A new family income-splitting program, announced with much political fanfare last fall, took effect at the beginning of this year. With Canadians now shifting their attention from RRSPs to income tax, it's a good time to investigate the Family Tax Cut and find out if you qualify to receive this handout, which is claimed as a non-refundable tax credit on your income-tax return.
The Family Tax Cut allows the spouse with the higher income to, on paper, transfer up to $50,000 of his or her income to the lower-income spouse. Not only does this provide a tax credit worth up to $2,000, it reduces the higher-income spouse's taxable income and thus may reduce his or her income tax payable. The Family Tax Cut may be claimed by one spouse or the other, but cannot be shared. It applies only to federal income tax, not at the provincial level.
"It should be noted that the Family Tax Cut is notional income splitting, as income is not transferred from the tax return of the higher-income spouse to the tax return of the lower-income spouse, as it is for pension income splitting," says Ed Bartucci, a tax partner with KPMG Enterprise. "As a result, it is important to understand that other tax items tied to income are not impacted by this calculation."
It's fairly simple to determine if you qualify for this credit. But just how much you can claim is another matter. As with many tax-reducing schemes, there are a host of conditions based on the incomes of you and your spouse, where and for how long a parent or child lived during the year, and what other tax credits you are claiming on your tax return.
Eligibility for the credit
Generally, you or your spouse (or common-law partner) may be able to claim the credit if you have at least one child under age 18 who ordinarily lived with you or your spouse throughout the year. Both spouses must be Canadian residents as of the end of the taxation year, and file a tax return for the year in question. You must not have lived apart (due to relationship breakdown) for more than 90 days at any time during the year. Nor can the credit be claimed if either spouse made a pension-splitting election during the year, or declared bankruptcy.
What counts as the child having "ordinarily lived" with you? This might seem obvious, but, in today's world of blended families and immigration, there are some conditions that must be met. First, the credit may only be based on the portion of the year following the child's birth or adoption.
If you were married or began a common-law relationship (as defined by the Income Tax Act), the credit can only be calculated as of that date onward. If a spouse became a resident of Canada during the year, only the period following the date of residency counts. And if a spouse died during the year, only the period before death is eligible.
How to calculate the credit
The Family Tax Cut is claimed on line 423 of the federal tax return. It's a non-refundable tax credit, which means that if you have no taxable income to report, you won't be able to claim the credit.
The actual credit calculation is done on Schedule 1A - Family Tax Cut, with the allowable credit result entered on line 423 of Schedule 1 - Detailed Tax Calculation. The calculation is done in several steps.
- You and your spouse calculate the combined tax you would normally pay after claiming any non-refundable credits. This is known as the "base tax payable."
- Then calculate the combined tax you would pay (after non-refundable tax credits) as if the higher-income spouse had notionally transferred one-half of the difference (up to $50,000) in your taxable incomes to the lower-income spouse. The result is the "adjusted base tax payable."
- Compare the first result with the second. The difference in taxes payable under these two calculations will equal the Family Tax Cut credit that one of you can claim. If the difference is more than $2,000, the tax credit is limited to $2,000.
Here is an example of how the Family Tax Cut works, based on information from the CRA. Barb and Mike are a working couple with two children. Mike earns $60,000 of taxable income and Barb makes $12,000, for a combined taxable income of $72,000. Mike faces a marginal federal tax rate of 22%, while Barb is in the lowest tax bracket (15%).
Since the value of Barb's non-refundable tax credits is greater than the tax on taxable income, she will not owe tax. For federal tax purposes, Mike would be able to, in effect, transfer $24,000 of taxable income to Barb. 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% bracket. In addition, Barb would be able to use up her unused non-refundable tax credits due to this notional income transfer.
As one spouse may claim the Family Tax Cut, they decide that Mike should do so. This would reduce Mike'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 Barb is able to use.
