown
- Can live separate and apart under same roof (Bellavance, Aukstinaitis, Perron, Scott cases)
- Must be because of breakdown, not other reasons (Venghent: visa issues don't qualify)
- Marriage ends only upon legal divorce; common-law partnership ends after 90 days
- Tax filings: Form T1158 for support registration, Form RC65 for marital status change
Support Payments
Distinguishing deductible spousal support from non-deductible child support and capital payments
Support Payment Basics
- Child support: never deductible or taxable (except pre-May 1997 agreements not varied)
- Spousal support: deductible to payor and taxable to recipient when conditions met
- Is tax deductibility desirable? Income splitting analysis when payor in higher bracket
- Impact of inconsistent income or non-resident status
Conditions for Deductibility
- Must be paid pursuant to court order or written separation agreement
- Payable on periodic basis (not lump sum for release of liability)
- For maintenance of recipient, spouse, or both
- Living separate and apart when payment made due to breakdown
- Recipient has discretion over use of payment
Support Amount Definition
- Allowance on periodic basis for maintenance of recipient, former spouse, or both
- Recipient must have discretion over use (unlike mortgage payment to third party)
- Payment while living together or on special occasions not support amounts
- Payment made after death of payor not support amounts
Periodic Payments Test
- McKimmon case factors: interval length, amount relative to income and living standards
- Weekly or monthly payments suggest periodic maintenance
- Indefinite or fixed-term payments linked to specific events (child reaching 18, remarriage)
- Payments releasing payor from future obligations more likely capital
- Avoid intervals greater than one year
Prior Payments Validation
- Subsections 56.1(3) and 60.1(3): written agreement or court order can validate prior payments
- Can only go back one calendar year from agreement date
- Agreement must reference that earlier payments are paid and received under agreement
- Only amounts in agreement are deductible, excess payments not deductible (Fisch, Kounnas, Hobbs cases)
Lump-Sum Payments
- Generally not periodic unless represent arrears of qualifying periodic payments
- Acceleration payments under court order to secure obligation (Ostrowski case)
- Retroactive court-ordered payments for defined period before order (Form T1198 for income averaging)
- Lump sum for release of liability does not qualify (Bennett case)
- Payments tied to irregular bonuses do not qualify (Berty case)
Third-Party Payments
- Subsections 56.1(1) and 60.1(1): deem payments to third parties as received by recipient
- Must be outlined in written agreement or court order
- Still must meet all other conditions (periodic, allowance, discretion)
- Subsections 56.1(2) and 60.1(2): specific third-party payments (medical, education, rent)
- Agreement should state subsections 56.1(2) and 60.1(2) apply
Division of Marital Property
Executing tax-deferred property transfers and navigating rollover rules
Spousal Rollover Rules
- Subsection 73(1): automatic rollover at cost for property transfers to spouse or former spouse
- Property must be capital property (not inventory), Canadian or foreign
- Taxpayer and spouse must be Canadian residents immediately before transfer
- Can elect out of rollover under subsection 73(1) to trigger gain (useful with capital losses)
Principal Residence Complications
- One property designation limit per couple for years after 1981
- Divorced or separated common-law partners can each designate property for subsequent years
- Married but separated can each designate if written separation agreement or judicial order exists (Blanko Estate case)
- First spouse to file designation trumps other's ability to designate
- Subsection 40(4): deemed ownership when acquired through rollover
- CRA position: first filer accepted, last filer cannot designate for same years
Principal Residence Strategy
- Calculate gain per year for each property owned by separating couple
- Make written agreement specifying which property each will designate
- Flipped property exception: subparagraph 12(13)(b)(iii) excludes breakdown of marriage if living separate 90 days
- Risk: without written separation agreement during years both own property, cannot each designate
Transfer of Deferred Plans
- Subsections 146(16), (21), 147.3(14), 147.5(12), Regulation 8502(b)(iv)
- RRSP, SPP, PRPP, RRIF transfers when living separate and apart
- Must be under written separation agreement or court order pertaining to property division
- Form T2220 filed with financial institution for direct transfer
- Cannot transfer to RRSP if transferee precluded by age (must go to RRIF)
Spousal RRSP Attribution
- Anti-avoidance rule attributes income back to contributor for contributions in year or two preceding years
- Rule does not apply when living separate and apart due to relationship breakdown
- Timing of withdrawal while separated avoids attribution
First Home Savings Account (FHSA)
- Direct transfer from FHSA to recipient's FHSA, RRSP, or RRIF with no immediate tax
- Recipient entitled under court order or written separation agreement
- Maximum: fair market value less any excess FHSA amount
Post-Separation Attribution and Tax Issues
Managing income and capital gains attribution after relationship breakdown
Spousal Attribution Rules
- Subsection 74.1(1): income attribution on property transferred or loaned to spouse
- Subsection 74.2(1): capital gains attribution on transfers to spouse
- Attribution ceases year after separation for income (subsection 74.1(2))
- Capital gains attribution continues until divorce unless election under subsection 74.5(3)
Subsection 74.5(3) Election
- Joint election to cease capital gains attribution before divorce
- Both parties must agree and file election
- Generally wise to make election unless specific reason not to
- If estranged spouse unwilling to elect, only divorce prevents attribution
Private Company Share Division
Tax-efficient strategies for dividing private company ownership
Private Company Share Basics
- Can transfer under subsection 73(1) rollover like any capital property
- Using shareholder loan balances to facilitate buyout
- Using capital dividend account (CDA) for tax-free distributions
