Who will benefit the most from income splitting?

Families with large income disparities making $60,000 or more will come out on top

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(MARCO DE SWART/AFP/Getty Images)

(MARCO DE SWART/AFP/Getty Images)

The federal Conservatives moved on a four-year-old election promise Thursday by introducing income splitting for families, dubbing it “The Family Tax Cut.” The government also rolled out a surprise enhancement of the Universal Child Care Benefit and a $1,000 increase in the maximum amount that can be claimed under the Child Care Expense Deduction.

As expected, the plan unveiled by Prime Minister Stephen Harper and Finance Minister Joe Oliver in Vaughan, Ont., allows families with children under the age of 18 to transfer as much as $50,000 worth of income from the higher-earning spouse to the lower-earning spouse for tax purposes starting in this year.

The wrinkle is that the resulting non-refundable tax credit has been capped at $2,000 per couple.

This means income splitting will provide a meaningful saving opportunity for Canadian families, but not as much as previously thought.

The maximum credit of $2,000 per couple was added after fierce criticism from pundits that income splitting would benefit higher-income families more so than lower-income families.

“The $2,000 cap limits the value of income splitting for higher income families,” says Knowledge Bureau president and MoneySense tax expert Evelyn Jacks. “The couples that will benefit most are those where there’s a large income disparity and they’re making roughly $60,000 to $70,000 in combined income, by our calculations.” At that point couples will hit the $2,000 cap, so those with higher incomes will not get a larger benefit. “It’s not as good as a provision that would allow up to $50,000 of income to be split all across the various income streams, particularly because we are losing the non-refundable Child Tax Credit in the process,” Jacks adds. The average market income for families with children under the age of 18 in Canada is $106,000.

 READ: How income splitting landed on the agenda »

Still, Jacks thinks income splitting will be beneficial for eligible families regardless of their income level, especially when combined with the Tax-Free Savings Account. That’s because couples with young children will be able to keep more of their pay including if one parent stays home to look after a baby. The savings can then be invested for the future, earning tax-free interest for life. (There are rumours brewing that the Harper government also plans to increase TFSA contribution limits, which would further sweeten the deal for Canadians.)

Canada’s current tax rate structure means that a couple with two children in which spouses report a taxable income of $60,000 and $20,000, respectively, would pay about $1,210 more in federal income taxes in 2014 than a couple with two children in which both spouses report a taxable income of $40,000, even though their combined household income is the same at $80,000.

Thursday’s announcement changes that by offering the first couple in the scenario above the chance to save up to $2,000 per year. It’s estimated that 1.7 million couples could benefit from income splitting. (Seniors who are pension splitting are not eligible.)

“It begins to address the real economic cost of raising families in Canada, in earning income and building up pension resources for the future. That’s a positive thing,” Jacks says.

Income splitting could also simplify the tax filing process. By allowing couples to pool their income, the government could be paving the way for a single filing between couples, though no one has indicated that’s the ultimate goal. Right now, in order to be eligible for income splitting, both partners need to file a tax return.

“But it begs the question, does it make sense to introduce joint filing like in the U.S.?” Jacks says.

For the time being, H&R Block senior tax analyst Caroline Battista advises taxpayers “not to rush to do anything until we know all the implications.”

She says only time will tell whether transferring the maximum amount allowable ($50,000) from one spouse to another will always be worth it or if there are advantages to only transferring the exact amount necessary to collect the maximum $2,000 benefit. When pension splitting was first introduced, some seniors found transferring more didn’t always pay off.

Changes to the Child Tax Credit and Universal Child Care Benefit

Harper also announced Thursday that the Child Tax Credit would be replaced in 2015 by increases to the existing Universal Child Care Benefit (UCCB). Starting Jan. 1, the Universal Child Care Benefit for parents of children under age 6 will rise from $100 per month to $160 per month. A new benefit for children aged 6 through 17 of $60 will also be introduced.

The new UBCC allows families with income too low to be taxable to benefit, which wasn’t the case with the Child Tax Credit. Under the new program, all families with children under 18 will benefit, Jacks says.

Child Care Expense Deduction increased

Finally, the Child Care Expense Deduction was increased from $7,000 to $8,000 per child under the age of 7 and from $5,000 to $4,000 for each child aged 7 through 16.

The net effect of all these changes? “For higher earners it means lower taxes,” says Jacks. “For lower earners, it could mean higher refundable tax credits.”

 

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