Several important changes in the tax rules that apply to charitable gifts will be coming into effect in the near future. Some of the new rules take effect in 2016, and others will apply beginning in 2017. The new rules provide increased flexibility and tax benefits for certain charitable donations, but the new rules will require existing plans for charitable donations on death to be reviewed, to ensure the plans comply with the new rules. This update provides a refresher on the current tax rules, and explains the upcoming rule changes.
Individuals receive a non-refundable federal and provincial tax credit for donations to Canadian registered charities. The combined federal and provincial credit on donations over $200 per year is as high as 50% of the donated amount (depending on the province the donor resides in). A lower credit applies to the first $200 of donations per year. The tax credit is capped at 75% of the individual’s net income for the year, or 100% of net income in the year of death. Individuals can carry unused donation tax credits forward for up to five years. In 2013 the government introduced a “super credit” for first-time donors: an additional 25% credit is received for the first $1,000 of charitable donations made by an individual who, together with the individual’s spouse or common-law partner, has not claimed any charitable donations since 2007.
Donations made after death, through an individual’s will, are subject to special tax rules. Under the current rules a donation made under a will is deemed to be made by the individual prior to death, and the donation tax credit can be applied against taxes payable on the deceased’s final tax return, or against taxes payable in the preceding year, in each case subject to a limit of 100% of the deceased’s net income in those years. The amount of the donation will be equal to the fair market value of the gifted property at the time of death. The new rules described below are a significant change from these existing rules.
Donations of property that has grown in value may trigger capital gains tax as well as a donation tax credit. The existing rules provide a special exemption from capital gains tax on the donation of public company shares, but donations of other types of property (i.e. private company shares and real estate) are subject to capital gains tax. Relief will be available for such donations under new rules that come into effect in 2017 (discussed below).
Corporations also benefit from donations to registered charities. Corporations receive a deduction from income for donations, rather than a credit against taxes payable. Unused deductions may be carried forward for the same periods as are noted above for individuals.
Donations Under a Will
Beginning in 2016, donations under a deceased person’s will are no longer automatically deemed to have been made in the year prior to death. Instead the donation is considered to be made by the individual’s estate - which is a separate taxpayer from the deceased. The estate can carry any unused donations forward for up to five years, but cannot carry the donation back to the tax returns of the deceased person, unless the estate qualifies as a “graduated rate estate” (discussed below). This rule change is an important restriction for most estates, because estates typically have limited taxes payable (as most of the income tax triggered on death is payable on the deceased’s final tax return).
The new rules will allow the estate to carry the donation credit back against the taxes payable on the deceased taxpayer’s final tax return and prior year only if the estate qualifies as a “graduated rate estate” (“GRE”). A GRE is an estate under an individual’s will (but not any separate trusts created under the will); GRE status only applies for the first 36 months after the individual’s death, and only if the estate is designated as a GRE on the first tax return filed by the estate. If the estate is a GRE, the estate can choose to apply a donation tax credit in the year of death, the year immediately preceding death, the year in which the donation is made by the estate (and up to five years afterward), or a prior tax year of the estate.
The rules for determining whether an estate qualifies as a GRE are complex, and readers who plan to make charitable donations in their wills should obtain professional advice to ensure that their estate will qualify as a GRE. Certain common estate planning vehicles, such as alter ego trusts and joint partner trusts, do not qualify as GREs, and charitable donation plans involving these types of trusts may need to be revised to fit within the new rules. Finally, wills that may result in a long-term estate (i.e. a will that contains a spousal trust for the lifetime of a surviving spouse of the deceased) may lose their GRE status before any charitable donations can be made. Wills designed to provide for both long-term trusts and charitable donations should be revisited to see if changes are required.
As a final note on the new rules, the amount of the charitable donation will be based on the fair market value of the gifted property at the time the donation is actually made by the estate, rather than the value at the date of death (which is the relevant date under the existing rules).
Sale of Real Estate or Private Company Shares
A donation of capital property (i.e. company shares or real estate) to a charity results in a charitable donation credit, but also can trigger capital gains tax if the donated assets have grown in value. For a number of years the government has exempted donations of public company shares from any capital gains tax, but donations of private company shares and real estate remain subject to potential capital gains tax. New rules that take effect in 2017 will provide capital gains relief for donors who sell private company shares or real estate, and then donate the proceeds to charity. If the proceeds from the sale of real estate or private company shares are donated to a registered charity within 30 days of the sale, no capital gains tax will apply. This new exemption only applies if the sale is made to a buyer that deals at arm’s length with both the donor and the registered charity. If the donor gives less than 100% of the sale proceeds to charity, the exemption from capital gains tax will be pro-rated accordingly. Note that under the new rules there is still no exemption from capital gains tax when private company shares or real estate are donated directly to a charity.