Common Mistakes in Separation Negotiations
March 2020
In this article, I offer you my thoughts on common mistakes made by people going through separation and divorce. They are based on only my observations and my opinions, not on statistics. Other professionals may differ in opinion with me.
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- Making decisions before you are emotionally ready. Decisions when you are sad and frustrated lead to, “Where do I sign to get this over with!” reactions. You will often settle for less than you should. Actions made out of anger and revenge often lead to delays in decisions. You ask for or expect too much, “I’ll make him/her pay for what he/she did to me!” Legal fees escalate by thousands or tens of thousands of dollars and the process lasts for years. Solution? Speak to a “family professional,” who will typically be a social worker or psychologist. They are trained to help you sort out your emotions, and even help you with a parenting plan for the children. Speak with your legal and financial divorce professionals, your medical or spiritual professionals or a local family services organization if you need help to finding someone. As difficult as it is, be civil and fair regardless of the reasons for your relationship breakdown, and you will benefit with less professional fees, better child adjustment and a more satisfactory long-term arrangement.
- Accepting the values placed on your assets by your spouse if you do not have a good understanding of the values yourself. What is real estate worth? How are businesses valued? You should get a second opinion to ensure you get a fair deal. Normally, a real estate appraisal and an independent business valuator (not your spouse’s accountant) is worth the cost. Meet with a financial divorce professional to understand how finances will work.
- Forgetting that income taxes reduce the value of your assets (or using the wrong tax rate). The family home appraised at $200,000 is worth a lot more than a Registered Retirement Savings Plan (RRSP) of $200,000. After taxes, the RRSP is going to give you a lot less money than selling the home. The RRSP is taxable and the family home is often tax-free. In addition, once you have divided your property, if you did so on a “rollover” basis to avoid immediate income taxes, “attribution rules” will apply to capital gains for property sales until you finalize the divorce. Consider property that you originally purchased but transferred to your former partner. If property has increased in value since originally purchased by you, you, instead of your former partner, may be required to pay tax on the gain. To avoid this unplanned problem, you can both agree to file an income tax election under Section 74.5(3) of the Income Tax Act.
- Using the pension value for a defined benefit pension plan provided to you from your employer, or your spouse’s employer. These values are typically prepared for employment termination purposes, not for divorce reasons. Pension valuations for divorce are calculated using special rules. The pension administrators work for your employer, not in a separation and divorce environment. Ensure you get the correct valuation. See my article on Pension Valuations and Equalization of Net Family Assets. The cost of hiring a pension valuator (typically less than $1,000) is usually worth the cost because of the significant value of pensions.
- Not hiring the right person for the right job. Professionals are trained for certain functions, and some have more experience in family law than others. Family counsellors are trained in helping you with your emotions, and in helping you explain things to your children. They can also assist you in working out parenting and custody arrangements. Chartered Financial Divorce Specialists and Certified Divorce Financial Analysts can assist you with your financial needs. These people help you with summarizing your assets for equalizing them between spouses. They also calculate your income in accordance with legal guidelines, which will be used to determine child and spousal support. Lawyers, of course, will help you use this information to prepare an agreement, and negotiate (or go to court) on your behalf when there are differences in opinions. Some CPAs and some lawyers will accept you as a client, but may not be family law specialists – you are at higher risk of errors or omissions in such cases, so enquire first. Sometimes, real estate appraisers, pension valuators (actuaries), and Chartered Business Valuators are also needed. In all cases, ask about experience and fees, use the right person for the need, and ensure they are independent.
