If you’re a parent, and your family’s income is between $30,000 and $119,000 per year, you could be subject to the new “parent tax”. This might not sound like a positive thing, but there are actually some ways you can benefit from this development.
The truth is, the total tax rates of parents can be very high, with marginal tax rates as high as 76%. But the tax also gives parents some exceptional planning opportunities. Here, I’ll go over exactly what this “parent tax” is and offer a couple stories to show how you can benefit from it all.
First of all, the “parent tax” is a new clawback tax that is part of the new Canada Child Benefit (CCB). The CCB provides great benefits, but is “clawed back,” or reduced, if your family income is over $30,000. Your family income is, of course, the taxable income you and your spouse earn combined.
Currently, the CCB pays a benefit of $6,400 per child under 6 and $5,400 per child age 6-17. That sounds great, right? But for parents with a family income as low as $30,000, the benefit gets clawed back, with an even greater clawback rate at $65,000 family income. Ultimately, the point is to prevent families with higher incomes from receiving the CCB and to support families that need the benefit more.
The CCB results in a significant tax increase for parents. It was introduced in 2016 with all sorts of talk about the increased benefits, but there was little talk about the associated “Parent Tax”.
The clawback tax costs you, and it is delayed one year. Your family taxable income in 2018 determines the Canada Child Benefit you get from July 2019 through June 2020.
Here are the benefit amounts and the clawback tax rates. Add your clawback tax rate to your marginal tax rate to get your new marginal tax rate.
Let’s take a look at some examples.
Noah and Emily both work and earn $75,000. They just had their second child, and Emily is planning to stay home for a few years while their kids are young. Noah and Emily have been contributing $15,000 each to their RRSPs and getting refunds of $6,000 each. They were thinking of skipping their RRSP contributions during maternity, and while Emily is at home. Where would they get the money? Plus, Emily is in a low tax bracket – right? She will get only E.I. of $20,000, and then earn nothing for several years.
After speaking with their fee-for-service financial planner, Emily and Noah found that they will both be in higher tax brackets during Emily’s maternity and while she is at home than when she goes back to work!
This means Emily will get a larger tax refund for an RRSP contribution during her maternity than when she is working.
How is that possible? Because when Noah and Emily both work, they are in a 30% income tax bracket and their family income of $150,000 is too high to get any of the CCB. However, during Emily’s maternity, their family income is only $95,000.
Noah’s tax bracket is the same, but Emily is in a 34% tax bracket – 20% income tax bracket plus a 14% clawback of her CCB.
This affects parents at low incomes, too. For instance, Bob and Megan both have minimum-wage jobs. They work only 3 days a week, so they can avoid day care for their 4 kids. Megan’s employer offered a group RRSP which matches her contributions. She thought her income was too low to benefit from an RRSP, but her fee-for-service financial planner told her she is basically in a 43% tax bracket. Megan may earn only $17,000 per year, but a contribution of $1,000 to an RRSP reduces the tax on Megan’s pay cheques by $200 every year and gives her an extra $230 per year in CCB. In the end, the government could pay her $430 towards her $1,000 RRSP contribution.
5 Ways You Can Benefit
One positive aspect of being taxed at increased rates is that tax planning is actually more effective for you, and every tax deduction has a much bigger benefit.
The CCB means the more children you have, the higher tax bracket you are in. Tax deductions are more effective for parents, and tax planning is, in turn, much more effective.
Here are 5 ways you can benefit:
- Use RRSP contributions effectively. You should consider your new effective tax brackets including the CCB clawback with all your RRSP decisions, especially in deciding whether RRSP or TFSA is better for you and when deciding how much RRSP to contribute. The CCB clawback makes RRSP contributions more beneficial and at lower income levels.
- RRSP loans can essentially pay for themselves. An RRSP loan in February provides a tax refund in March, plus more CCB monthly starting July to the following June. You can use the tax refund to reduce the loan, then use the CCB to help make RRSP loan payments.
- Figuring out whether or not to stay home with your kids? Consider the effect on the CCB. Working impacts your family income and your child care costs are tax deductible, so both can affect your CCB. The CCB clawback can make it easier to stay home. Your child care deduction may also give you more CCB.
- Avoid dividends and interest in regards to non-registered investments. Invest tax-efficiently with non-registered investments based on deferred capital gains. Because the CCB clawback is based on your taxable income including the “dividend gross-up” of 38%, dividends may result in a higher CCB clawback.
For example, Bob and Megan in the example above, are in a 43% tax bracket. This is 20% income tax plus 23% clawback tax on the CCB. If they receive $1,000 of dividend income, they pay 59% tax on it! This is because the $1,000 dividend is $1,380 of taxable income and the 43% total tax rate applies on the $1,380.
- If you are self-employed, you can better utilize effective planning to withdraw cash from your corporation. You can pay yourself a salary or dividend. The dividends are now “grossed-up” by 16%, so your CCB clawback tax is, also, 16% higher. If you are self-employed with a corporation, make sure you consider the CCB. The CCB clawback may make it more beneficial to leave more money inside your corporation or plan the timing of withdrawals.
This is a complex topic. The CCB and clawback tax can completely change many of your financial decisions. Talk to a skilled, professional fee-for-service financial planner about how you can personally benefit from the “parent tax.”