What the heck is tax withholding and why does it matter for whether maternity and parental benefits are ‘tax free’?

As you all may know, I recently wrote about the Conservative Party of Canada’s claim that they were making maternity and parental benefits (why for the love of all that is taxes, can’t they bring themselves to say parental benefits) tax free.

In a nutshell, no they are not making maternity and parental benefits tax free. They are simply created a nonrefundable tax credit that won’t be applied to the income until tax time. The credit will be paid out at 15% whereas someone women will, gasp, actually be paying a higher tax rate on the maternity and parental benefit income. In addition, we already have numerous tax credits in place that already make this income tax free or nearly tax free for others. Whether or not you, the beneficiary, actually derive any benefit from this tax credit depends on a host of complex factors, but overall to claim it is tax free when it is not tax free for everyone is just not factual.

The CPC has since made two claims related to my critiques. First, the nonrefundable tax credit will be allowed to be carried forward so that if you are unable to get the whole benefit in any tax year, you can try again in another. Great. It is unusual to treat nonrefundable tax credits in this way, but not unheard of. After all the tuition tax credit  has the same feature (but the tuition tax credit can also be transferred, and I don’t hear anything about a similar feature (yet) for the maternity and parental benefit tax credit). This stranded tax credit being allowed to be carried forward means lower income parents may eventually derive benefit from the tax credit, albeit not in the year in which they are actually, you know, on leave caring for an infant.

Does this change now mean their claim of making maternity and parental benefits tax free true? No, because it still ignores the complexity of a progressive income tax system and marginal tax rates.

My second critique has been that the existence of the nonrefundable tax credit does not change the fact that under the Income Tax Act, income from maternity and parental benefits are subject to withholding, meaning that when the benefits are paid, the payer (Services Canada) but, by law, withhold taxes on the income benefit. Withholding is set out in section 153 of the Income Tax Act.

This section requires anyone who pays the outlined forms of income must “deduct or withhold from the payment the amount determined in accordance with prescribed rules and shall, at the prescribed time, remit that amount to the Receiver General on account of the payee’s tax for the year under this Part or Part XI.3, as the case may be, and, where at that prescribed time the person is a prescribed person, the remittance shall be made to the account of the Receiver General at a designated financial institution.”

This means even with the nonrefundable tax credit in place, parents will still only receive the net of tax withholding amount at the time the benefits are paid. If the Conservative Party of Canada wants to exempt maternity and parental benefits from withholding they can’t just say “Hey CRA, don’t withhold taxes.” They have to actually change the Income Tax Act and any associated regulations, legislation, and prescriptions to make it so. They will have to be sure that they make these changes to apply only to maternity and parental benefits, increasing a host of implementation complexities. After all, you can in fact get both other EI benefits in the year you also get EI maternity and parental benefits. This what is behind my statements that in order for taxes not to be withheld, they need to modify the TD1 form.

And, just to be clear, for parent’s whose marginal tax rate on the benefit income is above 15% THEY WILL STILL OWE TAXES AT TAX TIME ACCORDING TO THE DIFFERENCE BETWEEN THE 15% CREDIT AND THEIR ACTUAL MARGINAL TAX RATE. While everyone wants to say well, wah, they are higher income people, they can afford it. I want to remind everyone that when it comes to an unexpected income tax liability when you are on reduced income and juggling a young family, that liability will come as a shock, especially since you were told by the party that brought in this regime that the income was supposed to be tax free.

It is simple. Don’t say you are giving maternity and parental benefits tax free status when you are not. The CPC are not doing this. They are creating a nonrefundable tax credit. Full stop. I am not saying anything about whether this policy is good or bad. What I am saying is their communication is not factual and is not consistent with the Income Tax Act. And any of their tweaks over the last few days does not change this.

 

2 thoughts on “What the heck is tax withholding and why does it matter for whether maternity and parental benefits are ‘tax free’?

  1. EI Maternity benefits and EI Parental benefits are two separate things. Which probably explains why they say maternity & parental.

    • Hi. They only refer to their policy as applying to maternity benefits in the public communications. It does though apply to both maternity and parental benefits.

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