Law Times

Law Times • November 10, 2008 FOCUS Risk of tax errors in family law issues BY GLENN KAUTH Law Times port payments because his in- come had gone down. It seemed simple enough, S but there was a major pitfall. Unintentionally, the agree- ment reversed what normally happens with spousal support in which the payments are tax deductible to the payer and taxable to the recipient. The wife realized that change and began claiming the deduction. The husband didn't fi gure it out and he continued claim- ing it, too. Years later, of course, the Canada Revenue Agency clued in to the discrepancy and went after the husband for back taxes. By that time, more than a decade had passed, and the amount owing had reached roughly a half-million dollars. The case ended up in mediation between the couple, and they eventually reached a settlement requiring them to split the taxes. The mediator involved says the case is a good example of the risks of tax errors in family law issues. In that instance, the couple drafted their agreement without a lawyer to save money, but Lorne Wolfson says even counsel can make mistakes when advising family law clients on tax issues. "Those who are specialists in family law would probably have a very good working knowl- edge of tax issues in family law. But someone who is a general practitioner who does a fam- ily law case in the morning, a real-estate deal in the afternoon, and [then] a will tomorrow will probably not have nearly as good an understanding of the tax issues," he says. The most common mistake relates to precisely the one the couple that drafted the home- made agreement made. "I would say that the No. 1 [error] is not ensuring that the agreement is papered properly to ensure that spousal support is tax deductible to the payer or taxable in the hands of the payee," says Wolf- son, who practises at Torkin Manes Barristers & Solicitors in Toronto. "Unless you satisfy a number of requirements in the Income Tax Act, if you miss one then it isn't deductible and not tax- able. That becomes signifi cant because usually the amount of support has been calculated and agreed upon on the assumption that it's going to be deductible to the payer and taxable [to] the payee. If it turns out as a result of poor drafting that you don't have that result, somebody's go- ing to be very unhappy." Pitfalls include not using the word spousal to refer to sup- port. Or, if payers don't make the payments pursuant to the agreement, they can lose the tax deductibility. "All I'm say- ing is there are lots of different ways you can screw up if you're not careful," says Wolfson, who warns that lawyers who make a Federal Pension Legislation Consulting Editor: Susan G. Seller Use this essential resource to review the key federal pensions Acts and selected regulations, applicable provisions of federal income tax legislation and regulations, selected Canada Revenue Agency forms and interpretation bulletins, selected Canadian Association of Pension Supervisory Authorities guidelines ... and much more. Perfectbound • 512 pp. • Published September each year • Standing order $73 • P/C 0150140000 Current edition only $83 • P/C 0150010000 • ISSN 1718-2751 Ontario Pension Legislation Consulting Editor: Susan G. Seller This valuable resource consolidates all of the important Ontario pension legislation you need including key Acts and selected regulations, as well as selected Canada Revenue Agency forms, guides and interpretation bulletins, selected Financial Services Commission of Ontario forms and pension policies, selected Canadian Association of Pension Supervisory Authorities guidelines ... and much more. Perfectbound • 742 pp. • November 2008 • Standing order $79 • P/C 0151140000 Current edition $89 • P/C 0151010000 • ISSN 1718-2743 Ontario Pension Law Handbook, Second Edition Susan G. Seller The second edition sets out recent significant developments in pension law including: the issue of partial wind-up surplus; pension plan mergers and asset transfers; class action proceedings … and more! Perfectbound • 324 pp. • July 2006 • $79 • P/C 0830010002 • ISBN 0-88804-429-1 Estates, Trusts and Pensions Journal Editor-in-Chief: Marni M.K. Whitaker Editorial Board: Cy Fien, Gordon MacRae, Timothy Matthews, Q.C., Marilyn Piccini Roy, Catherine Roberts, Mark Rowbotham and Siân Matthews This resource covers new trends in estates and trusts with special coverage of pensions issues. From powers of attorney to asset protection, cross-border issues to charitable trusts, this resource provides informative