Half of Canadian marriages end in divorce seeming like it’s become as inevitable for many as death and taxes.
Of course no one enters a relationship with the plan to later part ways, but it does happen and there are tax consequences to consider if it does. Things are specifically more complicated in situations where a farm or small business is involved
If the farm or small business is a family corporation, the shareholder agreement would likely have instructions and direction to determine the process of splitting up the shares.
If the business is not incorporated, the couple would need to consider the documents and agreements entered into during their marriage, such as wills, power of attorneys, mortgage, loans and bank accounts.
Any RRSPs they each hold likely have the other as beneficiary. A couple may now wish to name any children as the beneficiaries to their individual RRSPs. In general, in the event of death, an RRSP can be transferred tax-free to the spouse. However without a spouse, if transferred to a child, those funds are 100% taxable.
Life insurance policies held by a married couple likely also have each other as beneficiaries. By transferring the beneficiary of a life insurance policy to the children it may provide the funds needed to cover the taxes owing on any RRSPs or other assets at the time of death. Life insurance proceeds are not taxable.
Equitable Distribution of Assets
Distributing assets can be challenging. Consider a house valued at $300,000. If combined a couple has $300,000 in RRSPs. It may seem fair that one keep the house and the other takes the RRSPs so they each end up with $300,000. Seems fair, right?
However, the RRSP isn’t really worth $300,000 cash. At retirement when the funds are withdrawn from the RRSP there is income tax owing on the withdrawals. Therefore the value is not $300,000 but $300,000 less the applicable personal tax rate at the time. With a tax rate of 45%, the value of a $300,000 RRSP is actually only $165,000.
With a farm or business in the picture, you need to determine a fair market value for the business and it's assets. And if one spouse is to continue the operation the business assets can't be sold, so the couple will need to find other assets for an equitable departure.
One thing the tax rules suggest is that both spouses are now transacting at arm’s length and everything happens at fair market value.
Once that mess is all settled, down the road, should one or both of the parties decide to remarry they should include tax planning with their new partner.
If children are involved, someone starting a new relationship should ensure wills and other documents are in place to protect any claims the children may have on the farm or small business operation or other assets.