Donations: do them right

First, it’s important to understand the basic rules for claiming the charitable donation tax credit on your tax return:

• The first $200 of a donation to a registered charity brings a 15% federal tax credit, in addition to the applicable provincial credit.
• The portion of a donation above $200 qualifies for a 29% federal credit, which works out to a combined federal/provincial credit of between approximately 40.2% and 50%, depending on your province of residence.
• At income levels between $150,241 and $214,368, a $10,000 cash donation translates into a total tax credit of approximately $4,000 for an Ontario resident, about $4,580 in British Columbia and more than $5,331 in Quebec.
• For those with taxable incomes in excess of $210,000, the federal credit for the above-$200 donation would be more generous at 33%, which can increase the combined federal-provincial credit to between about 44.5% and 54%, depending on an individual’s province of residence.

Note that the credit for a cash donation cannot exceed 75% of your net income (although 100% for Quebec taxation purposes). However, any amounts of unused donation credits generally can be claimed in any of the next five taxation years.

“Donations made either directly by the individual or through their will in the  year of death can be claimed in the year of death and, if necessary, carried back to the preceding year,” says Joseph Micallef, national tax leader of financial services with KPMG LLP. “The 100% net-income limitation applies to both the year of death and the preceding year. In the year of death, an individual can claim the lower of 100% of net income, or the eligible amount of the gifts created in the year of death, plus the unclaimed portion of gifts made in the five years before the year of death. The donation credit may also be claimed on donations of registered retirement savings plans, registered retirement income funds (RRIFs), tax-free savings accounts (TFSAs) and life-insurance proceeds made by direct beneficiary designations on death.”

Donating gifts in kind
If you choose to make a donation in the form of capital property, such as stocks or other investment securities, artwork, or real estate, the limit is 75% plus 25% of the capital gain, as opposed to the normal 75% in the case of a gift of cash. The value of such a gift in kind is determined by its fair market value at the time you make the gift.

If a donation involves a gift of “certified cultural property” (that of an artistic or historic nature) or ecologically sensitive land, any capital gains would not be subject to tax.

High-income taxpayers should be aware that a donating a gift in kind that generates a capital gain could create an alternative minimum tax (AMT) liability. This might be the case if you will be claiming substantial tax deductions, dividend tax credits or capital gains exemptions related to other dispositions.

However, you have the option of electing to designate a different value for a gift-in-kind of between what you originally paid for it and its fair market value. “This may allow you to avoid realizing a capital gain or to realize a smaller one,” Micallef says. “The tax credit for your donation will be based on the value you designate between your cost and the asset’s fair market value.”

Investments instead of cash
If you make a donation in the form of eligible investments, such as securities listed on a designated stock exchange or units of a mutual fund or segregated fund, you will not have to pay capital gains tax on the transaction.

“These rules apply to donations of securities to private foundations as well as public charities,” Micallef says. “Be aware that private foundations are subject to tighter restrictions on the amount of shares they can own in a corporation, after taking into account non-arm’s-length party holdings.”

Consider the following example supplied by KPMG. If you have eligible securities that originally cost you $1,000 and are now worth $2,000, it’s worth considering whether you should sell the securities and donate the proceeds, or simply donate the securities directly to the charity. Assuming you live in Ontario and will be taxed at a marginal rate of approximately 48% during 2020 (i.e., your income is about $160,000), and you’ve already donated $200 in the year, it could make more sense to donate the securities.

This is because if you decide to sell the securities and donate the before-tax proceeds, a $1,000 capital gain will arise on the sale ($2,000 proceeds - $1,000 original cost). You would then have to pay $240 in tax on the taxable portion of your gain (50% of $1,000 × 48% assumed tax rate). Your $2,000 donation will give you a tax credit of $960 (48% × $2,000). In the end, the donation will result in net tax savings of $720 ($960 tax credit - $240 capital gains tax). Or, put another way, the after-tax cost of making your donation will be $1,280.

On the other hand, if you donate the securities directly, the charity will still get the full $2,000 value, and the taxable portion of the $1,000 capital gain will be tax-exempt to you. You will still get a tax credit of $960 for the donation (48% of $2,000). The net tax savings resulting from your donation in kind will be $960, or $240 more than if you sold the securities and donated the before-tax proceeds. Looking at it another way, the after-tax cost of your donation is reduced by $240 to $1,040 (from $1,280) when you donate the shares directly.

The power of planned giving
While wealthy individuals have long structured their estates to include philanthropy, in more recent years a tax-assisted framework has evolved that creates more incentive and flexibility for individuals.

“For instance, there are donation programs available whereby flow-through shares can be purchased and donated by an individual, which effectively ca reduce the cost of giving to under 20% depending on your province of residence, Micallef says. “With these types of programs, investors can either reduce the cost of giving or use such savings to increase the amount they are able to donate to their desired charity.”

In a more general sense, having a will directs donations to specified charities after their death offers tax advantages. Bequests are deemed by the tax authorities to have been made at the time the donation is actually transferred to the recipient charity, not at the time of death. This means the tax credit potentially need not be claimed on the deceased’s final tax return but alternatively can be claimed by his or her estate in a future year.

To do this, a graduated rate estate (GRE) must be set up through the will. A GRE can exist for up to three years following the date of death, after which it reverts to a regular estate trust framework. A donation made by a GRE may be claimed in the taxation year in which the donation is made, or in an earlier year of the GRE’s existence. Alternatively, the claim could be made on the deceased individual’s final tax return or in the return for the year immediately preceding death.

If a GRE becomes a regular testamentary trust after the three-year limit is reached, a donation credit will still be available for amounts donated up to five years following the date of death. The credit can be claimed in the year the former GRE makes the donation or retroactively in an earlier taxation year of the GRE. As above, the claim could be made on the deceased’s final tax return or in the return for the year immediately preceding death.

 “It is worth noting that any estate (including a GRE) can claim a charitable donation tax credit for a donation in the year in which the donation is made, or in any of the five following years,” says Micallef. “However, only a GRE or a former GRE can allocate a donation to an individual’s taxation year for the year of death or the immediate prior year, or to an earlier year of the GRE.”

In addition, to avoid having a donation credit denied, any estate must have taxable income that is not legally payable to the estate’s beneficiaries.

Any capital gain resulting from a donation of eligible securities by a GRE is exempt from tax, as long as it is made within 60 months of the date of death.

Shares from employee stock-option plans
If you donate public company shares acquired under an employee stock-option plan, you may be eligible for a tax deduction in addition to claiming the donation credit. This deduction effectively reduces the related income inclusion to nil, as would be the case for a capital gain realized on the donation of other shares. To qualify, you must donate the shares to the charity within 30 days of acquiring the shares under the stock-option, and the donation must take place during the same taxation year.