Tweaks welcome, but northern tax benefits could use an overhaul

While the Yukon government may still be grumbling over its recent loss of $6.5 million in federal transfer payments, local residents will end up with a little more money in their pocket come tax time next year.

While the Yukon government may still be grumbling over its recent loss of $6.5 million in federal transfer payments, local residents will end up with a little more money in their pocket come tax time next year.

Last week the Liberal government in Ottawa delivered on one of its election promises to northerners when it raised the Northern Residents Deduction in the budget. We will now be able to deduct $22 from our income for every day that we lived in one of the territories – an increase of $5.50 from 2015.

While the two policy decisions are unrelated, those who don’t think that the territorial government has a great track record of using its transfers responsibly or spreading the benefit evenly around the territory will be pleased that the federal government opted to do an end run around the local authority and give the money directly to us.

But there are some tweaks that could be made to the deduction to make it even better. For one, the deduction could be adjusted to provide more benefit for low-income northerners.

Tax deductions are by definition not a “progressive” policy tool and much more of their benefits end up in the hands of those with higher incomes.

For those of you who don’t do your own taxes it is important to understand the basic difference between a deduction and a credit. While the net benefit of a deduction will depend on your tax rate, the benefit of a tax credit is the same whether you make $40,000 or $100,000 or $200,000.

To calculate how much a tax credit will save you, simply take the amount of the credit and multiply it by the “lowest marginal rate” or the lowest combined federal and territorial tax rate. The fitness tax credit that the Liberals did away with last week, for instance, was a $1,000 credit. Since the lowest marginal rate in the Yukon is 21.4 per cent, everyone who spends $1,000 a year on their kids’ sports activities lost the same $214 when the credit was axed.

Deductions are done earlier in the tax calculation process. Rather than directly reducing the amount of tax you pay, deductions reduce how much of your income is counted when tax is calculated. Ultimately this has the same effect because less income means less tax, but since each of us pays tax at a different rate, deductions affect each of us differently.

If you can claim the full Northern Residents Deduction in 2016 you will be able to reduce your income by $8,052 – 366 days in this year (it’s a leap year remember) multiplied by $22. So what happens when you reduce your income by $8,052? Let’s do some crude calculations.

If you’re making $40,000 you will now calculate your taxes as if you made $31,948. For each dollar you make between those two amounts you would have paid 21.4 cents in tax, so the deduction saves you about $1,723.

If you were making $100,000 per year you calculate your taxes as if you made $91,948. As a result you will save about $2,971, because you were paying 36.9 cents in tax on the difference.

A $200,000 earner who was paying 41.8 cents on every dollar of income will save $3,365 – almost twice as much as a $40,000 income earner received.

(As an aside, for those who are curious, the increase announced last week will save our hypothetical tax filers about $430, $742 and $841 respectively.)

Obviously the solution to this inequity (if you think it is an inequity) isn’t to simply convert the deduction into a credit as that would just cost everyone except those in the lowest tax bracket a bunch of money.

We certainly don’t want that.

But one possible solution might be to make the deduction a credit and substantially increase its value so that every Yukoner gets the same amount.

Another tweak that could enhance the fairness of the deduction would be to extend the travel portion of the deduction to self-employed Yukoners.

The second (and more complicated) part of the Northern Residents Deduction allows Yukon employers to give their employees a “taxable travel benefit.” Subject to various arcane rules, employees can then deduct a portion of the amount that they spend on travel outside of the territory.

Contrary to popular belief, the travel portion of the Northern Residents Deduction need not be a separate lump sum payment given to the employee. All that is required is that the employer and employee agree (ideally in writing) that some portion of the employee’s pay is a “taxable travel benefit” and input that amount in the correct box on the employee’s T4. The misunderstanding that it must be separate payment is perpetuated by the fact that the Yukon government gives its staff the “Yukon bonus” once a year in one chunk and without withholding any tax.

There is no downside for the employer to make some portion of the employees pay a “taxable travel benefit” and it can mean hundreds of dollars in tax savings to the employee. Any employer who isn’t already doing so ought to take advantage. It is surprising how many aren’t.

But the travel portion of the Yukon benefit isn’t available to self-employed Yukoners and it is hard to envision a strong rationale for that. After all, people who work for themselves like to travel as well.

Perhaps the government ought to let self-employed northerners in the door by deeming some portion of their business income as being a “taxable travel benefit.”

Kyle Carruthers is a born-and-raised Yukoner who lives and practises law in Whitehorse.

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