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Tax Blog: Tax Planning in the Context of a Marital Breakdown

November 27, 2018

Tax Blog: Tax Planning in the Context of a Marital Breakdown

Synopsis
4 Minute Read

The impact of taxes, or deferral of taxes payable, during a divorce can be significant, but proper planning can see tax savings for both spouses.

During a divorce or separation, the tax impact of asset transfers may not be front of mind. However, this is an important financial aspect of the separation that must be considered by both parties. The current and future taxes on different types of assets in the division should always be considered. The more collaborative a divorce process can be, the greater the opportunity to achieve tax savings for both spouses.

Although there are many important aspects of the separation to consider such as spousal support and child support, this blog will focus on a divorce where marital assets include a private corporation and new tax legislation, also known as tax on split income (TOSI).

Consider a division of assets between a couple that includes a holding company owning a large passive investment portfolio. If the holding company is a large percentage of the overall assets for the couple, the passive investments within the company may need to be split between the two spouses. The tax implications and practical split of the assets needs to be analyzed.

Asset Transfers

Assuming the spouses do not want to be shareholders in the same corporation and make investment decisions together post divorce, the investment assets must be distributed to both parties. There are two main options, being:

  • Transfer investment assets to the individuals
  • Split the investments into two corporations

The baseline situation would be investments being transferred to the spouses at a personal level. Removing assets from a corporation will result in personal tax (and potentially corporate tax, depending on the assets within the corporation). In this situation, significant personal tax will be incurred, up to a personal tax rate of 40 percent depending on the attributes within the company. This will significantly reduce the overall value of the assets that will be held by the individuals moving forward. Can the transfer of the passive investments to the spouses be structured in a more tax effective way?

Split Investment

While the individuals are separated, but prior to the divorce being finalized, the individuals will still be related for tax purposes. With proper planning, this could allow for a transfer of the passive investments to a new holding company for one of the spouses.

This type of planning allows for personal tax to be deferred on the transfer of assets, which means that there is a larger asset base for each spouse, which is the goal of this type of reorganization. Depending on the amount of passive investments retained at a corporate level, the tax deferral can be significant. An illustration of a $2,000,000 holding company is illustrated below between the two alternatives:

Net After Tax Proceeds Distribute to Individuals Split into Two Corporations
Fair Market Value of Corporate Investments $2,000,000 $2,000,000
Personal Tax on Distribution of Assets to Individual (800,000) -
Total Investable Cash $1,200,000 $2,000,000

 

The above illustrates the advantage to deferring taxes payable where possible and allowing a larger asset base to be received by both spouses in the divorce. Each individual situation will be unique and should be consulted with a tax specialist to ensure the optimal tax outcome for both parties.

Tax on Split Income

The Department of Finance has introduced new tax legislation regarding dividends received from private corporations. The impact of TOSI to former spouses that receive assets at a corporate level must be analyzed. On a high-level reading of the new legislation, it appears that shares received through a separation or divorce will not be subject to TOSI.

However, when you dig a little deeper into the details, the shares must be received in a manner where 160(4) of the Income Tax Act applies, which is a specific situation, and does not apply to all divorce scenarios. Proper planning must be undertaken around divorce planning when private company shares are involved, specifically when children from the marriage would be involved in an active business of one of the spouses.

Conclusion

While tax is not the most important item on the list in a divorce, the impact of taxes, or deferral of taxes payable, to both parties can be significant. With proper planning prior to the divorce, significant tax savings can be achieved for both spouses.

For more information on tax planning in the context of a divorce or any other tax planning in general, contact Scott Assman, CPA, CA, at 306.790.7900 or email [email protected] 

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