Tag: Donation

Tax effect if a charity returns a donated life insurance policy to a policyholder

At issue

Most people donate to charity by cash or its equivalent, whether on a one-off basis or as a periodic routine. This allows the donor to take an immediate tax benefit from the donation and for the charity to use funds for current needs. However, when longer term projects are contemplated, it may be desirable to establish a ‘planned giving’ arrangement, and that’s often when life insurance comes into consideration.

One way to do this is to name the charity as beneficiary on a policy owned by the donor. That person pays the annual premiums, with the tax benefit coming to the estate when the proceeds are paid at death. While the charity expects to eventually receive the money, the policyholder usually retains the ability to change the beneficiary, in which case the charity may ultimately get nothing.

For the charity’s greater certainty, the policy itself could be donated so the charity controls it. The donor receives tax credit for the value of the policy (if any) in the year of donation, plus year-to-year credit for any further premiums paid on the charity-owned policy. Of course, the donor may still have a change of heart, and though the charity could technically continue to carry the policy, that may be politically unpalatable. But is it even legally possible to return a policy, and if so then what are the tax implications for charity and donor?

CRA Guidance CG-016, Qualified donees – Consequences of returning donated property

The CRA’s guidance on this issue warns off the top that it is a legal issue whether a gift has been made and whether circumstances allow for a return by the charity. The guide focuses on the tax result on those “rare and unique circumstances” when there is a legal requirement for a charity to return a gift.

Assuming that the return of the property fits this test (or is believed to fit), an information return outlining the particulars must be filed with the CRA within 90 days. If the test is not met, this would likely be construed as a gift to a non-qualified donee, or the provision of an undue benefit. The penalty for such action is 105% of the value, or 110% on a repeat infraction, all the way up to revocation of registered status in egregious situations.

For a donor, there will be a reassessment of any year’s tax return related to the returned property, with any claimed charitable tax credits disallowed. This may be mitigated by the fact that the taxpayer is deemed not to have disposed of the property in the first place if the original property is returned. No mention is made of interest on related reduced/unpaid taxes, so presumably the normal rules apply.

CRA 2016-0630351E5 – Return of a gift

A taxpayer had gifted a whole life insurance policy to a charitable foundation in 1981, and now sought the return of that policy on the basis that a condition of the gift had not been fulfilled.

The foundation raises money to support a particular college, and the gift was made conditional on the proceeds being used to create a scholarship in a specific program. When the program was terminated, the taxpayer sought the return of the policy. The foundation was willing to comply, but on condition that the taxpayer obtain assurance from CRA that this would not negatively affect the foundation’s charitable status. This technical interpretation is the response to the taxpayer’s inquiry.

The writer on behalf of CRA repeats the relevant provisions of CG-016 (summarized above) with respect to the charity’s reporting obligations and the taxpayer’s exposure to reassessment.

However, it could not assist on the two key issues: whether the gift was subject to a condition, and whether the foundation could legally return the policy. The former requires a determination of the facts, and the latter a review of applicable legislation, both of which are outside the scope of a technical interpretation.

Practice points

  1. Donations to charity are almost invariably one-way transactions. Even if a donor and charity expect that the gift could be returned, governing legislation seldom allows that to occur.
  2. If a gift is to be conditional, that should be clearly documented between the donor and charity, including objective criteria regarding fulfilment of the condition. And if the condition is not fulfilled, it should be agreed what is (expected) to happen with the gift.
  3. Per CG-016, a taxpayer is subject to reassessment and disallowed tax credits claimed in preceding years. It is that much more uncertain in a situation like that outlined in letter 2016-0630351E5 with a timeline going back over 35 years, how statute-barred years would be treated. Whether or not those are included, with interest charges this could be quite costly.

Revised charitable donation tax credit

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.

Whether a surviving spouse can claim donations of deceased spouse

At issue

Most tax credits are limited in value to the lowest bracket tax rate.  The charitable tax credit is generally more lucrative, as it is claimed based on two tiers.  Federally, the lowest bracket rate applies on the first $200 of annual donations, with any excess entitled to a credit at the top bracket rate.  (Provincial credits operate similarly, though not all are exactly at the top bracket rate.)

For spouses, there is a further benefit available via administrative practice of the Canada Revenue Agency.  CRA recognizes that donations are generally made based on the family unit, despite that one name may appear on a donation receipt.  Accordingly, the agency allows donations to be claimed on the return of either spouse or common law partner.  This simplifies reporting and efficiency of credit use, at the very least helping elevate past the $200 threshold.

Until recently, spouses could also depend on a related CRA administrative practice on the death of a spouse, but after 2015 it is no more.

2010-0372621E5 Donation by will claimed by spouse

The CRA was asked whether an individual can claim a tax credit for a charitable donation made by his/her deceased spouse’s will in the year in which the spouse died.

The response cited the CRA’s general administrative position on donations on behalf of a family unit.  It went on to highlight ITA s.118.1(5) (as it was at that time), which deems charitable gifts made by an individual in his or her Will to have been made by the individual in the year of death and not by the estate.  This is despite that the executor/estate really carries out the donation, and that it may not actually occur until a later year altogether.

The writer then stated that the deceased’s executor and the surviving spouse (which could very well be the same person) are entitled to claim the tax credit in the most beneficial manner available.  Thus, supported by the deemed timing of the donation, a spouse would be entitled to claim the donation on his/her own return for the year in which the spouse died.

Bill C-43, Royal Assent (2014-12-16)

This Bill enacted provisions of the February 11, 2014 federal budget.

The definition of “total charitable gifts” in s.118.1(1) was replaced, including explicit acknowledgement for either the individual or his/her spouse or common law partner to claim donations.  This somewhat codifies the past CRA administrative practice with respect to the family unit, except that this treatment does not apply to donations made by a trust.

In that latter respect, new provisions were also enacted to deal with donations made by Will.  Such donations would no longer be deemed to occur in the year of death.  Rather, the donation could be claimed in the year it is actually made, with the executor (on behalf of the estate, which is a trust) having discretion to claim the donation in any earlier estate year, in the terminal year or the year prior to death.

2014-0555511E5 E – Spousal sharing of charitable gifts

On November 7, 2014 (while Bill C-43 was still making its way through Parliament), a taxpayer inquired whether the CRA would continue to apply its administrative position from letter 2010-0372621E5.

The CRA response was issued January 27, 2015, citing the amended definitions and deeming provisions outlined above.  Given these amendments, the CRA’s administrative practice as stated in the 2010 letter will no longer apply for deaths occurring after 2015.

Practice points

  1. For modest donations (relative to prevailing income), it is likely that the full value of the credit will be able to be claimed through the carryback to the deceased’s terminal year or the year prior to death.  Where the donor has little income, the inability of a surviving spouse to report the donation may mean that some of the credit value may be unusable.
  2. The Bill C-43 amendments also encompass donations made by beneficiary designation under life insurance and through registered plans.
  3. Those who have strategically planned their charitable giving may wish to consult with their philanthropic and tax advisors whether reconsideration and revision may be warranted.  For some, it may swing the balance toward lifetime gifting, rather than being exposed to potential uncertainty in the estate.