The Income Tax Act permits the deduction of child care expenses under certain circumstances. A quick summary of those rules:
- Only the lower earner in the household can deduct the expenses. For a separated couple, the same rule applies receiving child support can deduct the expenses.
- There are some exceptions, where the higher earner can claim the expenses:
- If the lower earner has a disability that renders that person incapable of providing child care
- If the lower earner is attending post-secondary education
- If the lower earner is incarcerated
- The amount that can be deducted depends on the age and situation for the kids:
- $8,000 per year for a child age 6 or under
- $5,000 per year for a child age 7 to 16
- $11,000 per year for any child who qualifies for the disability tax credit (DTC)
- $5,000 per year for a child older than 16 who has a disability but does not qualify for the DTC
- All to a limit of 2/3 of the claimant’s earned income (basically, active employment or self-employment type income)
As an approximate example, let’s say that we have a couple with the following facts:
- Spouse A earns $110,000 per year (38.29% marginal tax rate)
- Spouse B earns $70,000 per year (28.20% marginal tax rate)
- There are 2 kids age 4 and 7, both in child care, neither of whom qualifies for the DTC
- The 4-year old’s child care costs $10,200 per year and the 7-year old’s child care costs $7,200 per year
- Resident in British Columbia
Only the $70,000 earner can deduct child care costs. The maximum deduction is $13,000, based on $8,000 for the younger child and $5,000 for the older child. This is less than 2/3 of the $70,000 earner’s income, which would be $46,667, so this taxpayer can deduct $13,000. The resulting tax savings are ($13,000 x 28.20% =) $3,666. Arguably, the true after-tax cost of child care for this family is ($13,000 - $3,666 =) $9,334. This uses 2020 income tax rates.
Because child care expenses are a deduction from total income, this will also increase the Canada Child Benefit, but will not reduce the RRSP Earned Income calculation.
Now, let’s consider a slightly different case study. Let’s say that we have a household that already has one child, age 4, and brings a second child into the world. We’ll assume that the parent who will take the majority of child care responsibilities starts their time off from work on July 1st of the year in question, and we’ll use the income levels from the case study above. We’ll assume that the parent in question takes exactly one year off work, returning to work on July 1st the year following.
In both years, the total income for that person will be approximately $35,000 of employment income plus approximately $11,000 of Employment Insurance benefits, assuming the employer doesn’t top-up income. At $46,000 of income, the marginal tax rate is only 22.7% in BC.
In the year in which the child is born, child care expenses are incurred for just half the year at ($10,200 x 50% =) $5,100. A limit of $8,000 can be claimed as an expense. Both amounts are far less than 2/3 of earned income, which would be ($35,000 x 2/3 =) $23,333. (Ordinary EI benefits don’t count towards the earned income total.) The 22.7% tax bracket in BC starts at $41,725 of income, which means this deduction pushes the taxpayer into the lower 20.6% tax bracket. The deduction is now worth ((($46,000 - $41,725) x 22.7%) + (($5,100 – ($46,000 - $41,725)) x 20.6%)) = $1,140.38.
Upon the return to work, child care expenses will be $10,200 (two kids both requiring full-time child care for a half year). This deduction results in savings of ((($46,000 - $41,725) x 22.7%) + (($10,200 – ($46,000 - $41,725)) x 20.6%)) = $2,190.98.
It is relatively easy to build an Excel spreadsheet for your province demonstrating the available tax savings for any child care expense. Just plug in the tax brackets and the total child care expenses. A sample of my BC sheet is available at https://businesscareer.sharepoint.com/:x:/g/Shared%20Drive/EdE0Ej4zCwJEt8Oq6rE0hEUB5Iyw4hMTqFeQW42_0x5zjg?e=yfVaZD
Other resources used in preparing this were: