As the pandemic continues into 2021, income tax will still present a challenge for some clients. Those who owe tax from government benefits received in 2020 will want to avoid the same outcome this year. Fortunately, we have the opportunity to plan ahead this time.
Out with CERB, in with…
In September 2020, the Canada Emergency Response Benefit (CERB) transitioned to three different benefits:
- The Canada Recovery Benefit (CRB) is for workers (including those self-employed) not eligible for employment insurance (EI) who had their income reduced by at least 50% due to Covid-19.
- The Canada Recovery Caregiving Benefit (CRCB) is available to those unable to work at least 50% of a week because they’re caring for children under 12 or a sick family member.
- The Canada Recovery Sickness Benefit (CRSB) is for individuals unable to work at least 50% of a week because they contracted Covid-19, had to self-isolate or have underlying conditions that make them more susceptible to Covid-19.
Ten percent is withheld as tax from all three benefits when paid. Those eligible for regular EI benefits can receive benefits similar to the CRB.
Three factors matter most for tax planning:
- Duration of the benefit received
- Taxes withheld at source
- Clawback of benefits (EI or CRB)
The CRSB is likely to have the smallest tax impact because the benefit is paid over a maximum of two weeks for a total of $1,000. The other three options (EI, CRB and CRCB) last longer, so the risk of owing tax is higher.
If a client’s marginal tax rate is higher than the 10% withholding rate or the rate applicable to EI, then additional taxes may be required by the 2022 deadline. EI or CRB clawbacks could increase amounts owing.
Mary, who lives in Manitoba, transitioned to the CRB from CERB in September. She expects to hit the 26-week maximum for CRB payments in 2021, which means she’ll receive 12 weeks of CRB payments in 2021 for a pre-tax total of $6,000. She then expects to resume making her full income, which is $52,000 on an annual basis.
What does Mary have to set aside once her regular income resumes to cover taxes related to the CRB (including clawbacks)? She’ll have to repay $0.50 of the CRB per dollar of her line 23600 income (excluding the CRB) above $38,000. With prorated income (40 of 52 weeks) of $40,000 and pre-tax CRB benefits of $6,000, her combined income for the year is $46,000.
|Table 1: Taxes owing at a marginal tax rate (MTR) of 27.75%|
|Tax on CRB at MTR||$1,665|
|Less: CRB withheld at 10%||($600)|
Based on our estimates, Mary will owe $2,065 in additional taxes (including clawback) on her CRB when she files her 2021 tax return. She is considering three options:
- saving the necessary funds to pay this amount;
- making an RRSP contribution of $2,000 and saving $510 to cover the remaining balance ($2,065 less clawback and tax savings on RRSP contribution); or
- making an RRSP contribution of $3,838, which would eliminate the outstanding tax balance, including the clawback. With her expected return to work in the last week of March, Mary will have 11 months to make RRSP contributions for 2021 (April 2021 to February 2022, inclusive) and 13 months to save (April 2021 to April 30, 2022, when taxes are due).
The options require a tradeoff between cost and wealth accumulation (see Table 2). Simply saving to pay the tax is the cheapest option, but it doesn’t build wealth. The other two options allow Mary to eliminate some or all of the tax on her CRB while accumulating RRSP assets ($2,000 for the combo or $3,838 for the RRSP-only). If Mary’s cash flow when she returns to work can support it, the higher RRSP contribution would help her save on taxes while saving for retirement.
Hopefully most of your clients, like Mary, will see a return to normal this year. Estimating taxes owing and setting aside funds from each paycheque or making RRSP contributions will make the transition back to stable income smoother.
|Table 2: Monthly cost of solutions (excluding interest earned on savings)|
|Monthly amount||# of months||Total cost|
|Savings to pay tax||$158.85||13||$2,065|
|RRSP to avoid clawback + savings||$228.18||11||$2,510|
|RRSP contribution equal to CRB||$348.89||11||$3,838|
Curtis Davis, FMA, CIM, RRC, CFP, is senior consultant for tax, retirement and estate planning services, retail markets at Manulife Investment Management.