1. Get your documentation in order
If you and your spouse agree to divorce and split your assets, you’ll need to know the proper value of those assets.
You won’t be making those calculations on your own. Lawyers and other financial professionals will be doing that for you. To assist them in what can be a drawn-out and complex process, Vivian Alterman, founding partner at AP Valuations in Toronto, says you’ll want to provide all the relevant information and documentation related to your assets and liabilities.
“You’ve got to have documentation to support all that,” she says.
2. Determine who gets what
Determining the value of your assets and how to most equitably divide them won’t be done by you or your spouse. That can take some of the heat out of the situation.
“When you go into the process, and you hire the right family law lawyer and the right professionals, they’re thinking about it, and guiding you and asking you the right questions to make sure that [everything] is done following the rules that allow for a tax-efficient transfer,” Alterman explains.
It’s important to remember that the value of each of your assets has to be determined on an after-tax basis. A $250,000 registered retirement savings plan (RRSP) or $100,000 worth of Apple stock, for example, won’t ultimately be worth those amounts to whomever receives them as part of a divorce settlement. The RRSP, for example, will trigger a tax hit once the funds are accessed and the stock will be taxed upon liquidation.
“When you’re looking at value and equalizing, everything is done on an after-tax basis,” Alterman says. “It’s sort of like horse-trading.”
3. Divide and conquer (your tax bill)
Here’s where, thanks to Canadian tax law, things actually get a little easier for divorcees.
To avoid selling off their assets and paying taxes on the proceeds, separating parties have the option of transferring assets that have unrealized gains from one spouse to another on a tax-deferred basis. It’s a move known as a “rollover.”
“It’s an amazing provision that we use to transfer assets that have this embedded tax liability,” Alterman says. “As long as the transfer is in settlement of property rights, you can transfer.”
Rollovers apply to many types of assets, from stocks to various savings accounts to holding companies containing millions of dollars in investments.
“Rather than transferring shares of an investment holding company to a former spouse so that the parties jointly own the asset, or liquidating investments and triggering taxes, the shares of the corporation can be restructured,” Alterman explains.
And some of those underlying investments can be transferred on a tax-deferred basis to a new holding company. “This allows both parties to divide the value of the company, avoid paying taxes and establish a clean break,” she adds.
Before crawling off to piece your life back together, a few more tax matters need to be worked out. If you and your spouse own multiple properties, you’ll have to decide which one gets your family’s tax exemption for principal residences.
“One spouse will end up with a property that may have a large tax bill associated with it when it is ultimately sold,” Alterman says. “This liability needs to be calculated and considered in the settlement negotiations."
There’s also the matter of spousal and child support.
Child support is a non-issue. It isn’t counted as taxable income for the recipient, nor can it be claimed as a deductible expense by the spouse who pays it.
Spousal support is just the opposite. The payer can use it as a deduction, while the recipient must claim it as income.
Those deductions can come in handy if a family’s breadwinner has been splitting income with her spouse to secure a lower tax rate. Once the opportunity to split income is removed, the better-paid spouse will likely vault into a higher tax bracket. But claiming the spousal support deductions can help reduce the tax she’ll have to pay.
Keep in mind any lump sum spousal support amount, or amounts paid outside of a separation agreement or court order, are not tax deductible.
It’s also important to remember that as a newly single person you’ll be responsible for covering all the expenses your household generates. If you weren’t in charge of your family’s budget before, it’s a responsibility you’ll have to take on whether you like it or not. So prepare to spend accordingly: Kleenex and tequila should only make up 60 per cent of your spending for the first few days.