articles, insightful comments on important cases and a discussion of useful texts. Parts and bound volume • $179 • P/C 0335090999 • Back volumes $100 • P/C 0335100999 • Index volumes 1-10 • $37 • P/C 0335080001 • Index volumes 11-20 • $53 • P/C 0335080002 Index volumes 21-25 $32 • ISSN 1487-3656 For a 30-day, no-risk evaluation call: 1 800 263 2037 or 1 800 263 3269 www.canadalawbook.ca CA024 Canada Law Book is A Division of The Cartwright Group Ltd. • Free Shipping on pre-paid orders. Prices subject to change without notice, and to applicable taxes. www.lawtimesnews.com CA024 (LT 1-3x4).indd 1 11/5/08 2:31:16 PM LT1110 'Unless you satisfy a number of requirements in the Income Tax Act, if you miss one then it isn't deductible and not taxable,' says Lorne Wolfson. mistake could fi nd themselves facing a lawsuit from a client. Wolfson's fi rm, in fact, deals with LawPro claims against lawyers alleged to have made an error. Besides discrepancies in spousal support agreements, transfers of capital assets are an- other common pitfall. "In the whole area of trans- fers of capital property, there is a range of tax issues that relate to that, and it can be fairly com- plicated," says Wolfson, noting the question is who should pay any capital gains tax on any fu- ture sale of the asset. In fact, the Income Tax Act allows for a tax- free rollover of property between spouses and former spouses, but that exemption will only ap- ply if the parties sign a docu- ment. Otherwise, the tax obli- gation falls on the spouse who ome time ago, a couple agreed to reduce the husband's spousal sup- transferred it in the fi rst place. Handling capital gains is- sues on a principal residence is another challenge. Because CRA allows a couple to ex- empt the capital gains on just one principal residence, con- fusion can arise when people own and then split two prop- erties, such as a house and a cottage. A spouse who takes the house, for example, may later claim the exemption on the house only to fi nd out that the ex-partner already claimed it on the cottage. "CRA will put the two together and say: 'You can't claim the [exemption] on the house during the years of your marriage because your ex- husband has ready claimed it for the same years. Too bad. The fi rst person to claim gets it. You pay tax.' Then she goes back and sues her lawyer," says Wolfson. "The solution is [that] when you make the deal in the fi rst place, somebody has to agree [on] who's going to get the principal-residence exemption. It can't be both," he adds, noting one spouse could compensate the other for getting it. "It's not a hard thing to solve if people think about it, but if nobody thinks about it, then you're waiting for a big problem down the road." Perhaps scariest for clients is the prospect of joint and several tax liabilities. If someone trans- fers a property to an ex-spouse for less than market value in exchange for release from spou- sal support, for example, the person who receives the asset could later be on the hook for taxes the CRA goes after the former partner for. Options to prevent the problem include the recipient getting an indemnity for any future tax obligations. Wolfson notes that a person can avoid the liability if the transfer is pursuant to an order or writ- ten agreement on the condi- tion that the couple was living separately at the time. "The problem is that a lot of lawyers don't know that there's potential joint and several li- ability," he says, adding that the economic downturn will prob- ably result in an increase in such cases. "It will certainly be more common when we go through a recession. It takes a while for these to ripple through the economy and show up in matri- monial cases." In the meantime, Wolfson says family lawyers can beef up their knowledge and hence re- duce the risk of mistakes by at- tending continuing legal educa- tion seminars on tax issues. Also key, he adds, is knowing when an issue is beyond their level of ex- pertise and therefore requires the advice of an outside expert. "Some tax issues are very com- plicated. I've been doing this for over 30 years and I have issues that I don't understand . . . Half the battle is identifying the issues and then not being afraid to get a second opinion." LT PAGE 13 LLP Barristers 1235 Bay Street, Suite 800 Toronto, Ontario M5R 3K4 Tel: (416) 921-1700 • Fax (416) 921-8936 www.nzgfamlaw.com Practice restricted to Family Law It pays to stay up-to-date on pension law

• Cover
• Fatboys Running
• Avoiding Equalization
• Focus On Family Law