An important part of sharing in our society is the support we provide to charitable causes and organizations. In fact, our tax system has a variety of rules that ease the cost of donating.
While keeping the needs of the charity at the forefront, a tax-informed donor may wish to act strategically to gain greater benefit personally and for the charity. In that way, a donation can achieve its philanthropic purpose at the least tax cost to the donor – a value proposition that benefits both parties to the transaction.
Two-tier credit structure
Despite that many people casually refer to donations as being tax-deductible, they instead entitle a donor to claim a tax credit. Deductions are generally more valuable as they can reduce high-tax-bracket income, whereas tax credits are usually limited to the lowest-bracket rates. However, the charitable donation tax credit is structured to quickly become a tax-lucrative proposition.
The initial tax credit rate is indeed set at the lowest federal bracket rate of 15%, but once donations exceed $200, then the highest bracket rate of 29% applies. Provincial and territorial credits are applied against respective provincial/territorial taxes in a similar two-tier manner, using this same $200 threshold. For first-time donors, the 2013 Federal Budget introduced an enhanced “super” tax credit. It adds 25% to the federal credit rates (i.e., 40% and 54% at each tier) for cash donations up to $1,000. To qualify, a taxpayer (including the spouse) cannot have claimed charitable gifts since 2007. The enhanced tax credit is available until 2017.
For a given tax year, a person can claim a donation amount up to 75% of net income. Any unused donations can be carried forward to be claimed up to five years into the future.
Rather than simply making a cash donation, a donor might consider giving appreciated marketable securities, such as stocks, bonds or mutual funds. If these securities are donated in-kind to the charity, a special rule allows any as-yet unrealized capital gains to be effectively negated by the donation. Had the donor instead cashed out the investment before donating, taxes on disposition would have reduced the cash available for the subsequent donation.
Administratively, the Canada Revenue Agency allows spouses to pool donations to determine the amount of credit available, and either spouse is entitled to make the claim. Since it is a credit against tax due, there is no serious tax revenue loss for the government by making such concessions, except that it allows couples to collectively break through the $200 threshold sooner than if they were required to do so individually.
Donations at death
A special rule applies in the year of death, whereby donations can be claimed against as much as 100% of net income. If donations exceed this amount then the excess can be carried back to the year prior to death, again with the potential to offset 100% of that year’s net income.
Donations made by beneficiary designation on registered plans and life insurance are deemed to occur in the year of death, despite that it is the person’s death that leads to the payment.
Similarly, donations by a person’s Will are deemed to occur in the year of death, but the actual donation must occur in the first year of the estate in order to take advantage of this rule.
Charitable remainder trust
Though, as mentioned above, a greater amount of credit is available in the year of death, it remains a benefit after the person’s death. For someone planning to make a very large donation at death but looking to take advantage of the tax credits personally while living, a charitable remainder trust may fit the situation.
This is a formal arrangement that requires the assistance of legal, tax and actuarial advice. The value of the donation is the present value of the capital at the person’s expected date of death, which is when final outright ownership passes to the charity. In the meanwhile, the donor retains a life interest, for example, to continue to live in a house, or possibly even receive income from the property until death.
As this is an inter vivos trust (i.e., settled during the donor’s life), the donor can claim the donation in the year of settlement, with the five-year carry forward available. This might be ideal for someone donating everything to charity at death, as the tax credits would otherwise go unused.