While donations to charity should always be driven by philanthropic desire, tax issues can influence the manner and timing of a gift.
Our tax system provides a fair amount of flexibility to allow donors to manage the fiscal component in an optimal manner. Although the charitable tax credit is limited to a donation amount up to 75% of a taxpayer’s net income, any unused amount may be carried forward up to five years.
This carry-forward opportunity obviously has limited value for donations made at death. In recognition of this, special rules have long applied to estate-related donations. Here are some milestone developments in this field, including the most recent evolutionary development coming out of the 2014 Federal Budget.
Section 118.1 of the Income Tax Act (Canada)
This is the section of the Act dealing with claiming the charitable donations tax credit. It spans three dozen or so subsections.
Rather than the general 75% limit, the donation limit is 100% when claimed in the year of death, or “terminal year”. Any excess may be carried back to the year prior to death, where again the higher 100% threshold applies. Donations made by way of a donor’s Will are deemed to occur in the donor’s terminal year, and may also be carried back to the prior year.
As discussed below, there are modifications coming out of the 2014 Federal Budget, but the foregoing rules will continue to apply for deaths occurring before the end of 2015.
2000 Federal Budget Designations in favour of charity
Up until February 2000, donors faced a conundrum when determining how to make donations sourced from a registered retirement savings plan, registered retirement income fund or life insurance policy. To take advantage of the deemed donation at death, such proceeds had to come into the estate, and in turn be donated via the Will provisions. Of course, this potentially exposed those proceeds to estate creditors, probate tax (where applicable) and administrative delay.
In order to provide consistency in the income tax rules, the 2000 Federal Budget allowed direct beneficiary designations to also be deemed to occur in the donor’s terminal year, with the same carryback provision. It applied retroactively with respect to deaths after 1998. (The treatment was extended to beneficiary designations from tax-free savings accounts once they became available in 2009.)
2014 Federal Budget – Estate donations
A donation made by an estate will initially be applied against the estate’s income tax otherwise payable. Donations made by Will and direct beneficiary designations will now be deemed to have been made by the estate. However, for qualified donations occurring in the first 36 months of the estate, the trustee of the estate will have the flexibility to allocate the available donation among any of:
- the taxation year of the estate in which the donation is made;
- an earlier taxation year of the estate; or
- the last two taxation years of the individual
This measure will apply for donations when death has occurred after 2015. For other estate donations (i.e., past the 36-month limit), the credit may be claimed in the donation year, again with the five-year carryforward.
For testator/donors, this greater flexibility may allow individuals to simplify otherwise more complex estate planning previously put in place to work around then-existing hurdles.
For executors, not having to rush to dispose of assets will doubtless provide some welcome relief. Prior to this change, a donation by Will had to occur within the estate’s first year in order to qualify for carryback. This was particularly challenging where the estate was named as a residual beneficiary, since most of the estate activity had to be complete before determining the donation value, let alone delivering the cheque. With the longer timeframe now available, executors may take more time to realize assets with greater due diligence. Of course, they should otherwise perform their duties with appropriate expediency.
Direct beneficiary designations will continue to be the most efficient route for timely and intact delivery to the charity. Where the particular plan proceeds may be needed for the estate’s liquidity however, it may be necessary to channel funds through the estate proper. A coordinated consultation among executor, lawyer and financial advisor should help guide the options and implement the plan.