Will the new math influence your giving?
Much of the tax hoopla following the Liberal election victory was about the implementation of the ‘middle class tax cut’, dropping the federal rate from 22% to 20.5% on the second income threshold, $45,282 – $90,563 in 2016. That reduction came hand-in-hand with a new 33% bracket for income in excess of $200,000.
But establishing a new rate at the top end required that the government also revisit the rules on claiming the donation tax credit. Failing that, the new rate structure could have led to an even greater gratuitous break to more than just the ‘middle class’. The solution preserves the existing treatment for those with income under $200,000, while assuring that high income taxpayers will not be deterred from donating.
Charitable credit structure
Most tax credits are limited to the lower bracket rate, 15%. For charitable donations, the credit has to now been worth 15% on the first $200 of annual donations, and 29% on amounts over $200. Respectively, those were the prevailing lowest and highest bracket rates prior to the change. Thus, not only was a higher rate allowed on large donations, but it was designed to jump all the way to the top personal rate, and it applied irrespective of the person’s income.
The policy purpose of this credit structure is clearly to encourage taxpayers to support worthwhile charitable causes. The two-tier structure encourages people to donate in excess of $200, and the high rate on the over-$200 portion gives them more bang for their donated buck. The trade-off for the government is of course lost tax revenue.
Consider someone at roughly $80,000 taxable income making a $10,000 donation in 2015. (We’ll constrain our analysis to federal taxes here.):
- If the donation credit was like most other credits, it would be worth $1,500 based on the 15% rate.
- In reality, the credit is $30 on the first $200, and $2,842 on the remaining $9,800 for a total of $2,872.
- That’s even better than if the system allowed a donation to be treated as a deduction, which for that taxpayer would have been worth only 22% in 2015, or $2,200.
Sidestepping unintended results
The relevant sections of the Income Tax Act make reference to the “highest percentage” used to calculate an individual’s tax due. Had the government done nothing more than to adjust bracket rates, on making the same donation in 2016 our donor would receive an extra $400. (33% – 29% = 4% x $10,000.)
Clearly for a government trying to manage an expected deficit, this would not be helpful.
At the same time, if the second tier of the credit is not at the new top bracket rate, those making over $200,000 may be less inclined (in a tax management sense) to make large donations.
Multi-step credit calculation
In effect, the solution introduces a second test to the second tier of the calculation. The 15% rate still applies up to $200 in donations, and 29% generally applies thereafter. However, the higher 33% rate is available to the extent that a taxpayer has income over $200,000.
To illustrate how this will work, consider that same $10,000 donation made when the donor has taxable income of $203,000.
- The first $200 receives a credit at 15% as before. Of the remaining $9,800 to be claimed, $3,000 is entitled to the 33% credit rate, and $6,800 is claimed at 29%, for a total of $2,992 ($30+$990+$1972).
- If taxable income had been over $209,800, the credit would have been worth $3,264 ($30+$3,234).
- On the other hand, if taxable income had been below $200,000 as in our $80,000 donor example, it would have been $2,872. (It is unaffected by the 1.5% bracket reduction.)
With that in mind, for those at or near the $200,000 income level, future years’ donations may require more strategic planning. When their income fluctuates below that level in a year, they might consider delaying a donation in order to claim a higher value credit in a future year – bearing mind time value of money, and being mindful if this works to the detriment of a charity in current need.