If you're planning to deduct the cost of child care as an expense on your tax return, you better be able to prove it if challenged by the tax man, or it could cost you more than just your lost deduction. Take the recent tax case of an Ontario couple who tried to deduct child care expenses of about $13,000 in each of 2007 and 2008.
Under the Income Tax Act, the amount you can deduct annually is $7,000 for each child age six and under and $4,000 for each child between seven and 16. If the child is eligible for the disability tax credit, you can deduct $10,000 regardless of the child's age. The total childcare expense deduction is generally limited to two-thirds of the lower-income spouse or partner's "earned income," which includes employment or self-employment income, taxable bursaries or fellowships and research grants.
During the two years under review, the taxpayer had two children under the age of six. The taxpayer testified that he paid $260 in cash every two weeks to the person who was babysitting his children, who was either his mother or his mother-in-law or his sister, depending on who was available. The taxpayer testified that he "had no receipts to show that he paid any amount for child care because it was only when he was having his income tax returns prepared that he learned that he could deduct child care expenses."
When he was being audited by the Canada Revenue Agency, the taxpayer sought the advice of his tax preparer who prepared a letter in which a babysitter said that she had babysat for the taxpayer in 2008 for total pay of $6,500. In Court, however, the taxpayer admitted that he had "bought the letter" from the babysitter for $800 to give to the CRA's auditor.
The taxpayer also acknowledged that he and his wife would not have required a babysitter for all of 2007 nor all of 2008 since his wife was on maternity leave for part of 2007 and he, in fact, did not work for four or five months in 2008 as he was unemployed and collecting employment insurance benefits. While he testified that "he did pay some amount as he had two small children during this time," he ultimately admitted that he didn't actually pay $13,000 in 2007 and 2008.
Unfortunately, without any evidence as to what the correct amounts for child care should have been for those two years, the judge was unable to allow any deduction at all for the tax years in question, writing: "I cannot just guess at an amount. He did not have his mother or mother-in-law or sister attend the hearing to give evidence on (his) behalf. He stated that he did not ask them to attend because he did not want to get them in trouble."
And, to make matters worse, the Judge awarded the CRA costs of $625 based on its argument that "there was an abuse of process because the [taxpayer] was not honest in [the taxpayer's] pleadings and this hearing was a waste of the Court's time."