WOULD YOU LIKE SOME TAX-FREE INCOME?
Here are some of the kinds of income that are not taxed, based on the provisions of the Income Tax Act, CRA interpretations, or court decisions:
• Bequests and other inheritances from a deceased person
• Capital gains on your home, subject to rules that ensure that your family has only one “principal residence” at a time. However, if you build a home with an intention or secondary intention to sell, this does not apply. Even if you move in and live in the home for a while, the exemption will not be available because your gain will be business profit, not capital gain, and the principal-residence exemption applies only to capital gains. Also, since 2016 you must report the gain to claim the exemption. (Income Tax Act, 40(2)(b) and 54 “principal residence”)
• Compensation for damage to business operations in some circumstances. (Federal Court of Appeal, Toronto Refiners & Smelters case (2002); Tax Court of Canada, Frank Beban Logging case (1998) and Henco case (2014))
• Compensation for mental or emotional damage at the workplace, such as harassment of an employee, or for human rights violations. (Several Tax Court of Canada cases, such as Dunphy (2009) and Abenaim (2017), and numerous CRA interpretation letters)
• Compensation to parents for the cost of transporting students to school when a school board discontinued bus service. (CRA interpretation letter, 2004)
• Damages for breach of an employment contract before it began. (Supreme Court of Canada, 1996 decision in Schwartz v. The Queen)
• Damages or compensation for personal injury, including structured settlements and awards from a provincial Criminal Injuries Compensation Board, and including Indian residential-school settlements. (Interpretation Bulletin IT-365R2, and CRA interpretation letters)
• Disaster relief payments, including from an employer (if the purpose is philanthropic, not based on employment, and the employer does not deduct the payment). (CRA interpretation letters)
• Foster care and similar in-home care that you provide, provided it does not cross the line into being a “business” for you. (Income Tax Act, paragraph 81(1)(h))
• Gifts, provided they are not disguised employment income or business income
• Grants under most government programs, unless the program has been prescribed in the Income Tax Regulations as taxable, or it relates to your business (Tax Court of Canada, Layton case, 1995). Note that the Canada Emergency Response Benefit, paid during the COVID-19 pandemic, is taxable under a provision (56(1)(r)) covering “income replacement benefits” that are similar to EI. However, the special COVID-related grants to seniors and to persons with disabilities are non-taxable.
• Income of a “status Indian” earned on a reserve. If you aren’t a status Indian, this exemption can’t help you!
• Lottery or other gambling winnings, unless you are so organized and active in your gambling that it constitutes a “business” from which you could deduct losses if you lost money. (Interpretation Bulletin IT-213R, and several court decisions)
• Reimbursements of expenses to volunteers. (CRA interpretation letter, 2005)
• Strike pay from a union. (Supreme Court of Canada, 1990 decision in Fries v. The Queen). A union’s cash gift to a member is also usually tax-free.
• Television game show prizes, even where the taxpayer trained to develop expertise in the subject matter (Tax Court of Canada, Turcotte case, 1998))
• Welfare and similar social assistance payments. These must be reported as income, but an offsetting deduction is available when calculating taxable income. (Income Tax Act, 56(1)(u) and 110(1)(f))
• Workers’ compensation benefits. These must be reported as income, but an offsetting deduction is available when calculating taxable income. (Income Tax Act, 56(1)(v) and 110(1)(f)(ii))
• Certain employment benefits (see CRA guide T4130). A few examples are:
— Your employer’s contributions to your registered pension plan, or a private health services plan.
— Your employer can give you up to $500 in non-cash gifts and awards per year, such as for a birthday or Christmas. As well, a separate non-cash “long service” or “anniversary” award of up to $500 can be non-taxable; it must be for at least five years of service and at least five years since the last such award.
— Board and lodging at, and transportation to, a “special work site” where you work temporarily, or a “remote work site” that is remote from any established community.
— Transportation to the job, if provided directly by the employer.
— Uniforms, special clothing or safety footwear that you need for your job.
Examples of how to save tax by planning for tax-free income
1. Suppose you are fired from your job in circumstances where you suffer emotional trauma.
If you sue for “wrongful dismissal” and reach a settlement with your employer, the settlement will be taxable.
If instead you sue not only for “wrongful dismissal”, but also for emotional injury and/or violation of your human rights, you may be able to have at least part of the settlement classified as compensation for your personal (emotional) injuries or human rights violations. This portion of the settlement will be non-taxable.
2. Suppose you have a choice of employment benefits from your employer. You can choose between the use of a company car, or a health care plan (drug and dental). The two packages cost the same to your employer, so the employer does not care which one you choose.
If you choose the company car, that is a taxable benefit. You will be required to report, as employment income on your tax return, an annual “standby charge” of 24% of the original cost of the car, or 2/3 of the leasing cost, plus an amount for operating costs if the employer pays those.
If you opt for the health care plan, you will not have a taxable benefit, either when the employer pays the premiums for the plan or when you receive health care benefits such as reimbursement for drugs or dental care. Thus, you will have a lower income tax bill. Note in the province of Quebec, employer paid premiums are taxable to the employee.
3. Long-term planning: You can choose between buying a home to live in, or continuing to rent a home and investing your money.
If you invest in securities, the return on your investment will normally be taxable, whether fully taxed as interest income, taxed somewhat lower as dividend income, or half-taxed as capital gains. The rent you pay to rent a home is not deductible (except to the extent you have a home-based business).
If you “invest” in your own home to live in, and sell it for a gain, then the capital gain will be tax-free.
Of course, it can be hard to predict whether residential home values will increase at the same rate as the return you can obtain by investing. But of course it’s also hard to predict what those stocks and mutual funds will do for you in the same time frame!