Deductions Versus Credits
A deduction reduces the taxable income on which you pay tax. If you have a $100 deduction, your taxable income is reduced by $100 and your taxes payable are reduced by $100 times your marginal tax rate. Some items, such as medical expenses or charitable donations, generate tax credits and reduce your taxes payable by a set percentage of the expense or donation. The set percentage is the same for all taxpayers, regardless of income level. Thus, the tax saving you realize from these tax credits is NOT a function of your marginal tax rate.
Separation And Divorce
Transfer of Assets
Most assets can be transferred on a tax-deferred basis to a spouse or common law partner. The assets eligible for transfer are capital property, including depreciable property, portfolio investments, shares in private companies and personal use assets. Life insurance policies also qualify. At the time of the transfer, both parties must be resident in Canada to qualify for a tax-deferred transaction.
There is no restriction on the transfer if the new owner is a spouse or common law partner at the time of transfer. In this context, a spouse remains a spouse until a divorce is processed and approved by the court and also during the time when the parties are separated but still legally married. For a common law partner, the time frame is shorter and would include only transfers within the first 90 days after separation.
Inventory cannot be transferred on a tax-deferred basis. Accordingly, farm crops or livestock, business inventory of a sole proprietorship, land acquired for resale and development and other assets for which the only potential return is increased value on resale, cannot be transferred without current income tax consequences.
Transfer of Tax-Deferred Assets
You may transfer assets from your tax-deferred accounts to the tax-deferred accounts of your spouse or common law partner provided you and your spouse/former spouse, etc. are living apart. Tax-deferred accounts would include RRSPs, Registered Retirement Income Funds (“RRIFs”), most employer Registered Pension Plans (“RPPs”) Tax Free Savings Accounts (“TFSAs”) and Deferred Profit Sharing Plans (“DPSPs”). To avoid potential tax consequences, there must be a direct transfer between plans pursuant to a written separation agreement, decree, order or judgment.
Attribution of Income and Gains
The “attribution” rules discussed in paragraph 8.1.1 do not apply if the spouse or common law partner is living separate and apart by virtue of a breakdown of the marriage or common law partnership. Once living separate and apart, most income is no longer subject to attribution. Capital gains remain subject to the attribution rules after living separate and apart unless you jointly elect with your spouse or common law partner.
Payments to Settle Property
In divorces and separations, there are often payments from one party to another. Generally, these fall into two categories, support or property settlement. The latter are often made by way of property transfer rather than wholly in cash. Payments to equalize or settle matrimonial property generally have no income tax implications for either spouse. They simply divide the property of the family as part of the divorce. As discussed above, transfers of property can take place at cost for income tax purposes.
Support Payments To Spouse Or Common Law Partner
Qualifying spousal support payments are deductible to the payer and taxable to the recipient spouse or common law partner. Qualifying amounts must be:
- Payable on a periodic basis.
- Pursuant to a written agreement, decree, or judgment (the agreement may refer to payments made before signing within certain time limits).
- Made for the maintenance of the spouse or common law partner.
- Explicitly stated in the agreement to be separate from the child support component if paid in conjunction with child support.
The child support component cannot be in arrears;
- Paid to a spouse or common law partner living separate and apart at the time of payment and for the remainder of that year.
- Registered with CRA, by filing form T1158 Registration of Family Support Payments.
Child Support
Generally, payments of child support are not deductible to the payer or taxable to the recipient. Where the payments are made pursuant to a pre May 1st, 1997 agreement, it may still be possible to treat child support as a deductible item to the payer and taxable to the recipient parent.
Deduction Limitation For Most Employees
Businesses generally can deduct most expenses incurred to earn business income. Salaried employees, however, are restricted in their ability to claim tax deductions. Commission employees have some latitude and can claim a number of expenses, up to the amount of their commission income.
Every deduction claimed by an employee must be specifically permitted by the Income Tax Act; chapters 2 and 3 outline some of the differences between employment and business income.
In addition to the usual requirements for deducting expenses, employees are generally required to have documentation signed by their employers (Form T2200) certifying that they are required to incur the specific expenses as part of their terms of employment.
Home Office Expenses
If your employer does not otherwise provide you with a workspace and you are required to have an office in your home to properly perform your employment function, you may be eligible to deduct a portion of the costs of owning and maintaining the home. Your home office must be your principal (more than 50%) place of employment activity or must be both used exclusively to earn employment income and used regularly to meet customers or others in the course of employment.
Claiming CCA (Capital Cost Allowance) for office use of some of your home is usually not recommended because:
- That portion of your house on which you claimed CCA will NOT qualify for the principal residence exemption. That portion of the appreciation over original cost realized on sale will be taxed as a capital gain.
- If you sell your house and at least recover your costs, you will include in taxable income all of the CCA you previously deducted. That could result in income being taxed at a rate exceeding the rate at which you received the original deduction.
Meals And Entertainment
Employees required to incur meal or entertainment costs under their contract of employment may deduct the costs of meals incurred on business. For example, salesmen who take customers or prospective customers to sporting events may claim a deduction. Eating out alone generally is not an eligible cost. You may be able to deduct these expenses, when you are required to be away from the municipality where your employer’s place of business is located for at least 12 hours.
