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Section 7 Support for Child Care Expenses Reduces Tax Deduction for Child Care

Brief takeaway of this article

A person paying tax deductible child care expenses will have their tax deduction reduced if they receive child support under Section 7 of the Federal Child Support Guidelines as a reimbursement of those childcare expenses.

Background

A separated parent who has sole custody of a child often pays tax deductible child care expenses to enable their employment, education or for certain other reasons. The former spouse is typically required to pay them additional child support pursuant to Section 7 of the Federal Child Support Guidelines. Section 7 requires certain special expenses to be shared in proportion to the parent’s incomes. This is in addition to paying the basic “table” amount of child support.

The Federal Child Support Guidelines calls this additional “child support.” Unfortunately, the Canada Revenue Agency (CRA) does not consider it support, but rather as a reimbursement of the child care expenses. Consequently, the CRA has indicated that the deductible child care expense must be reduced by the Section 7 payment received, and only the “net” amount of the child care is tax deductible.

Consequences by way of example

Assume a mother has sole custody of a child and she and the father have equal incomes. She pays $1,000 to enable her to work, she would be able to deduct $1,000 on her tax return if she receives no reimbursement. If she is in a 20% tax bracket, she would save $200, and have a net cost of $800. Her Canada Child Benefit (CCB) and the GST/HST credit would also increase. However, for simplicity, my example includes only income taxes, and excludes CCB, GST/HST Benefit and any other credits that may be impacted.

If she receives a Section 7 support payment from the father of 50% of the after-tax cost (being $400), she can only claim $600 ($1,000 minus $200 tax savings minus $400 support) on her tax return. This reduces her tax deduction from $1,000 to $600, and her tax savings from $200 to $120. In addition, the father is not allowed to deduct the $400 because it does not qualify as child care expenses for him.

A further complexity

Return to my above example above. Pursuant to the Income Tax Act, with a $400 reimbursement, the taxpayer is only allowed to deduct $600 child care expenses. However, each time the Section 7 reimbursement is calculated, the recipient’s tax deduction changes. While a $1,000 tax deduction would save $200 in taxes, a $600 deduction would reduce the taxpayer’s tax saving to $120. This means that the father need only pay $440 ($1,000 minus $120 tax saving times 50%), not $600. This, in turn, creates another calculation, because the custodial parent can now only deduct $560 ($1,000 minus $440 reimbursement). The tax saving is now $112, and so on – three or four calculations are required to reach a reasonable reimbursement figure.  Unfortunately, this circular calculation must include the resulting impact on the Canada Child Benefit and the HST/GST Benefit (and possibly other income tested items, such as provincial child benefits). This is a very complex calculation, especially without purchased computer software.

The Technical Details

For income tax purposes, the reimbursement pursuant to Section 7 does not qualify as “support” because Income Tax Act Subsection 56.1(4) requires the payment is to be an allowance paid on a periodic basis for maintenance of the child or spouse with the recipient having discretion as to its use. In Income Tax Folio S1-F3-C-3, Support Payments, the CRA states

an allowance is a specified sum of money which has been established in advance of payment by the Court or the parties as being the required payment to be made by the payer to the recipient for the maintenance of the recipient, children of the recipient or both.” [Emphasis added]

With respect to child care expenses, the “allowance” is not likely to be a specified sum of money established in advance – it will be based on the amount of time the child spends at the day care, which can vary. Furthermore, child care payments might not be made on the “periodic basis”. For example, payments might not be made when day care is not needed, such as during parents’ vacations, Christmas break, children’s camps, etc. These would be “questions of fact” for the particular circumstances. The requirements to qualify as a periodic allowance would likely only be met in unusual situations where the cost of childcare could be established in advance and set out in the court order or agreement to be paid in equal payments over a future period of time.

However, even if the payments qualify as a periodic allowance, such payments must also be available to be used at the recipient’s discretion. The Section 7 payment for child care expenses would not qualify because it is specifically directed to child care. In certain cases, the Income Tax Act “deems” the payment to be for the recipient’s discretionary use, and these specific circumstances are set out in Subsection 60.1(2). This deeming subsection is applicable only with reference to Income Tax Act Section 60, Section 60.1 and Subsection 118(5), but not to Subsection 56.1(4). Unfortunately, it is Subsection 56.1(4) that defines “support” and creates the problem. The sections referred to in Subsection 60.1(2) only refer to conditions that need to be met for deductibility of support, mainly spousal support.

