Children Come First: A Report to Parliament Reviewing the Provisions and Operation of the Federal Child Support Guidelines - Volume 1

APPENDIX 2:  CHANGES IN TAXATION RULES FOR CHILD SUPPORT

(Provided by the Federal Department of Finance)

INTRODUCTION

The child support reform package, announced in the 1996 budget, included new rules for the taxation of child support and an enrichment of the Child Tax Benefit. This appendix describes: the old rules for the taxation of child support and the rationale for changing them; the new tax rules; the enrichment of the Child Tax Benefit; and, the impact of the new tax rules and the enriched Child Tax Benefit on government revenues.

THE TAXATION OF CHILD SUPPORT

Prior to the child support reform, payers of child support could deduct the payments from their income for tax purposes, while recipients of child support were required to include the payments in their income for tax purposes. In other words, under the deduction-inclusion rules for taxation of child support, support-paying parents were able to claim a tax deduction and receiving parents were required to pay tax on child support.

RATIONALE FOR CHANGING THE TAXATION OF CHILD SUPPORT

In the years leading up to the child support reform, the government became aware that some Canadians had concerns about the deduction-inclusion rules for taxation of child support.  In response, the government participated in public consultations on the taxation of child support through the Family Law Committee and the Task Group on the Taxation of Child Support.  The consultations revealed broad-based support for change.

Few Canadians were in favour of giving support-paying parents a tax deduction for the costs of raising their children.  These costs were seen as the normal obligation of being a parent and were not considered to warrant special tax assistance.  At the same time, few Canadians thought it was right to tax child support as income in the hands of the support-receiving parent.

There was widespread agreement among support-paying parents, support-receiving parents, lawyers and judges that the deduction-inclusion tax rules added complexity to the determination of child support awards.

Taking the tax implications into account required lawyers and judges to perform complex tax calculations that added to the expense of family law cases.  The complex tax calculations also made it more difficult for parents to negotiate child support amounts that they both perceived as fair.

The deduction-inclusion tax rules for child support provided a tax benefit when the support-paying parent was in a higher tax bracket than the custodial parent because the tax savings from the deduction exceeded the tax paid due to inclusion.  It was seen as unfair that whether or not there was a tax benefit available to a family depended solely on the income discrepancy of the two parents, and not at all on the needs of the children.

Parents also complained about the cash-flow impact of the deduction-inclusion tax rules.  Under these rules, the support-receiving parent had to set aside the money needed at the end of the tax year to pay the tax liability on the amount of child support received.  These parents complained that they did not know how much they needed to set aside and, in any event, found it difficult to do. In the case of payers, they could have the amount of tax withheld from their earnings adjusted to reflect their child support payments.  However, some payers of child support may not have been aware of this as they complained that they were required to make high monthly payments throughout the year and had to wait until they filed their tax return to benefit from the deduction.

NEW RULES FOR TAXATION OF CHILD SUPPORT

The new tax rules for child support are based on the recommendations of the Task Group on the Taxation of Child Support and the Family Law Committee.  Under the new rules, child support payments are not deductible to the payer, and are not included in the income of the recipient.

The new tax rules apply to all child support awards under written agreements or court orders made on or after May 1, 1997, regardless of whether the parents were married or in a common-law relationship.  They do not apply to orders made before May 1, 1997, unless the orders are varied in one of the following ways:

  1. a court order or agreement made on or after May1,1997 changes the amount of child support payable under the old agreement or court order;
  2. the agreement or court order specifically provides that the no-deduction/no-inclusion tax rules apply to payments made after a specified date (which cannot be earlier than May1,1997); or,
  3. the payer and the recipient both sign and file a form with the Canada Customs and Revenue Agency (CCRA) stating that the no-deduction/no-inclusion tax rules apply to payments made after a specified date (which cannot be earlier than May1,1997).

IMPACT OF THE NEW TAX RULES

When the child support package was announced in the 1996 Budget, the government estimated revenue gains from the new tax rules of about $15 million in the first year, $65 million in the second year, and $120 million in the third year.  The estimated revenue impact was due to the loss of the income-splitting tax benefit under the deduction-inclusion tax rules.

The government committed to reinvesting the anticipated revenue gains on measures to benefit children.  Specifically, the anticipated gains were to fund the implementation costs of the Federal Child Support Guidelines and new enforcement measures, and contribute to a significant enrichment of child benefits, which are described below.

ENRICHED CHILD BENEFITS

In the 1996 Budget, it was announced that the benefits under the Working Income Supplement (WIS), which was part of the Child Tax Benefit, would be doubled.  The WIS provided a maximum of $500 in benefits to low-income working families.  This maximum benefit was to increase to $750 in 1997 and to $1000 in 1998, at a cost of $250 million annually when fully phased in.

However, with the 1997 budget, the federal government began restructuring and further enriching child benefits.  The new Canada Child Tax Benefit (CCTB), introduced in 1997, has two components: a base benefit for low- and middle-income families and the National Child Benefit (NCB) supplement for low-income families. The WIS was replaced by the NCB supplement.  In the 1997, 1998 and 1999 Budgets, the federal government announced major enrichments in the CCTB totalling $2 billion per year.  Further enrichments were announced as part of the Five-Year Tax Reduction Plan in the 2000 Budget and the 2000 Economic Statement and Budget Update totalling $2.6 billion per year. The CCTB has been enriched every year since the introduction of the new child support regime and the yearly maximum benefit for the first child has grown from $1,625 in July 1997 to $2,444 in July 2002, and will rise to over $2,500 by 2004.  The enrichment of the CCTB since 1997 has far outweighed the projected revenue gains from switching to the no-deduction/no-inclusion tax treatment of child support.

CONCLUSION

The federal government responded to the concerns expressed by Canadians about the deduction-inclusion tax treatment of child support by implementing new tax rules that address those concerns.  The government has also more than fulfilled its commitment to invest the anticipated revenue gains in measures for children from switching to the new tax rules for child support, by significantly enriching the CCTB.

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