Filing an income tax return for your children

If you do not have taxes payable you are not required to file an income tax return, unless Canada Revenue Agency (CRA) has sent you a request to file.

For this reason, many children do not file a tax return.  Children may have income they have earned from a paper route, babysitting, yard work, wages and tips from service jobs, but brought home less than the exemption amount, which for the 2007 tax year this is $9,600.

Employers are responsible for deducting the appropriate amount of Canada Pension Plan contributions, Employment Insurance premiums and income tax if applicable.  Employees who are under the age of 18 are not required to pay into CPP, but there is no age limit for paying EI premiums, so don’t assume your payroll department is withholding the correct amounts.  We have seen situations where CPP was withheld when a child was exempt.  Children who obtain part time jobs during the summer will often have a small amount of income tax withheld from their pay cheques.

If your child is under 18 years of age and had CPP or income tax withheld then it is important that you file an income tax return.  By filing a tax return, your child should receive a refund of the CPP and income tax withheld, provided total income in 2007 does not exceed $9,600.

If your child has earned income below the basic exemption amount, no income tax is payable.  Let’s also assume that no income tax was withheld, and all withholdings were correct.  Why would you want to file an income tax return in this situation?  By filing an income tax return for your children you are reporting earned income and begin to accumulate an RRSP deduction limit.  The deduction limit is based on 18 per cent of all earned income reported.  If a tax return is not filed then no income is reported.

Consider  Ben, who has a paper route and helps his mother with some filing in her office.  Ben earned $5,000 at age 13 and does not have to file a tax return because he has no taxes payable.  If he does file an income tax return he will generate $900 ($5,000 x 18 per cent) in RRSP deduction limit that may be carried forward indefinitely.  Over a number of years your child may create a significant deduction limit.

Children’s tax returns are generally easy to complete.  Whether you obtain paper forms or use tax software, there should be no cost to complete these additional returns.  If an accountant prepares your tax return you should mention any income your children have earned.  There are two important points to note before you proceed with completing a tax return – your child must have a social insurance number and all first-time filers must mail in their income tax return.  After the first year your child will be able to Efile or Netfile returns.

Your child will receive a Notice of Assessment whre you will see an RRSP Deduction Limit Statement.  This is an excellent opportunity for you to explain what an RRSP is to your child.

Younger investors often confuse an RRSP as being a type of an investment.  Explaining to your child that an RRSP is a type of an account is a great finance lesson.

Although minor children can build up their RRSP deduction limit, it does not make sense from a legal standpoint to set up an RRSP account.  Children under the age of majority are unable to enter into a binding contract.  It also does not make sense from a financial standpoint for people with really low incomes to contribute to an RRSP.  Let your children know that their RRSP deduction limit may be carried forward and used in the future.  The deduction limit should be used when the timing is right and they can dedicate the funds for retirement.  The effort of building up the deduction limit today should benefit your child in the future when they are older and have greater taxable income.

We realize that some parents reading this will have wished that they had completed tax returns for their children over previous years.  The good news is that it is not too late for the current year.  If the numbers make sense you may want to consider looking at prior years as well.

From an education and future benefit standpoint, we like the idea of parents helping their children file income tax returns.  This is one of those excellent teaching moments that combine accounting and finance.