Lesser-Known Tax Effects of COVID-19 Benefits 

In response to the COVID-19 pandemic, the government introduced new benefits to help affected Canadians. These benefits were all taxable. In this article, we will see the lesser-known effects of these benefits on the tax return; more specifically, how the definition of earned income can have profound effect on the tax return results.

Earned income when calculating child care expenses and disability supports deduction

For the 2020 tax year, the federal government recently announced that for the purposes of the child care expenses and disability supports deduction, all COVID-19-related benefits, such as the CERB and the CRB, would be considered as earned income.

 No change to earned income definition for other amounts

While the earned income definition has changed for child care expenses and disability supports deduction, it has not changed for other amounts on the tax return, such as the Canada Worker’s benefit (CWB), refundable medical expense supplement, RRSP deduction limit and the Canada Training Credit limit. This fact can have a profound effect on the tax situation of a taxpayer who would ordinarily be eligible for these amounts, as we will see below.

Case study of earned income effects

To sum up the effects of the COVID benefits on amounts that use earned income, let’s look at a hypothetical comparison.

Below are the results of a hypothetical single parent who has childcare expenses of $1,000, medical expenses of $1,000 and ordinarily gains $24,000 of employment income. We will then try the same case, but instead of $24,000 of employment income, the individual receives the full amount of CERB possible, which was $14,000, and $10,000 employment income.

Note 1 - $1,000 - (3% X $23,000) = $310

Note 2 - 25% of $310 = $77.50

Note 3 -

W/O COVID Benefits: $2,379 - [($23,000 - $17,348) X 12%] = $1,700.76

With COVID Benefits: $1,820 - [($23,000 - $17,348) X12%] = $1,141.76

Note 4 -

W/O COVID Benefits: $24,000 X 18% = $4,320

With COVID Benefits: $10,000 X 18% = $1,000

From the case study, we can observe some profound effects:

·        For the current year, the individual has a substantive reduction in the Canada Worker’s Benefit credit due to the reduction of earned income. In this example the individual gets almost $600 less. This is due to a substantial decrease in earned income.

·        Substantial reduction in the RRSP deductible room for the following year by over $3,000 due to a decrease in earned income.

We can see that the taxation of these benefits is not a simple matter of them being taxable like any other income. As the case study above shows, due to the earned income definition in the amounts mentioned above, an individual receiving these benefits might pay substantially more tax in the current year (CWB reduction). The taxable income in both instances is the same; however, the result of the tax return is substantially different due to the earned income definitions for certain credits.

The substantial reduction in RRSP room will also increase an individual’s tax bill for the following years due to the lost deduction room.

For other amounts such as the medical expense supplement and the Canada Training Credit, in the case study, there was no effect due to the earned income requirements being based on a threshold amount instead of the actual amount earned (for example, the earned income criteria of the CTC is $10,100 of earned income). However, these credits could also be lost if the individual does not reach the threshold amounts due to having received the pandemic related benefits instead of earned income.

The only amount not affected is the child care expenses deduction due to the change in legislation.

The point of the exercise is to dig deeper on the effect of these benefits on an individual’s tax return. As was shown above, not only can the current tax bill increase, but these benefits can adversely affect the future tax returns as well, all because the definition of earned income remained unchanged for the majority of the amounts that use that term.