- ERDTOH and NERDTOH: when 38.33% refund exceeds or approximates personal tax
Butterfly Reorganizations
- Paragraph 55(3)(a) related party butterfly for divisive reorganization
- Parties must be "related": common-law partners cease after 90 days, married parties on divorce
- Much easier for legally married parties to remain related throughout reorganization
- Can divorce at end of series of transactions
- No proportionate division required (unlike 55(3)(b) for non-related parties)
Butterfly Execution Example
- One spouse incorporates Newco, transfers shares under section 85
- Operating company repurchases shares owned by Newco for promissory note
- Deemed dividend under subsection 84(3) is tax-free inter-corporate under subsection 112(1)
- Part IV tax not applicable if no refundable tax in operating company
- Avoid subsection 55(2) recharacterization by remaining married during reorganization
Alternative Structures for Common-Law Partners
- After 90 days separation, paragraph 55(3)(a) not applicable
- Subsection 55(2) recasts deemed dividend as proceeds creating capital gain
- Opportunity to use lifetime capital gains exemption on share transfer to Newco
- Section 84.1 limits PUC bump, creates potential capital gains surplus stripping concerns under GAAR
Trust Distributions
- Subsection 107(2): tax-free distributions from trust to former spouse or common-law partner
- Simple transaction to divide trust property
- Often overlooked opportunity in separation planning
Partition of Matrimonial Property
- Subsections 248(20) and (21): general rules for partitioning jointly-held property
- Subsections 248(22) and (23): additional rules for matrimonial property
- Subsection 248(22) deems property to belong to taxpayer who brought it into relationship
- Useful for dividing inventory not subject to subsection 73(1) (e.g., land held for development)
Legal Fees, Credits, and Other Considerations
Deductibility rules and post-separation tax planning opportunities
Deductible Legal and Accounting Fees
- Establishing support payments (child or spousal): deductible
- Seeking increase in support payments: deductible
- Defending against reduction in support: deductible
- Collecting late support payments: deductible
- Deductible on accrual basis, not cash basis
- Apply to child support even though not taxable to recipient
Non-Deductible Legal Fees
- Obtaining separation or divorce: not deductible
- Establishing custody or visitation rights: not deductible
- Equalizing family assets: not deductible
- Collecting amounts that are not support amounts: not deductible
- Payor establishing, negotiating, contesting, reducing, or terminating support obligation: not deductible
- May capitalize some fees into cost of business assets acquired or retained (IT-99R5)
Eligible Dependent Credit
- Paragraph 118(1)(b): same amount as spousal credit
- Available to single parent living with child
- Subsection 118(4): can only claim for one child
- Taxpayer must be unmarried, not in common-law relationship, or separated
- Must maintain self-contained domestic establishment with wholly dependent related person
- Subsection 118(5): no amount if support amount paid to former spouse for that person
Year of Separation Planning
- Can claim either spousal support payments or spousal tax credit in year of separation (not both)
- Support is deduction, spousal credit is credit at lower value
- Generally better to claim support payments deduction
- Can claim eligible dependent credit in subsequent years if conditions met
Child Care Expenses
- Generally lower income spouse claims child care expenses
- Higher income spouse may claim for separation period if: 90+ days, living separate at year-end, higher income spouse paid costs
- If separate entire year, payor of costs may claim subject to normal limitations
- CRA position: only custodial parent can claim (Folio S1-F3-C1)
- Joint custody: payor parent may claim for their period if conditions met
- If reconciled at year-end, no special rules apply for separation period
Tax Discounts and Equalization
- Some assets have inherent tax liability: RRSPs, appreciated securities, private company shares, rental properties
- Other assets are tax-paid: cash, principal residence, shareholder loans
- Must discount value of assets with tax liability to compare "apples to apples"
- Consider timing of tax payment and discount the discount (e.g., 50% tax discounted to 25%)
- Factors: years until tax payment, prevailing interest rates, tax-deferred accrual within RRSP
Canada Child Benefit
- Means-tested benefit: $7,437 per child under 6, $6,275 per child 6–17 (2023 indexed amounts)
- Adjusted income includes income of spouse or common-law partner
- Grind starts when family income exceeds $34,863 (2023)
- Subsection 122.62(6): adjusted income excludes spouse income if separated 90+ days and Form RC65 filed
- Opportunity to increase benefit for custodial parent
CPP Credit Split and Other Matters
- CPP credits earned during marriage can be split equally (Form ISP 1901)
- Available on divorce or separation with written agreement
- Payroll variation letter (Form T1213) to reduce withholding for deductible support payments
- Mandatory disclosure rules: separation agreements with indemnity provisions may require reporting
- Cross-border planning opportunities when one party non-resident
Meet Your Presenters
Michael Cadesky
Michael Cadesky is the managing partner at Cadesky Tax and a committed contributor to the tax and accounting professions since 1980, earning the title of Fellow from CPA Ontario. He is a past governor of the Canadian Tax Foundation, past chair of STEP Canada and STEP Worldwide, and past chair of the CPA Canada Tax Committee for Small and Medium-Sized Enterprises. Michael is also the co-author of 11 books on tax subjects and the author or co-author of numerous papers and articles on Canadian and international taxation.
Hugh Woolley
Hugh Woolley is an independent tax consultant who has taught income tax for over 30 years for many professional organizations. Hugh has written courses for CPA Canada and over 10 papers for the Canadian Tax Foundation and STEP Canada. From 1990–1992 he worked at the CRA's Rulings Directorate in Ottawa writing "butterfly" tax rulings. Hugh is a past Governor of the Canadian Tax Foundation.
FAQ
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