Recently, Terry and George (not their real names or a real couple) came to my office asking about the new tax effects of living as gay common law spouses. Using my high powered PC I was able to scan the Income Tax Act and found that the term "spouse" appears over 400 times. To further complicate matters, as a result of the Rosenberg decision, same sex common law partners are given equivalent status to spouses under the Income Tax Act.
Unfortunately, a good deal of the Income Tax Act revolves around the federal government doing things to taxpayers that should only happen in a committed relationship. That being said, there are also tax benefits afforded to Canadian couples, gay, straight, common law, married or something in between, but only if the couple can prove that they "cohabit in a conjugal relationship."
The semantics of the ever-expanding definition of spouse are going to drive practitioners bonkers.
Therefore, as a service to Canadians, I am making an executive decision amending the Income Tax Act so that the term "spouse" is extended to all couples in qualifying (by this I mean conjugal) relationships.
Don't get all hot and bothered; remember we are discussing tax, so conjugal is not necessarily sexual or romantic. Instead, the courts have focused on living arrangements, sexual and personal behaviour, domestic services, social activities, economic support and children as the important elements to consider in determining if a relationship is "conjugal." George was shocked to discover that he and Terry have been engaged in a lot of conjugal relations. "Geez, I thought I was doing Terry's laundry", he commented. A list of good and bad effects of living in a conjugal relationship would be unwieldy. For example, the first place the term spouse appears in the Income Tax Act is in reference to travel expense deductions for railway workers.
Instead, I will touch on a few common items and a few key terms that can be thought of as triggers to understanding if the effect is going to be good or bad.
As far as bad effects are concerned, first, and nastiest is third party tax liability in non-arm's length transfers.
With the new rules, Terry can no longer transfer the family Rembrandt for $1.00 to George, and then refuse to pay an outstanding tax debt. The Canada Revenue Agency will assess George. The Income Tax Act allows the government to assess spouses for a taxpayer's debts, where property has been transferred to that spouse for less than its value after the taxpayer's debt arose.
The Income Tax Act also abhors some forms of income splitting. For example, phantom income would accrue to Terry, as a sole shareholder of a holding company that issued shares to George for dividend purposes. The Act assumes that George has a lower income than Terry and punishes them for trying to efficiently allocate income.
As a more common example, the spouse who earns the least money must deduct childcare expenses. The deduction has less oomph when deducted by the lower income spouse. Historically, Terry and George have been able to circumvent this rule because the Income Tax Act did not recognise their relationship as spousal. Childcare expenses were deductible by Terry or George as single parents. No longer. The Canada Revenue Agency will expect the lower income earner to use the expense.
The good effects probably make up for the bad effects.
Generally, transfers of property create tax. However, spouses can transfer property back and forth without creating a tax liability. Take the Rembrandt example above and remove the pre-existing tax debt owing by Terry. The painting can be transferred to George without creating a tax debt via a capital gain. Again, don't get too excited. If George then sells the painting, any gain would be attributed to Terry.
Terry was happy to learn that George still has some tax value after he dies. George should consider amending his will to leave property in trust for Terry, rather than leaving it to him directly. The Income Tax Act allows a trust created in a will to exist as a separate person. The trust can invest, earn income at the regular graduated rates, pay tax and give the after tax amounts to Terry. If George's estate is given directly to Terry, any income earned from investing that estate is added to Terry's existing income. Higher income means higher taxes for Terry.
The transfer of the Rembrandt and the transfer into a spousal trust are examples of "tax rollovers". When tax advisors are discussing rollovers they mean property transfers that occur without creating a tax liability.
Next, certain spousal rules permit eligible taxpayers to claim tax savings in recognition of the costs of supporting a "dependent spouse or common law partner". The Income Tax Act also provides benefits for infirm "dependants" and their caregivers. When tax advisors discuss whether someone is dependent, they are discussing financial dependence only.
Finally, the most commonly used benefits now available to Terry and George are in relation to RRSPS. The Income Tax Act allows for spousal contributions to RRSPs and for unmatured RRSPs to be transferred to surviving spouses with a nil net tax result.
Taken individually, the tax rules that apply to spouses can be overwhelming. However, when grouped according to broader concepts like non-arm's length transfers, spousal rollovers and dependent spouses, the rules are more manageable. Same sex couples should, at a minimum, review their RRSP contributions and beneficiary designations with a financial advisor. To get a detailed understanding, same sex couples will probably have to do what George and Terry did (and what opposite sex couples have been doing as long as there has been income tax in Canada), hire an expert to help.
The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.
