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TAXFlash News from IncomeTaxCanada.net
:: Deducting child care expenses may trigger reduction in supplements paid under Child Tax Benefit program
:: Have you ever had an urge you couldn’t control? A rhetorical question to be sure but, where income taxes are concerned, the urge to deduct child care expenses could be costing you money and you may not even know it. During 2002, if you or your spouse (common-law partner) paid someone to look after your child(ren) so one of you could earn a living or go to school, you or your spouse may be eligible to claim the cost incurred as a deduction on your tax return. The child in respect of whom the cost was incurred must be under age 16 or mentally or physically infirm. Generally, only the spouse with the lower income (and that includes no income) can make a child care expense claim. Claiming a deduction on your tax return is always a good thing, right? Usually, the answer is yes but that’s not necessarily the case, particularly when it comes to deducting child-care expenses. How so you ask? Well the answer to this little secret is found in a set of rules in the Income Tax Act that work to link child care expenses claimed to the supplements paid under the Child Tax Benefit program. As CCRA so aptly states in their Interpretation Bulletin on child care expenses, “a claim for child care expenses… may reduce an individual's entitlement to the child tax benefit supplement”. In case you missed it, the operative word here is “may”. And if “may” becomes “will”, the supplement (available for each qualified dependant who is under 7 years of age at the start of each month) is reduced by 25% of the child-care expenses deducted. Let’s take a look at a situation where this rather innocuous provision can kick in. Assume we have a double-income family where one spouse earned an income of $50,000 in 2002 and the other spouse made $18,000. At these income levels the higher-income spouse is in the middle income tax bracket whereas the lower-income spouse is in the lowest income tax bracket. The couple has one child that was over the age of six in 2002 and two under the age of seven. During 2002 the couple spent $1,000 on daycare for the two younger children. Using this set of facts and claiming the child-care expense as a deduction on the lower income earner’s tax return, the couple will qualify for a Child Tax Benefit Supplement of $232 per year for each of their two youngest children. The total Child Tax Benefit Supplement available to this couple would therefore be $464, however, the fact a child-care deduction has been claimed causes a reduction in the Supplement amount the couple will actually receive. This reduction is equal to 25 per cent of the child-care deduction claimed. Given our couple deducted $1,000 of child-care expenses, the reduction works out to a total of $250 leaving them with a net Supplement of $214. But what would the outcome be if the couple opted not to claim the $1,000 child-care expense as a tax deduction in 2002? Obviously, there would be no reduction in the Supplement so the couple would be entitled to the full $464 benefit. By not claiming the child-care expense deduction, the lower income earner (on whose tax return the deduction would have been claimed), will pay an additional $220 of income tax. To summarize, by foregoing a child-care expense claim, this couple will gain $250 of Child Tax Benefit Supplement with the tradeoff being payment of an additional $220 of income tax for a net gain of $30. Clearly the decision here is to scrap the child-care expense deduction and opt of the Supplement instead. The logic for this outcome is actually quite simple if you know the marginal tax rate of each taxpayer. In our example, the lower income earner pays income tax at a rate of 22 per cent. As we’ve seen, the child-care expense reduction is calculated at a rate of 25 per cent. The difference between these two tax rates is 3 per cent. If you multiply this 3 per cent difference by the $1,000 child-care expense the couple incurred the net result is $30. Now let’s tweak our example a bit and see if we can change the outcome. Assume the same combined income of $68,000 only this time let’s allocate $33,000 to one spouse and $35,000 to the other spouse. This allocation will result in both spouses paying income tax at the same rate, that being the middle rate of roughly 31 per cent. All other variables in our example remain unchanged. Claiming the $1,000 child-care expense deduction will reduce the available Supplement by 25 per cent or $250. Notice that this is the exact same result as was the case in our first scenario. Because the lower-income earner is now in the middle tax bracket paying tax at a rate of 31 per cent, the $1,000 child-care expense deduction will generate an income tax saving of approximately $310. In this case, the net advantage to claiming the child-care expense deduction, at the cost of losing part of the Supplement, is $310 less $250 or $60. Once again the basis for this result is found in the difference between the taxpayer’s marginal tax rate (31 per cent in this example) and the 25 per cent rate applied to reduce the available Supplement. In our example, the difference is 6 per cent which, when multiplied by the $1,000 child-care expense deduction, yields a net result of $60. Considering our two examples, the conclusion seems to be that, where a child-care expense deduction will be claimed by a taxpayer in the lowest tax bracket, taxpayers will be better off foregoing the child-care deduction in favour of maximizing their Child Tax Benefit Supplement. On the other hand, where the deduction will be claimed by a taxpayer in the middle or high tax bracket, the decision is the opposite – claim the child-care expense deduction and forego the Supplement. If you have internet access you don’t have take my word for it. CCRA’s website (ccra-adrc.gc.ca) contains a “benefits calculator” that should help you reach your own conclusion. Use this calculator to figure out your total Child Tax Benefit with and without claiming child-care expenses. Then recalculate your income tax with and without claiming the child-care expense deduction. Compare the two outcomes and there’s your answer. Unfortunately, CCRA won’t have the calculator updated with the current rates until mid-April so you’ll have to be patient. If you’re the type of individual who wants to squeeze every nickel out of the government it’ll be worth the wait. Where child-care expenses are concerned, you may need to control the urge to claim a deduction on your 2002 tax return. If you lose part of your Child Tax Benefit in the process, automatically claiming a child-care expense deduction may not necessarily yield the optimum result.
Free Tax Advice Article Submitted to Income Tax Canada.net exclusively by Jim Maroney Official details about this and other topics on income taxes can be found in English & Francais at www.ccra-adrc.gc.ca Income tax information offered by www.IncomeTaxCanada.net is done so without endorsement by Canada Revenue Agency (CRA) - l'Agence du Revenu du Canada (ARC) (formerly Canada Customs and Revenue Agency - l'Agence des Douanes et du Revenu du Canada CCRA-ADRC and formerly Revenue Canada – Revenu du Canada) or any Canadian government agency. The free advice is of a general nature for Canadian taxpayers seeking legal ways to reduce their personal and small business income taxes payable to the federal and provincial (or territorial) governments in Alberta, British Columbia, Manitoba, New Brunswick Newfoundland-Labrador, Northwest Territories, Nova Scotia, Nunavut, Ontario, Prince Edward Island, Quebec, Saskatchewan or Yukon. Specific taxation situations vary from taxpayer to taxpayer, province to province, territory to territory. The free tax advice here is only a general guide. Canadians should always seek individual guidance on accounting rules and tax laws from knowledgeable accountants and lawyers. To prepare your income tax return online and NetFile your Canadian income taxes electronically in English or Francais, please visit www.ufile.ca or www.impotexpert.ca websites. Additional information on financial products and services for Canadians can be found at www.CanadianCreditCenter.com. |
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Jim Maroney