- Giving permission for a “conflict of interest” to your existing family lawyer or accountant. This means that you are allowing your lawyer or accountant to work for your spouse (hence, against you). You will need to find someone new to work for your best interests. Your professional advisors know you well (or should know you well!). Do you want someone working against you that knows your skill and education levels, as well as your personality? Furthermore, why should you be the one sign off on their conflict? Maybe you should flip the request and ask your spouse to find someone new? My advice is for both spouses to find a new lawyer/accountant just for the separation process. If you are working through mediation or collaborative practice, perhaps your existing professionals can act for you both? However, be sure you are comfortable that the person will be fair to you both. (If your former partner suggests that keeping the “company accountant” will save money because of their experience with the company, it is likely true. Just make sure they are working for you…)
- Keeping the family home. Before you agree to keep the family home, even if it is emotionally important to you and the children, do your budget! Statistically, many individuals need to live off of 25-40% less money after separation, and the house (and mortgage) are often not affordable. It will be emotionally difficult to move, but not as bad as being forced to move a few years later because of financial ruin.
- Tax preparation errors. Common mistakes include:
- Monthly spousal support – Where spousal support is being received, you cannot agree with your former spouse not to claim the spousal support as income even if they agree not to deduct it. The law requires you to report qualifying spousal support as taxable income.
- Eligible Dependant Amount – You cannot claim the eligible dependant amount (EDA) (formerly called the equivalent to spouse amount) if you are paying child support. Only the recipient of child support may claim this credit. In a shared custody situation, where both parties have custody between 40% and 60% of the time, the rules are very complex. If both parties are legally required to pay support, either person may claim the EDA for one child, and if there is more than one child, then it is possible for each parent to claim one child. This assumes you meet all of the conditions, not just those discussed here (such as being a single parent). If your child support agreement states that only one person will pay a set-off amount, only the recipient of the set-off amount may claim the credit. If your agreement states that both persons pay each other, with no reference to a set-off amount, and it is clear that you each have a legal obligation to pay support, both parties may claim the credit. You should seek tax advice from a professional who understands current legislation, and also ensure your legal counsel negotiates and drafts your agreement appropriately to meet your goal. Unfortunately, while separate payments may save taxes, they may increase maintenance enforcement risks if one person’s payment “bounces”.
- Deduct professional fees for support – Legal and financial fees can be claimed by the person receiving qualifying child or spousal support. Fees related to equalization of assets, obtaining a divorce, or to avoid paying support are not deductible. Fees in a shared custody situation where both parents are receiving support can only be claimed by the recipient receiving the higher amount; in a split custody situation, both recipients can deduct.
- Child care expenses – If you qualify and pay child care expenses, they may be deductible, but any Section 7 support reimbursement must be deducted first. And, if you pay the total bill but part of the expense is for your former spouse, your former spouse can claim his or her share (not you), but you must issue a receipt to him or her for their share.
- Lump sum payments of spousal support –
- Payments of arrears are deductible; payments of future amounts are not.
- Lump sum payments for arrears arising prior to the date of a court order may be deductible if the court order is worded appropriately to meet the definition of regular periodic payments. However, lump sum payments for arrears prior to the date of a written agreement (not a court order) are not deductible.
- Qualifying payments already paid prior to an order or agreement (i.e. regular, periodic, etc.) may be deductible retroactive to the beginning of the prior calendar year, subject to correct wording.
- You cannot transfer a RRSP on a tax-deferred rollover basis to settle a lump sum of child or spousal support. This can only be done for property.
Finally, make sure you understand the process. It is difficult in many ways, and knowing what to expect is important. Call your local Public Legal Education Association (the name varies by province, such as the Community Legal Association of PEI or visit their website, legalinfopei.ca) and see my other articles.
Blair Corkum, CPA, CA, R.F.P., CFP, CFDS, CLU, CHS holds his Chartered Professional Accountant, Chartered Accountant, Registered Financial Planner, Chartered Financial Divorce Specialist as well as several other financial planning related designations. Blair offers hourly based fee-only personal financial planning, holds no investment or insurance licenses, and receives no commissions or referral fees. This publication should not be construed as legal or investment advice. It is neither a definitive analysis of the law nor a substitute for professional advice which you should obtain before acting on information in this article. Information may change as a result of legislation or regulations issued after this article was written.©Blair Corkum