The term “earned income” can mean different things for income tax purposes. For individuals, the definition is important for at least two different issues, as noted below.
First, it is relevant for the purposes of determining your deduction room for a taxation year for contributions to your registered retirement savings plan (RRSP). Second, a different definition of “earned income” is relevant for the purpose of determining your deductible child care expenses.
For RRSP purposes, one of the main components in computing your deductible contribution room for a taxation year is the lesser of your “earned income” for the previous year and 18% of the dollar amount for the current year (the dollar amount is $25,370 for 2016). Thus, for example, if you had no earned income in 2015, you will have zero new contribution room for 2016.
A person’s earned income for RRSP purposes includes the following:
- Net income from employment,
- Net income from business, whether alone or through a partnership,
- Net rental income from real property,
- Royalties in respect of a work or invention of which the person was the author or inventor,
- Spousal support payments received,
- Net research grants, and
- A disability pension under the Canada Pension Plan (CPP) or similar provincial plan,
- Minus the total of
- Loss from a business,
- Loss from a rental real property, and
- Spousal support payments paid.
Child care expenses
For child care expense purposes, the maximum amount of deductible expenses is generally limited to the lesser of 2/3rds of your earned income for the year and a fixed annual dollar amount per child ($8,000 under the age of 7, $5,000 if 7 to 16, and $11,000 per child eligible for the disability tax credit).
Usually the lower-income parent must claim the deduction based on that parent’s earned income.(In some cases, the higher-income spouse can claim a limited deduction, such as where the lowerincome parent is attending school, is physically or mentally infirm, or is in prison.)
For child care expenses purposes, the definition of “earned income” is narrower than for RRSP contributions, and includes:
- Employment income and benefits before any deductible expenses,
- Net income from business,
- Net research grants,
- Employment insurance benefits, and
- A disability pension under the CPP or similar provincial plan.
Because of the earned income limitation, a married (or common-law) couple with one spouse who stays at home to care for the children and with no earned income cannot deduct child care expenses (except for the situation described above where the lower income spouse is in school, in prison, or physically or mentally infirm).