On August 20, 2019, the Conservative Party of Canada (CPC) announced that they will “make maternity benefits tax free.” I have so much to say here.
For starters, while all the communications from the CPC and Andrew Scheer focus solely on the word ‘maternity’, the proposal actually applies to both maternity and parental benefits. Maternity leave is a 15 week leave that only the birth parent can take and it is a period of time allotted solely for the birth parent to recover from the trauma of birth. Parental leave is a 35 week leave (or 78 week leave if you opt in for the extended benefits) that either parent can take to allow them time to care for and bond with their new child (whether the child be physically birthed by one of the parents or adopted). It is perplexing to me why they would only use the word ‘maternity’ in their highlights, but I expect that has something to do with political spin, something that is lost on me.
More importantly though, I am sorry to say the CPC are not making these benefits ‘tax free’. If we look in the Oxford dictionary tax free is defined as ‘exempt from tax.’ That is, people reading this statement will think, and rightfully, that the income will be free from tax, not taxed, that they don’t have to pay tax on the income received from maternity and parental benefits. That, my friends, is not the case. What they are offering is a 15% nonrefundable tax credit. Anyone saying that a nonrefundable tax credit is the same as something being tax free knows very little about the tax system.
Let’s look at this. First of all, benefits paid out under the EI system, including maternity and parental benefits, are taxable income. Premiums paid into the EI system are paid out of your pre-tax employment income. Benefits then paid out of these contributions are then taxable. That makes sense. Income should only be taxed once (in theory, yes there are examples where it is taxed more than once and there are examples where income is never taxed) so you don’t pay tax on the contributions to EI, instead you pay tax on the income stream derived from these contributions, the income you get when you make an EI claim.
Second, in order to qualify for maternity and parental benefits you must have had 600 hours of insurable employment in the period before the start date of the benefit period. You have to had worked and earned employment income from that work. That is, you must have earned income before the benefits are paid. The maternity and parental benefits are paid after that qualifying income is earned, meaning the applicant parent will owe their marginal tax rate on these benefits. That marginal tax rate will depend on their income earned in the period before they take maternity and parental leave which will also depend on what month the child is born.
Third, when you receive your maternity and parental leave benefits, tax is withheld (this is called withholding) on that income. You only receive the after tax amount. But our tax system does not work well for people with multiple sources of taxable income. The withholding on each source of income only factors in that source of income into withholding. The end result is most people with multiple sources of income do not have enough income withheld on their earnings and they owe money when they file their tax system. This is true for maternity and parental benefits. The amount withheld assumes that this income is the only income you have earned, ignoring the actual marginal tax rate that you will owe on these benefits. This is why most people who receive maternity and parental benefits tend to owe money when they go to file their taxes. Sadly, because few people understand the system, they are mostly quite shocked and annoyed by this.
Fourth, unless the CPC modifies the TD1 form to allow for their proposed nonrefundable credit to be applied directly to maternity and parental leave benefits then what is outlined in the previous paragraph would still hold if this credit comes to fruition. That is, anyone receiving maternity and parental benefits will still have taxes withheld from their weekly benefit payment and will not be able to able to apply to have this nonrefundable credit applied until tax time.
Fifth, not many people understand how nonrefundable tax credits work. Just because you claim it does not mean you get any benefit from it. The way it works is first you determine your taxable income which is on line 260 of the income tax form. Taxable income is your total income less deductions (like RRSP contributions, union dues, child care expense deduction, capital losses, norther residents deduction, etc.). This is the income to which the federal and provincial statutory tax rates are applied. As noted on this site, the federal statutory tax rates are as follows:
So on the first $47,630 of income you pay 15%, income over that but under $95,259 is taxed at a higher rate of 20.5%, and so on. So if you earn $55,000 in annual income, your tax owing before credits are applied is 47630*0.15+(55000-47630)*0.205=$8,655.35. It is now that nonrefundable tax credits are then subtracted from the tax owing. They are applied in a particular order and the total of the nonrefundable tax credits cannot exceed the amount of tax owing, $8,655.35. That is the total amount of non-refundable tax credits can only reduce the amount of taxed owed to $0, any amount that remains is forfeited. Nonrefundable tax credits are almost always calculated at the lowest statutory tax rate of 15%. For example, there is the basic personal amount of $12,069. To determine the amount of this tax credit you multiply that amount by 15%=$1,810.35 and then subtract that amount from tax owing: $8,655.35-$1,810.35=$6,845. Now you only owe $6,845 in taxes!
OK, now that we have the basics of the system down, let start by looking at two otherwise identical people who claim EI maternity and parental benefits, but will owe a different amount of taxes on their benefits and see how this credit works. We will just work at the federal level here since that is what matters for the proposed credit. It is through this example that we will see more clearly how tax credits may not actually benefit you, despite you thinking they do.
Janice was working full time before she took her maternity and parental leave. She took her leave starting in July 1 and took the full amount of regular combined benefits. Before she took her leave she had already earned $55,000 and qualified for the maximum benefit payment of $562 a week, receiving then $14,612 in gross benefits (accounting for the one week waiting period) in the birth year and $12,926 in the subsequent year.
