The Family Tax Cut - Should Joint Filing be Next?

In late October, while I was vacationing in South Africa, details of the proposed Family Tax Cut were announced by Prime Minister Stephen Harper. Since the financial press was all over this, I will provide a quick recap below. Then for a fun (hey I am an accountant, I know fun!) mental exercise, I will compare the income tax burden for a family that maximizes the income splitting benefits of the Family Tax Cut in Canada, to that of a comparable U.S. family that files a joint income tax return.

Family Tax Cut

In Canada, we are required to file our own personal tax return; there is no concept of a joint family filing. Thus, in many cases, where one spouse earns significantly more income than the other spouse (either the second spouse is a stay at home spouse or just makes less money), that family unit often pays more income tax than a two-earner couple that has the exact same family income, but has two working spouses making roughly the same money.

This is because our tax rates are graduated and two spouses making the same income may both be in the 25% tax bracket, whereas a large single earner may be in the 35% tax bracket.

The proposed Family Tax Cut attempts to fix this family income inequality, by allowing the higher-income spouse to transfer up to $50,000 of taxable income to a lower income/lower tax bracket spouse for federal tax purposes. The maximum tax benefit available to a qualifying family is $2,000. Amongst the various conditions to claim the tax credit is that you must have at least one child who is under the age of 18 at the end of the year and who resided with you or your spouse throughout the taxation year. More details can be found here.

Department of Finance Example

In the backgrounder to the Family Tax Cut press release, the Department of Finance provided the following example of the family tax cut:

“Pat and Chris are a two-earner couple with two children. Pat earns $60,000 of taxable income and Chris earns $12,000, for a combined taxable income of $72,000. Pat faces a marginal federal tax rate of 22 per cent. Chris is in the first tax bracket, where income is taxed at 15 per cent. Since the value of his non-refundable tax credits is greater than the tax on taxable income, Chris does not pay federal tax.

For federal tax purposes, under the proposed Family Tax Cut, Pat would be able to, in effect, transfer $24,000 of taxable income to Chris. This would bring their taxable incomes for the purposes of calculating the credit to $36,000 each, which puts both of them in the 15-per-cent tax bracket. In addition, Chris would be able to use up his unused non-refundable tax credits with the notional transfer of income. As one person in the couple may claim the Family Tax Cut, they decide that Pat would do so. The Family Tax Cut would reduce Pat’s tax payable by about $1,260 in 2014, taking into account both the reduced tax on their taxable incomes, and the additional value of the non-refundable credits that Chris is able to use.”

Greater Detail

I ran some numbers for Pat and Chris and determined that they would pay approximately $10,900 in tax in Ontario before the Family Tax Cut. Thus, after the Family Tax Cut they would owe around $9,640 ($10,900 less $1,260 Family Cut Savings).

Since the Conservatives initially announced this income splitting initiative a couple years ago, I have wondered (often aloud or in writing) why they chose an income splitting option as opposed to moving to a U.S. style joint return? If philosophically the government is concerned about inequities in dual family incomes, why not just file as a family and put all couples, on the same tax footing?

I thus thought it would be interesting to compare how much tax Pat and Chris would owe if they lived in California, or if they lived in Michigan. I asked a CPA friend in the U.S. to run some numbers for me. He told me that if Pat and Chris lived in California, they would owe approximately $4,700 in U.S. federal and California state tax. If they lived in Michigan, they would owe approximately $6,130 in U.S. federal and Michigan state tax. Since I always thought California was a high taxing state, I asked him how this happened and he said it was because California has graduated tax rates, while Michigan has a flat rate.

The numbers reflect that, the Canadian Pat and Chris would owe approximately $5,000 more than if they lived in California (keeping in mind that the CA state rate would increase at higher income levels) and $3,500 more in tax than if they lived in Michigan. This comparison assumes the same exchange rate.

As I am comparing Canadian apples to U.S. oranges, this comparison can be misconstrued, but it does reflect that the Family Tax Cut does not save Canadians as much as if they went to a comparable U.S. joint return, with similar U.S. federal and state tax rates.

There are various macro factors as to why Canada has a higher tax rate. As demonstrated above, most U.S. citizens pay far less tax than the equivalent Canadian. However, the U.S. imposes estate tax for wealthier citizens when they die. We can characterize the Canadian tax system as a “pay me now”, while the U.S. is more of a “pay me later” tax system.

As I stated at the outset, this post was sort of a fun mental exercise for me and does not prove much of anything. However, I would suggest that since we are now into family income splitting, it would probably make some sense to move to a joint return filing system in Canada in the near future.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts 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.

20 Things I Don’t Understand About Income Tax

Rob Carrick recently wrote a great column in The Globe & Mail entitled, “20 things I don’t understand about personal finance”. The article caused me to smirk and chuckle several times. As they say, imitation is the sincerest form of flattery, so here are the top 20 things I do not understand about income tax:

1. Why can’t spouses file joint income tax returns as is permitted in the United States? It would equalize income tax rates, simplify our tax system, reduce the administrative time required to prepare and process personal income taxes and reduce the amount of paper the Canada Revenue Agency ("CRA") receives each year.

