Tax credit – Doug Carroll

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

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.
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.
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.

Claiming medical expense tax credit on hot tubs, pools and warm weather

At issue

The medical expense tax credit (METC) may be a bit of a mystery for the average taxpayer. Likely this is because it is intended to capture large outlays (individually or in aggregate), leaving smaller amounts in each taxpayer’s hands. To the point, the credit is only available on expenses in a year that exceed the lesser of $2,000 and 3% of net income.

But for those with a standing medical condition, the METC addresses a fundamental financial need. It is also a substantial government spend — and unfortunately is open to abuse, particularly where an element of leisure attaches to large ticket items. On closer examination though, what is a luxury to some may be a necessity to others, irrespective of tax considerations.

Hot tubs and hardwood

In the early 2000’s there were a number of court cases and Canada Revenue Agency (CRA) letters dealing with hot tubs and hardwood floors. Generally a medical practitioner had recommended the former for alleviating mobility problems, and the latter for asthma sufferers.

CRA letters usually opined in the case of hot tubs that at best the installation costs may be allowed. The court dispositions were not always consistent. Here’s a selection:

Gibson v. Canada, [2000] T.C.J. No. 753 – Costs of renovation for installing hot tub could be claimed, but not hot tub itself. (Fybromyalgia with severe neck pain)
Donahue v. The Queen, 2003 TCC 888 – Cost of hot tub is an allowed medical expense. (Severe chronic back pain)
Canada v. Klywak, 2005 FCA 354 – Cost of hot tub allowed as a device that is designed to assist an individual in walking. (Fybromyalgia impairing walking and other mobility)

These and other cases conducted under the informal procedure relax the rules of evidence and are not binding on other courts. Adding to uncertainty, more than one judge had allowed the hot tub cost in one case while denying in another. Outcomes were fact-dependent.

2005 Federal Budget and after

The 2005 Budget amended the criteria for claiming medical expenses. The supporting notes to the Budget explicitly referred to Department of Finance concerns with hot tubs and hardwood floors.

Income Tax Regulation 5700(i) was amended to limit mobility claims to devices “exclusively” designed to assist “walking”, effectively over-ruling future claims akin to Klywak. And an over-riding test was added at Income Tax Act s.118.2(2)( l.2), requiring that any alterations or additions:

could not increase the value of a dwelling, and
could not be a cost that someone without mobility challenges would typically spend.

Pools and warm weather

The new provisions shifted judicial analysis toward these legal tests, leaving less latitude for discretionary fact-driven outcomes.

Barnes v The Queen 2009 TCC 429 – A regular swimming pool used for rehabilitative physiotherapy does not meet the second part of the new test as it is something that a person with normal mobility might install. (Cerebral palsy and Special Olympics training)
Johnston v The Queen 2012 TCC 177 – Hot tub solely used for subject person shown to assist wheelchair mobility throughout home, but still fails the second part of the new test. (Cerebral palsy, related quadriplegia, and contractures of limbs)
Sotski v The Queen 2013 TCC 286 – Replacing relatively new carpet with inexpensive laminate flooring satisfies all requirements. (Parkinson’s condition with serious trip/fall concern)
Tallon v. The Queen, 2015 FCA 156 – And as to that warm weather? A taxpayer initially succeeded on claiming costs of being in a warm southern climate to alleviate chronic joint pain experienced during the cold Canadian winter, but was later reversed on appeal.

Practice points

The selection of cases here is not comprehensive, but rather shows the range of outcomes, and that each situation is unique.
Even so, the rules are much tighter since 2005. As more than one judge has stated: “The bar has been clearly set high by Parliament.”
As Sotski shows, it may still be possible to succeed on a claim under the new rules, less likely though that may be for hot tubs and pools.

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.