What tax does she owe on this income before credits are applied? 47630*0.15+(50000-47630)*0.205=$8,655.35 on her employment income (an amount reduced once she claims the personal exemption on the first $12,069 of this income, the tax credit for her EI and CPP contributions, and any other credits that she may qualify for) and, gasp, $14,612*0.205=$2,995.46 on the maternity and parental benefits she received. Notice she will have to pay the 20.5% tax rate on her maternity and parental benefits…wait, you say. Right here, right here exactly is where you should be able to see a punchline about the proposed tax credit.
She will owe $2,995.46 in tax on the benefits, but only get $14,612*0.15=$2,191.8 in offsetting tax credit AT TAX TIME on that income, for a net tax owing on her parental benefits of $803.66. But remember, when she received her benefits, the government already withheld taxes on the income, withheld at 15% so she only gets the benefit of the credit calculation in March or April when she files her taxes and will be shocked to see she still owes taxes on that income. Hmmmmm, that does not exactly sound tax free?
Now in the next year, however, things change. She earns $12,926 in parental benefits which she receives from January to June. She will then pay $12,926*0.15=$1,938.9. That seems to match up with the offsetting tax credit now, does it not? What if in June Janice decides not to return to work? In this case her total earnings for the year are $12,926. She owes $12,926*0.15=$1,938.9 in taxes before credits are applied. But because this is her only income, the personal exemption applies as well as the proposed tax credit. Her tax credits amount to $1,810.35 from the personal exemption, reducing her tax liability to $128.55. The tax credit from the proposed tax credit is $13,488*0.15=$2,032, but because the credit is not refundable she only gets $128.55 in additional benefit from this new proposed tax credit, not the full amount as advertised. That is, she derives most of her benefit from existing tax credit. And this is rub with the tax credit for anyone with a low income. Most of the credit forfeited because the credit is non-refundable.
Let’s take instead Piper. Piper was also working full time in a government job before she took her maternity and parental leave. She took her leave starting in January 1 and took the full amount of regular combined benefits. Piper too qualifies for the maximum benefit payment of $562 a week, but because she timed her birth for the new year (her and her partner are really hoping that the child will become a professional hockey player) she has no employment income in her birth year, just maternity and parental benefits. She collects $27,538 in parental benefits, on which tax were fully withheld. Again, here her tax owing is $27,538*0.15=$4,130.7. Wait, you think, we now the proposed credit seems to work well. Except again, don’t forget that first we get the personal exemption of $1,810.35 for tax owing now of $2,320.35 to which the proposed tax credit is applied. The proposed tax credit is $27,538*0.15=$4,130.7. Again, her tax liability is reduced to $0 but she has $1,810.35 in forfeited tax credits from the proposed tax credit.
If we compare their various situations, we see that they differentially ‘benefit’ from this tax credit despite being otherwise identical. Both earned $27,538 in maternity and parental benefits. Janice ended up paying $803.66 in taxes on this income, whereas Piper paid no tax on this income. Janice forfeited $1,903.45 in value from the tax credit and Piper forfeited $1,810.35 in value from the tax credit. Two identical women differentially benefit because of how their births were timed. And this also shows how marginal tax rates matter for the application of the proposed tax credit.
You can do a whole host of different calculations and see who: (1) obtains absolutely no benefit from this proposed tax credit because existing tax credits already reduce their tax liability to zero; (2) who derives only a partial benefit from the proposed tax credit; and (3) who derives a full benefit from the proposed tax credit. The thing is not only does your income matter, so too does the timing of the birth. Births are not just randomly allocated. There is a pattern to births in Canada, called birth seasonality. This seasonality of birth in Canada sees more children born in the late summer and fall months, meaning more woman are like Janice, fewer women are like Piper. This pattern I’ve also shown is highly influenced by public policy. If this credit were to come to fruition, we might expect to see women changing their birth seasonality. There are costs and benefits to doing so.
But bottom line, the CPC’s advertising this scheme as making maternity and parental benefits tax free is not factual at all. And the other part they did not tell you is that for many women on maternity and parental leave, they already derive most of their tax benefits from existing tax credits and little from this new proposed credit.
UPDATE: The CPC have just uploaded a new backgrounder on their website here: https://cpcassets.conservative.ca/wp-content/uploads/2019/09/12094250/4d940e964f7d315.pdf
In what appears to be a direct response to my points above, albeit with no citation (said face), they are now saying that the stranded tax credit that I mention above for both Janice and Piper’s case, wait forward, will be allowed to be carry forward. That, to me, is new and was not there in the past. And sorry folks, but the only person who talked about public policy implications and month of birth is typing this right now.
That sort of gets at some of the criticism of the policy. It does not address the fact that someone like Janice has a higher tax liability on the income than 15% so will still owe money. It does not address the fact that those parents that self finance their leaves receive no benefit from this policy. And given that the carry forward provision is unusual for tax credits (tuition comes to mind) and requires you to have future income seems ancillary to support women make the choice that is best for them, including to, you know, stay home if they want. And, ironically, the fact that they had to make the carry forward provision actually reinforces the point that the income is not, you know, tax free.
And for all that this means, why not just make the tax credit refundable so parents get the benefits earlier in the child’s life and while on a reduced income?