The last few federal budgets have attempted to increase tax fairness and simplicity in compliance. That has impacted Canadian taxpayers in a variety of ways, particularly their ability to split income, implement effective estate and tax-planning measures, and claim various personal tax credits or other tax relief measures.
Over the next 3 weeks, we’ll look at three family scenarios and examine how recent tax changes affect them in 2016 and in years to come.
First up, the Zhang family.
Mom and Dad are in their early 40s. They’re both employed with an arm’s-length employer and they have two daughters, ages 5 and 8.
What has changed?
As Mr. and Mrs. Zhang are employees, they have limited ability to split income and have been impacted by a number of changes to federal tax credits.
- The Family Tax Cut is gone. For 2014 and 2015, the Family Tax Cut allowed a higher-income parent to shift up to $50,000 in income to the other parent and apply a non-refundable tax credit of up to $2,000 to reduce the family’s overall tax liability. Budget 2016 proposed to eliminate the Family Tax Cut starting in 2016. That means Mr. and Mrs. Zhang will not save upwards of $2,000 from their combined federal tax liabilities.
- New child benefits. Budget 2016 introduced the Canada Child Benefit (CCB) to replace the Universal Child Care Benefit (UCCB) and Canada Child Tax Benefit (CCTB) starting in July 2016. The CCB will begin phasing out when family income exceeds $30,000 and is virtually eliminated when family income exceeds roughly $190,000 – depending upon the number and ages of the children. For the July 2016 implementation, the CCB will be calculated based on the family’s 2015 income. If Mr. and Mrs. Zhang reported family income of less than $150,000 in 2015, they will receive more from the CCB program, and it will be a tax-free receipt. If Mr. and Mrs. Zhang reported family income in excess of $150,000 in 2015, they will receive less under the new CCB.
- Phase-out of child benefits. Budget 2016 proposed to phase out and then eliminate the federal child fitness and arts tax credits over the next two years. Finance has said it will introduce new fitness and nutrition programs that will benefit all Canadian school-aged children. If Mr. and Mrs. Zhang spent, or intend to spend, $2,000 on soccer and dance and $1,000 for piano lessons for their two daughters in 2015, 2016 and 2017, either of them would be entitled to a federal tax credit of $450 in 2015, $225 in 2016 and nothing in 2017.
What income-splitting or effective tax-planning measures remain?
- Paying a relative older than 18 for child care. To be effective, the relative should be in a lower income tax bracket than the parent claiming the appropriate childcare deduction. This generates overall tax savings.
- Contributing up to $2,500 to a child’s RESP annually. This results in a Canada Education Savings Grant of up to $500 annually, while income on the contributions is tax-sheltered until ultimately withdrawn by the child when they attend a qualifying institution, and who likely will be in a lower tax bracket than the parents. The federal Tuition Tax Credit is also still available.
- Setting up in-trust-for (ITF) accounts for gifts, particularly annual birthday and holiday gifts from well-intentioned relatives. In addition, capital gains generated from gifts to minors are not attributed back to the giftor – so consider an investment solution geared toward generating capital gains only (as interest and dividend income would be attributed back).
- As always, where there is a significant discrepancy between two spouses’ incomes, consider:
- the higher income earner should pay the family and household expenses, allowing the lower income earner to invest;
- having the higher earner gift funds to the lower income earner for annual TFSA contributions; and
- setting up a prescribed rate loan, which currently can be negotiated at a 1% interest rate. The higher income earner loans the lower income earner funds to invest, and any investment income generated on the funds is taxed in the lower income earner’s hands. From a practical perspective, the loaned funds have to generate returns in excess of 1% plus any management or advisory fees annually, and not be at risk of capital losses; otherwise, the prescribed rate loan strategy may be detrimental overall.
Finance, in its goal of promoting simplicity and fairness, has started to implement thresholds and to phase out benefits and tax credits relating to families. Families with school-aged children where both parents are employees will have fewer federal tax credits available and will be more restricted in implementing income splitting.