Private Health Plan Premiums
Self-employed individuals can choose between deducting private health plan premiums in computing their business income or including them in their eligible medical expenses. To be eligible for the deduction, the business income must exceed 50% of the individual’s total income for the current year or the preceding year, or the other income must be under $10,000.
Other Expenses Of Employment
Supplies Consumed
If you are required, as a condition of your employment, to pay for supplies you consume, you can deduct these expenses. Teachers, who are required to provide their own paper, pencils, art supplies, etc., would be able to deduct these costs. As well, supplies consumed in a home office, such as a separate phone line, Internet connection, fax and computer paper and printing supplies would be fully deductible. Even though these are consumed in the home office, they are claimed under a separate provision. There is no need to prorate these expenses, as you must with other home office costs. “Supplies consumed” often has a broader meaning than might be first thought and has been interpreted to include items such as pagers, telephones, and other handheld electronic devices (such as Blackberries, iPhones, etc.)
Assistant’s Salary
If your contract of employment requires you to hire an assistant, these costs are deductible. This could include ongoing costs paid to someone to help you fulfill your work requirements, or hiring someone to replace you while you are ill, on holidays, or otherwise unavailable. Wages paid for a housekeeper are considered a non-deductible personal cost even though it may allow you more time to earn employment income.
Dues and Membership Fees
If you pay dues or fees to be a member of an organization to maintain a professional status recognized by law, these costs may be deductible. Initiation or reinstatement fees are not deductible. You can also deduct union dues and payments under a collective agreement. None of the above can be claimed if reimbursed by your employer.
In some cases, a fee may not be deductible because it does not meet the technical requirements. For example, the payment of fees to a provincial law society is generally deductible, as it is required in order to practice law in that province. However, amounts paid to the Canadian Bar Association are technically not deductible by an employed lawyer, as the lawyer can retain his/her professional designation without paying these fees. If the payment of the fee is for the benefit of the employer, the employer can pay them without a taxable benefit to the employee. However, if the amount paid by the employer is included in an employee’s income, then the employee may be entitled to claim the deduction
Commission Expenses
Where you are remunerated in whole or in part on a commission basis, you can deduct many of the costs related to earning that income. Automotive, office in home, meals and entertainment and other expenses noted above are generally available.
There are significant limitations to the total deductions that may be claimed. For example:
- Regular employees cannot claim expenses in excess of their employment income
- Commissioned employees cannot claim certain deductions that exceed commission income and apply the excess to reduce their salary.
- Self-employed persons cannot create a loss by claiming home office expenses. Excess home office expenses carry forward indefinitely and may be deducted from the related income in subsequent years.
GST/HST And QST Rebates
Employees are entitled to a GST/HST rebate for deductible employment expenses, if the employer is a GST/HST registrant.
The refund does not reduce the current year’s expense deduction. Instead, it is reported as other employment income in the following year. Where costs are only partially deductible, such as the 50% meals and entertainment limitation, the same limitation applies to the GST/HST refund on that expense.
Where a vehicle is used for employment purposes, the GST/HST refund may include 5/105 (12/112 or 13/113 for GST/HST and 9.975/114.975 for QST) of the current year’s deductible CCA claim. The portion of the GST/HST refund that relates to the CCA claim then reduces the UCC pool in the following year.
Childcare Expenses
Expenses incurred by a family unit to obtain care for children can be tax deductible in certain circumstances. Eligible children include:
- Your children.
- Children of your spouse or common law partner.
- Other children dependent on you, your spouse, or common-law partner if the child’s income does not exceed the income equivalent of the basic personal tax credit.
As discussed elsewhere in this book, “common law partner” for tax purposes includes a same sex partner. These provisions apply to same sex couples who have children in their family unit and incur qualifying costs.
To claim expenses, the childcare must enable you, your spouse or common-law partner to:
- Earn employment income.
- Carry on business as a sole proprietor or partner, or
- Attend school “full-time” (minimum 3 consecutive weeks of at least 10 hours per week) or “part-time” (minimum 3 consecutive weeks and at least 12 hours per month).
The deduction equals the actual eligible expenses paid per child, subject to upper limits determined by the age and status of the child, as follows:
The deduction cannot exceed two-thirds of the taxpayer’s “earned income” (employment and business income, qualifying scholarships and research grants, CPP disability payments and certain special EI payments usually involving retraining).
Eligible expenses include payments to:
- Individuals, day nursery schools and day care centers for childcare services.
- Educational institutions for the portion relating to childcare.
- Day camps if the primary purpose is to provide childcare.
- Boarding schools, overnight schools or camps, subject to additional limits.
You must be able to prove the amounts expended. As discussed elsewhere in this book, CRA (Canada Revenue Agency) routinely denies legitimate expenses that are not supported by proper receipts or similar documentation. It is suggested to have receipts showing a social insurance number if payments are to an individual.
The childcare deduction is based on when services are provided, NOT when you pay for them. Prepaying expenses in December will NOT accelerate deductions.