Consequently, because Section 7 expenses are not considered “support” by the CRA, they are considered to be a reimbursement to the parent with the child care needs. The Income Tax Act Subsection 63(1)(d) states that child care expenses paid qualify for deduction “to the extent that … the amount is not an amount … in respect of which any taxpayer is or was entitled to a reimbursement or any other form of assistance.” As a reimbursement, the Section 7 payment must be subtracted from the full child care expense payment before being claimed for income tax purposes.

As a result of the above interpretation, the Income Tax Act is inconsistent with the Federal Child Support Guidelines. The Federal Child Support Guidelines, Section 7, states:

  • 7(1)In a child support order the court may, on either spouse’s request, provide for an amount to cover all or any portion of the following expenses, which expenses may be estimated, taking into account the necessity of the expense in relation to the child’s best interests and the reasonableness of the expense in relation to the means of the spouses and those of the child and to the family’s spending pattern prior to the separation:
    • (a)child care expenses incurred as a result of the custodial parent’s employment, illness, disability or education or training for employment;…

(3) Subject to subsection (4), in determining the amount of an expense referred to in subsection (1), the court must take into account any subsidies, benefits or income tax deductions or credits relating to the expense, and any eligibility to claim a subsidy, benefit or income tax deduction or credit relating to the expense.[Emphasis added]

And, of course, that leads to the circular calculation discussed above.

Conclusion

The Section 7 formula reduces the child care part of the support payment by the income tax savings of the recipient.  Then, the recipient’s income tax savings are reduced by the Section 7 payment.

If you are receiving Section 7 support from your former spouse for child care expenses, ensure you deduct it from the amount you claim on your tax return to avoid a possible future tax reassessment. If you are a tax professional, ask your clients if they are in receipt of support payments towards child care expenses. If you are financial divorce professional or a lawyer, ensure your Section 7 support calculations take the above issue into account.

Is there a workaround?  Subject to advice from your own legal counsel, if the Section 7 amount can be determined in advance, including the period of time to which it will apply, perhaps the basic Table amount of support can be increased by that amount for a specified period of time.  The legal documentation would need to be worded such that the child support was not tied to the specific amount of child care being paid (to avoid a tax challenge).  However, if you increase basic support in the agreement without specifically referencing the child care costs, how do you know that the recipient spouse could not coming looking for Section 7 child care reimbursements again later (pretending it had not been included)? I have no specific answers here – perhaps your lawyer does.

In my opinion, income tax legislation should be changed so that parents are allowed a full deduction for qualifying child care costs. Separated couples should be treated equally to married couples. The married couple paying qualifying child care expenses of $1,000 would be able to deduct the full $1,000. A separated couple paying the same amount on a combined basis is only getting a partial deduction even though the cost is the same.

This is also another injustice to separated couples in the Income Tax Act. Subsection 118(5.1) also discriminates against couples who share custody of one or more children by limiting use of the Amount for an Eligible Dependant when a “set-off” child custody payment is made (instead of two individual cross over payments to each other). Even though the Federal Child Support Guidelines Table amounts used in the calculation for each parent are reduced by the amount of the Amount for an Eligible Dependant, only one parent is entitled to receive it.

The content of this article is based on the Federal Child Support Guidelines, the Income Tax Act, certain income tax interpretation documents, as well as a telephone discussion with a senior agent of the Canada Revenue Agency Income Tax Rulings Directorate on September 11, 2019, confirmed in a letter dated May 8, 2020 from that office.   In defense of the CRA, they are only enforcing the laws as set by the Department of Finance and the Minister of Finance.

Blair Corkum, CPA, CA, R.F.P., CFP, CFDS, CLU, CHS holds his Chartered Professional Accountant, Chartered Accountant, Registered Financial Planner, Chartered Financial Divorce Specialist as well as several other financial planning related designations. Blair offers hourly based fee-only personal financial planning, holds no investment or insurance licenses, and receives no commissions or referral fees. This publication should not be construed as legal or investment advice. It is neither a definitive analysis of the law nor a substitute for professional advice which you should obtain before acting on information in this article. Information may change as a result of legislation or regulations issued after this article was written.©Blair Corkum