Civil servants must act now to get deferral: Ways to reduce tax bill on pay-equity settlement
Next month, about 230,000 federal civil servants, present and past, will
begin receiving equalization payments from the federal government.
The amounts paid will eliminate the gap between what women earned in
government clerical jobs from 1985 through 1999 and what their jobs have
subsequently been valued to be worth -- based on comparable jobs performed by
men. All payments will be made in 2000 -- in two cheques for the lump sum owed,
and a separate cheque for interest.
If you're expecting a pay equity windfall, there are some important tax
considerations and planning opportunities. The lump-sum payment represents wage
adjustments for several years of employment and the accumulation of interest on
that pay adjustment.
Although both the employment income and interest portions of the payment are
taxable in 2000, only the employment portion will be subject to source
deductions such as income tax, Canada or Quebec Pension Plan (CPP or QPP)
contributions and Employment Insurance (EI) premiums.
The interest component, however, will be paid to you in full with no
deductions. A T5 information slip will be issued to report the amount of taxable
interest income that must be reported on your 2000 personal income tax return,
filed in April, 2001.
One of the best ways to defer tax on the lump sum payment is to contribute
all or a part of the payment to your registered retirement savings plan --
provided you have unused contribution room. If you contribute by March 1, 2001,
you will be entitled to claim an offsetting deduction on your 2000 tax return.
The contribution, along with any growth or earnings on the payment, will remain
tax-deferred as long as the money remains inside an RRSP or a registered
retirement income fund.
For amounts under $10,000, the Canada Customs & Revenue Agency (formerly
Revenue Canada) has prepared a modified waiver letter for recipients to file to
ensure no tax is withheld from the employment portion of the pay equity payment,
provided you transfer that portion to your RRSP (or a spouse's plan).
No withholding tax is taken from the interest component, so you might owe tax
on that amount when you file your 2000 return. The waiver does not have to be
submitted to the CCRA, but needs to be given to the payroll office of your
employer as soon as possible as the payments will begin in April.
On the other hand, if you do not want to have any tax withheld from the
employment portion of your payment, and the payment is greater than $10,000, you
may need to get permission from the CCRA. Approval for reduced withholding tax
is possible on the amount equal to your RRSP deduction limit, minus the
estimated interest payments to you on the wage adjustments.
Because many government benefits and credits are tied directly to net income,
the mere fact that the entire pay equity payment is taxable in 2000 may reduce
or even eliminate some of your government benefits in 2001. For example, child
tax benefits, GST credits, Old Age Security (including the Guaranteed Income
Supplement), as well as provincial social assistance payments may all be reduced
due to the unusual one-time increase in your taxable income. In some situations,
repayment of benefits already received may be required.
Also, some non-refundable income-based credits on your 2000 income tax return
may be reduced or entirely eliminated, such as the age and spousal amounts, as
well as the medical expense credit.
Since these benefits and credits are tied directly to net income, an RRSP
deduction may be the ideal way to reduce net income to a level at which they
will not be affected. Naturally, this strategy is only effective if you have
RRSP contribution room available for 2000.