Recently, Jeff Sheldon and Terry Ritchie were featured in Advisor.CA to discuss the topic of divorce. Divorce can disrupt even the most solid financial plan, especially when cross-border considerations are involved. We’ve seen many planning cases where one person moves from Canada to the U.S. or vice versa for marriage. For those clients, the tax impact can be significant. Identifying the type of assets for distribution, their locations and the cost basis of non-retirement plan assets are all critical.
Property transfer due to divorce could have differing Canadian/U.S. tax results. Per U.S. transfer rules, unintended gift taxes could be imposed based on the spouses’ tax residency and citizenship. To find out what will happen if clients transfer property to each other, first determine if one spouse is a non-resident alien (NRA).
U.S. citizens are considered U.S. residents for a range of tax purposes, no matter where they generate/receive investment income, hold/transfer assets, or die. An NRA is generally subject to tax on U.S. source income and some types of U.S. investment or pension income. However, under the Canada-U.S. Tax Treaty, one may withhold taxes at source to address this obligation.
Canadian income tax doesn’t apply upon the sale of real estate as part of a divorce settlement. However, if one/both spouses are U.S. citizens, U.S. income tax could apply upon the sale/transfer. A U.S. tax resident can exclude up to US$250K of his share of the gain from U.S. income tax if certain qualifications are met.
It may be difficult to collect spousal and child support between both countries. Using Maintenance Enforcement may sometimes help. If paying alimony to a previous spouse who now lives in Canada, the U.S. citizen payor can deduct this amount under U.S. tax rules with documentation.