The Benefits of Charitable Gifting
Providing financial and other assistance to those who are in need is very important to many Canadians. Every year registered charities receive billions of dollars in gifts and countless hours are spent doing volunteer work on behalf of a favourite cause. In addition to the satisfaction of helping others, making a charitable gift can provide generous tax breaks for those in the top marginal tax brackets. The federal tax credit for charitable gifts can reach 33%, and combined with provincial tax credits, a large charitable gift can significantly reduce an individual’s tax bill.
While charitable gifting while alive is both popular and tax efficient, this article will focus on how charitable gifting through your will or by making a charitable beneficiary designation can assist with estate planning. In particular, a charitable gift on death can reduce taxes triggered on death, such as the deemed realization of capital gains on capital property and the triggering of tax on registered assets. In the absence of proper planning, your estate may not have sufficient liquidity to pay this potentially large tax bill without selling valuable and prized assets.
Making Gifts on Death
When you make a charitable gift through your will, the donation will be treated as having been made by your executor, at the time the property is transferred to the charity. Provided certain conditions are met, your executor has the flexibility to allocate the donation tax credit among the following tax returns:
- The taxation year of the estate in which the donation is made;
- Any earlier taxation year of the estate;
- Your final tax return; and
- The tax return immediately preceding the year of death
To be eligible for this flexibility, the estate must elect to be a “graduated rate estate” in its first tax return, and the donation must be made by your executor within 60 months after your death.
Normally, a charitable tax credit cannot be used to offset more than 75% of net income in a year, with any remaining credit available to be carried forward and claimed in the following five tax years. However, this limit is increased to 100% of net income where the credit is used in the deceased’s final tax return or the return for the year immediately preceding death. If effect, a charitable gift arising on death can be used to fully offset income arising in the year of death or the immediately prior taxation year.
Similar rules apply for individuals who gift the proceeds of an RRSP, RRIF, TFSA or life insurance death benefits, via a beneficiary designation in favour of the charity.
Life Insurance Donations
When considering the use of life insurance to make a charitable gift, there are two main ways of structuring the gift. The first, as noted above, is for the person to designate the charity as the beneficiary of the insurance proceeds. In this case the premiums paid by the donor are not deductible, but the full amount of the death benefit (which can be significantly more than premiums paid) will be available to claim as a charitable tax credit (as noted above). Another benefit of this approach, versus gifting an insurance policy (discussed below), is that the donor retains control of the policy. If for any reason the donor wants to direct the death benefit to another charity or to a family member, all that is required is a change in the beneficiary designation.
Another approach would be for the donor to purchase a policy, or use an existing policy, and gift the policy to the charity. If an existing policy is being gifted, its value may be significantly higher than the policy’s cash surrender value. It is best to get an independent valuation to confirm the policy’s value, which in turn will typically be the amount receipted by the charity. The gift will also result in a disposition of the policy for tax purposes, causing tax reporting of any policy gain to the donor. Part of the charitable tax credit can be used to offset this taxable income. The donor will normally continue to pay the premiums on the gifted policy, with the charity providing a charitable receipt when each premium is paid.
The shareholder of a private corporation can also establish a life insurance gift through the corporation. Typically, the corporation would be the owner and premium payor, with the death benefit being gifted to the charity upon the death of the life insured (the corporation rather than the charity should be the designated beneficiary). The payment of the death benefit to the charity will result in a charitable deduction to the corporation equal to the policy’s death benefit. In addition, the death benefit will create a credit to the capital dividend account of the corporation. This will permit the payment of tax-free capital dividends to the business owner’s estate or other shareholders of the corporation.
As can be seen, there are several different considerations when contemplating a large charitable gift on death, particularly where life insurance will be used to make the gift. It is therefore important to consult with your tax and insurance advisors to ensure the gift is structured in a way that both meets the client’s objectives while maximizing the tax benefits of the gift.