2. Why are parents only allowed a transfer of $5,000 of their child’s unused tuition, education and book credits? The parent is often the one who paid the costs of tuition, why is the credit transfer restricted. At a minimum, this cap should be re-evaluated in the wake of rising tuition costs.

3. Why people are so consumed with saving income tax that they buy tax shelters of dubious nature? There are numerous shelters or schemes out there that purport to reduce income taxes significantly. People are so hungry to reduce their taxes that they forgot their common sense – if it sounds too good to be true, it probably is.

4. Why child care expenses must be claimed by the lower income spouse? The motivation behind the child care deduction is to get people with children back to work to help drive the economy. Who’s to say which spouse was the spouse that was enabled to head back into the work force by hiring child care?

5. Why so many people ask for their RESP tax deduction receipt? Receipts aren’t necessary since the contributions are not tax deductible.

6. Why when one spouse has a tax refund and the other owes money, you can’t net the refund and tax payment against each other? Again, this would simplify our tax system and reduce the administration and paper work for the CRA.

7. Why people are loathe to realize a capital gain on an investment because they will have to pay income tax on the gain (which by the way, will be subject to tax at maximum rate of 23%)? Often individuals wait too long before selling and end up converting what would have been a capital gain into a capital loss (case in point: individuals who held shares of Nortel too long because they did not want to pay the income tax on the inherent gain). I have a whole blog on this topic upcoming.

8. Why do so many people think they can contribute the maximum RRSP limit to both their spousal RRSP and their own RRSP? It is one RRSP limit per person, regardless of the number of RRSPs contributed to.

9. Why people complain about income tax preparation fees, which help reduce the risk of costly potential future re-assessments, yet they are willing to "blow" thousands of dollars on investments in ridiculous companies or options trading they heard about on the radio without blinking an eye? 

10. Why don’t people who can deduct their car expenses, not note their odometer reading on January 1st and December 31st of each year. This would provide them with at least the total km driven in a given year, even if they are not willing to keep log books? The CRA has relaxed their administrative position concerning log books recently, but I still think there is no substitution for a log book and at minimum, noting your odometer readings at the beginning and end of each year.

11. Why the withholding taxes on RRSPs are graduated? Withdrawals up to $5,000 are subject to a 10% withholding tax; withdrawals between $5,001 and $15,000 are subject to a 20% withholding tax; and withdrawals of $15,001 or greater are subject to a 30% withholding tax. These graduated rates often cause significant income tax owing in April since the size of the withdrawal has no correlation to the taxpayer’s marginal income tax rate. All withdrawals should be subject to higher withholding rates (or withholding at the highest marginal tax rate) to prevent this issue.

12. Why does the CRA constantly send information requests for documentation to support child care claims in relation to nannies? Taxpayers are required to report the nannies social insurance number when claiming a child care expense. All that is required by the CRA is to match the social insurance number to the T4 filed by the employer for the nanny. The CRA has other programs which match items in a person’s tax return to a T-slip, why can’t they include this?

13. Why do people pay no attention to the RRSP contribution limit information on their income tax assessments when planning their RRSP contributions for the year? An individual’s RRSP contribution limit for the upcoming year is printed right on the Notice of Assessment for the prior year. It is also available on-line assuming that you register for on-line access on the Canada Revenue Agency’s website.

14. Why don’t people create a file folder for charitable donations they make during the year? If a donation is made online, they can print out the confirmation at the same time and replace the confirmation with the actual online receipt when received. Alternativey, if a cheque or pledge is made, make a copy and replace that copy when the actual receipt is received in the mail. By doing such, at year end it will be clear which donation receipts are missing and have to be chased down.

15. Why do people have money in non-registered accounts but yet they have not fully funded their TFSAs? Just transfer $5,000 each year, non-taxable is always better than taxable.

16. What do post-secondary aged children have against printing out their T2202A tuition receipts for their parents without being admonished? They are now at the age where they are supposed to be considered responsible adults – they should act like one.

17. Why do people who buy stocks not create a spreadsheet to track the cost (adjusted cost base) of the stocks purchased? In addition, when stocks are inherited from parents or grandparents, why not note the value reported on the parent’s or grandparent’s terminal income tax return so the cost base is not lost. You wouldn’t believe the number of times that shares have been passed down from one generation to the next where the recipient has no idea of the actual cost base.

18. Why do people transfer assets to try and save probate taxes without understanding the consequences for income tax. See my blog on probate taxes for a discussion of some of the possible detrimental income tax consequences when tranfers are made blindly for probate purposes.

19. Does the public transit credit or the children’s fitness/activity credit really incentivize anyone to use public transit or put their child in a sports/activity program? The tax benefit from these credits is so small. If the government really wanted to advocate these behaviours or activities there are better ways to do this than offer petty tax credits.

20. Should the labour sponsored funds tax credit be more appropriately called the convert $5,000 and turn it into a $1,000 credit? Enough said.

I am sure I could come up with another list of 20 plus things I don’t understand about income tax, but I will leave that for another blog for a rainy day.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts 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.