My name is Mark Goodfield and I am a tax partner and the managing partner of Cunningham LLP in Toronto. This blog is about income tax, business, the psychology of money and investing topics and is meant for taxpayers no matter their income bracket, but in particular for high net worth individuals and entrepreneurs who own private corporations. I also blog about whatever else crosses my mind; I have to entertain myself. This is my personal blog and the views and opinions expressed in this blog do not reflect the position of Cunningham LLP. I am blunt and opinionated (at least for a Chartered Professional Accountant). You've been warned.

The blogs posted on The Blunt Bean Counter provide information of a general nature and should not be considered specific advice, as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Friday, April 1, 2011

Confessions of a Tax Accountant-Week 5- Taxing the Family Unit -Harper almost got it right

It is April 1st, and I still only have 40% of my clients' income tax returns submitted. However, one client did receive a T5013 on Tuesday, two days before the supposed deadline for issuing such. This sighting of a T5013, was rarer than sighting the Ivory-Billed Woodpecker.

Sarcasm aside, for this week, I am scrapping the usual income tax issues of the week. Today I want to discuss the concept of taxing the family unit. As many are aware by now, this week the Conservative Party announced as part of their election platform that, if elected, and only when the budget is balanced in four or more years from now, they would allow families with dependent children under 18 to split up to $50,000 of income for Federal income tax purposes. Ignoring the fact that this proposal requires the Conservatives to be re-elected and, implementation is dependent upon a balanced budget, I believe that this type of proposal should not have restrictions related to dependent children, but apply to any family unit (I will not address the taxation of single parent families in this blog). In my opinion, the Conservatives almost have the concept correct, although the application may be wanting.

As a tax accountant who has prepared US income tax returns in the past, I fully understand the concept of taxing a family unit, and how the current Canadian system can be punitive where two families have the exact same family income, but the allocation amongst the spouses is different. With this thought in mind, I ran a few numbers to illustrate how the current system is flawed.

Say what? My family income is the same?

To illustrate the income tax disparity caused by our current taxation system, I first looked for discrepancies. The following examples assume a married or common law couple (we will call them Ward and June Weaver) with two children (Theodore and Wally) living in Ontario.

Assume Ward had a great year in 2010, earning $150,000 in commissions selling Beaver Tail franchises. During 2010, June stayed at home taking care of Theodore and Wally. The income tax payable for the Weaver family after claiming the spousal and child income tax credits is approximately $47,200. However, if Ward has only earned $100,000 and June had worked from home and made $50,000, the 2010 Weaver family income tax bill would have only been approximately $36,000. A difference of $11,200 for the same family earning the same total income.

This difference is further illustrated if Ward earned $125,000 and June had no earnings. The total family income tax bill would be approximately $35,600. However, if Ward and June each earned $62,500, the tax bill would only be $25,300, a difference of $10,300 on the same family income.

Equivalently Un-equivalent

After looking at the discrepancies, I then turned it around and looked for equivalent income tax burdens, with very un-equivalent earnings.

Say Ward was the sole wage earner making $100,000, the Weavers would pay approximately $24,800 in income taxes. This is the same income tax burden another family, the Haskells (who also have 2 children) would have where Teddie, the husband earned $80,000 and Thelma, the wife, earned $42,000. The Haskells have earned $22,000 more in income, yet pay the same income tax as the Weavers.

What would happen in the US if these families filed joint income tax returns? The Weavers would owe $10,900 in US Federal income tax (I will ignore US state tax since it varies from nil in some states such as Florida, and goes as high as 10% in some states such as California).

The Haskells would owe $16,400 in US Federal tax. Clearly the US grasps the concept that if total family income is higher, you should pay more income tax.

Finally, if June was earning $140,000 and Ward was a stay at home dad, the Weavers would pay approximately $42,500 in income tax. If both Teddie and Thelma each earned $86,000, the Haskells would have approximately the same income tax liability as the Weavers, yet their family unit would have made $32,000 more.

In the United States, the Weavers would have a Federal income tax liability of approximately $21,000 while the Haskells would have a Federal income tax liability of approximately $29,000.

The above is summarized in the chart below.




Weavers
Haskells
Income
Ward
100,000
-

June
-
-

Teddie
-
80,000

Thelma
              -
   42,000
Total Family Income

 100,000
122,000
Income Tax Canada

   24,800
  24,800
Income Tax USA

  * 10,900
  *16,400






Weavers
Haskells
Income
Ward
-
-

June
140,000
-

Teddie
-
86,000

Thelma
              -
   86,000
Total Family Income

 140,000
172,000
Income Tax Canada

   42,500
  42,500
Income Tax USA

  * 20,900
  *29,000




* Excludes any applicable US state tax

So what lessons can be learned?

The Conservatives conceptually have the correct idea, that the current system is punitive; however, they should be proposing taxing the “family unit”, not worrying about income splitting.

The US clearly grasps the taxation of a "family unit" concept, but it also grasps the concept that the "family unit" should pay more income tax as the family income rises, no matter the allocation of income between spouses or partners.

[For further discussion of family taxation, taxation of single parents and how Harper's proposal is beneficial for the rich, see the Canadian Capitalist's  blog this week].