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---- MARRIAGE AS A TAXING EVENT---- (Written by Gary Connolly, partner, Weldon Connolly Chartered Accountants, Stittsville, ON) The following is a brief look at how the income tax system will impact on a marriage of two people. Our analysis and commentary is based on current tax law which is subject to change. You should seek the advice of your tax advisor before implementing any tax related strategies. The facts related to your own particular situation will impact upon how any strategies should be implemented. First of all, we need to determine what the definition of a spouse is. The income tax act has its own definition when it comes to the question of . . . who is your spouse? For tax purposes your spouse includes anyone of the opposite sex with whom you were cohabiting in a conjugal relationship throughout a 12 month period. Webster’s defines a conjugal relationship as "the sexual rights or privileges implied by and involved in the marriage relationship". Most tax advisors will take your word on whether or not you meet the definition and we’re not commenting on the political correctness of "rights or privileges". As a result of this definition, it is possible under the income tax act to have multiple spouses at any one time. For example, partners who are content to let their relationships dissolve over time without a formal agreement to an end could have a series of spouses at any point in time. Rules which provide favourable treatment to spouses are summarized as follows: Personal tax credits If your spouse’s income does not exceed $538 in the year then you will be entitled to claim a full spousal amount tax credit of $5,380. This is gradually reduced to zero for every dollar of your spouses income over $538. This is in addition to your basic personal tax credit of $6,456. You may also be entitled to claim other unused tax credits of your spouse such as the disability amount, tuition fees and education amount and the age amount. Medical expenses Medical expenses for any 12 month period ending in the year should be combined for both spouses and dependent children. You must deduct 3% of your net income (up to $53,800) from the combined medical expense before you can claim a tax credit. Therefore, you should consider claiming medical expenses on the person with the lower net income. However, in situations where one spouse is paying the new Ontario flat tax (commonly referred to as the fair share healthy levy) , it may be more beneficial for the higher income spouse to make the claim. Since the tax credit is non-refundable it should not be claimed by a spouse who would not otherwise be taxable. Charitable donations As with medical expenses, charitable donations should be combined in order to maximize the benefit. However, unlike medical expenses there is no deduction based on net income. As a result, the tax credit is worth the same amount to either spouse, provided they have income. The benefit of combining the donations comes from the fact that the first $200 of donations are valued at the low tax rate and everything over $200 is valued at the high tax rate. Donations can also be carried forward up to five years. Therefore, it may be advantageous to carry donations forward and only claim them when they exceed $200 in the year. Dividend tax credit Dividends from taxable Canadian corporations entitle the recipient to claim a dividend tax credit. Where the recipient spouse has very little income and would not otherwise be taxable because of the personal amount tax credit, then, it is possible to elect to transfer all taxable Canadian dividends to your spouse who would then be entitled to claim the unused dividend tax credit, as well as any unused spousal amount tax credit. RRSP’s Current RRSP rules allow one spouse to contribute to an RRSP plan of the other spouse naming that spouse as the annuitant. This is referred to as a spousal RRSP. You should ensure that the spouse in the higher tax bracket makes the RRSP contribution first before a spouse in a lower tax bracket to ensure the maximum tax benefit. Future income splitting can be achieved when RRSP’s are built evenly between spouses in such a way that future tax costs will be split when the funds are removed. You should consider whether either spouse belongs to a pension plan as this would alter how you should split your RRSP contributions now. Your contribution entitlement is based on your own RRSP contribution room as advised by Revenue Canada on your notice of assessment. In other words, you cannot make a contribution based on the contribution room of your spouse. Also, your spouse cannot withdraw funds from a spousal RRSP to which you have made any contributions during the prior two taxation years. RRSP’s and RRIF’s on death You should consider naming your spouse as the beneficiary of your RRSP and/or RRIF in order for the rollover provisions to apply automatically on your death. Otherwise, the deemed disposition rules could apply and the RRSP and/or RRIF would be taxable to your estate. Without a spouse or qualifying dependent the proceeds of your RRSP and /or RRIF would be taxable to your estate on death. Rules which provide unfavourable treatment to spouses are summarized as follows: Refundable tax credits Many of the tax credits which may have been available to a person before marriage may no longer be available because the income of both spouses must now be combined in order to determine eligibility. For example, eligibility for the goods and services tax credit, child tax benefit and Ontario tax credits are based upon the combined income of both spouses. Equivalent to married credit An equivalent to married tax credit is available to a person who was unmarried in the year, or, separated and did not support or was not supported by a former spouse and supported a dependent person such as a child under 19 or a parent who resided with you. When you become a spouse of someone else, you will lose your entitlement to the claim beginning with the next taxation year. The rules relating to this tax credit are complex and you should seek the assistance of your tax advisor. Principal residence Each taxpayer is entitled to claim one principal residence for tax purposes. This means that any capital gain from the disposition of a home would not be subject to tax. Where two persons are living separate and apart they may each claim one principal residence. However, when they become spouses they are only entitled to one principal residence between them. Income splitting Any attempt at income splitting should carefully consider the attribution rules which are a special set of complex rules designed to prevent income splitting between spouses. Basically, one spouse who transfers income producing assets such as a term deposit by way of a gift to the other spouse must continue to report the income earned on that asset. The attribution rules can be avoided where the recipient spouse pays fair market value for the asset or, pays interest at prescribed rates within 30 days of the end of each calendar year on a bonafide loan arrangement. Attribution does not apply to the income earned on the reinvested income. Therefore, a carefully planned structure could achieve some degree of future income splitting. Also, the attribution rules would not apply to income earned from an active business. It may also be possible for a lower income spouse to sell a valuable asset to the other spouse for cash. The cash could then be invested in an income producing asset thereby creating investment income in the hands of the lower income spouse, without triggering the attribution rules. There is an automatic election at cost when certain assets are transferred between spouses, thereby avoiding capital gains and recaptured depreciation. You should consult with your tax advisor before attempting a transfer of any asset with your spouse for tax purposes. Couples who have excess income available for long-term investment may want to consider having the higher income spouse pay for all household expenses while the lower income spouse invests excess income. This effectively allows the lower income spouse to build assets in their own name for tax purposes. The foregoing is a brief summary of some of the more common income tax issues which are faced by persons who become spouses in the year. It is intended for information and discussion purposes only. You should seek the advice of your tax advisor before implementing any income tax related strategies. This commentary is presented by Connolly & McNamara Chartered Accountants. We are a local firm servicing the needs of individuals and businesses across the Ottawa-Carleton region and the Ottawa Valley. For more information please visit our web site at www.connollymcnamara.com or call (613) 831-3042 . |