By: Florence Marino B.A., LL.B., TEP | Vice President, Tax & Estate Planning
An in-kind gift of a life insurance policy to a charity can result in a significant endowment that could fund large expenditures that further the long-term objectives of a charity, for example, capital projects, scholarships or bursaries in perpetuity, medical equipment/facilities and the like. Tax benefits and tax consequences to the donor arise from such a gift. In this article we summarize the considerations and rules relating to these types of gifts and provide an update on recent, specialized clarifications from the 2024 CALU CRA Roundtable and the August 12, 2024 draft legislation.
Warning – for something seemingly simple, complexity abounds!
In-kind gifts of life insurance – a primer
Tax credits and deductions
For an in-kind gift of life insurance (i.e. the policy is absolutely assigned to a charity and the charity is named as beneficiary), a donor that is an individual (including a trust) may claim a donation credit (section 118.1). A corporation may claim a deduction (section 110.1). Donations by partnerships are deemed to have been made by the partners (subsections 118.1(8) and 110.1(4) respectively). The eligible amount of an in-kind gift of life insurance is the fair market value (FMV) of a policy less any advantage the donor receives.
Fair market value otherwise determined
What is the FMV of an existing life insurance policy? As with any FMV determination, this is a question of fact. In numerous technical interpretations, the CRA has referenced factors listed in Information Circular IC-89-3. These include: cash surrender value (CSV); policy loan value; face value; state of health and life expectancy of the life insured; conversion privileges; other policy terms and riders; double indemnity provisions; and, replacement value.
As a rule of thumb and subject to the special rules that deem the FMV in certain circumstances discussed below, the CSV would generally be the floor, with these other factors possibly contributing to a greater FMV determination. Use of a qualified valuation professional to establish the FMV of such a gift is important for a charity to provide an appropriate donation receipt.
Deemed fair market value
Special rules apply in determining the FMV of an in-kind gift of life insurance, limiting the amount of the gift to the lesser of FMV otherwise determined and the cost of the life insurance policy in certain situations. For these purposes, “cost” means the adjusted cost basis (ACB) of the policy. Subsection 248(35) provides that FMV is deemed in this manner where:
- the donor acquired the policy less than three years before the gift is made, or
- the donor acquired the policy less than ten years before the day the gift is made and it is reasonable to conclude that, at the time of acquisition, one of the main reasons for acquiring the policy was to make a gift to a charity.
Acquisition of the policy is a key concept since it is from that point where these timeframes are measured. Many CRA technical interpretations have dealt with aspects of this question:
- #2021-0882391E5 provided no clarity (i.e. a mixed question of fact and law and a case-by case determination) regarding whether the conversion of a term insurance policy to a permanent policy results in a new policy from which these timeframes would be measured;
- At the 2024 CALU Roundtable (#2024-1007081C6) the CRA addressed scenarios in which a transfer is made to the donor of a policy after a long period of ownership by the transferor but the policy is then donated by the transferee within these timeframes. In each of the scenarios, the key element was that acquisition of the policy was made by the donor on the transfer from the original owner and this started the clock again – whether the transfer was made out of a partnership to a partner and then donated, into a corporation at no consideration and donated by the corporation, a child rollover of a policy occurred (See: Roll-over of life insurance to a child – it’s a thing! – Tompkins Insurance) and then donated by the child, or a spousal rollover of a policy occurred and then the spouse donated the policy. What this series of responses tells us is that it doesn’t matter how the donor got the policy being donated, if the donation occurs within these timeframes/conditions, FMV would be limited to the policy’s ACB for purposes of the donation credit/deduction. Particularly in the spousal rollover context, it seems odd that this should result since spouses can claim a donation tax credit for gifts made by their spouse.
Also another, more specialized and limiting rule (subsection 248(36)) applies where the policy was previously acquired by a person or partnership that is not at arm’s length with the donor, the policy is transferred to the donor by the non-arm’s length party (other than on death) and the gift is carried out, all within these timeframes. This rule further limits the donation amount to the lower of the cost of the non-arm’s length party and the donor’s cost at the time of the gift. Cost for these purposes has been clarified by the August 12, 2024 technical amendment to be the ACB of the policy, formalizing the CRA’s view on the matter (#2017-0692361C6).
Disposition of the policy
When an in-kind gift of life insurance is made to a charity by an individual, trust or corporation, the donor will have a disposition of the policy and may have a taxable policy gain to report. The proceeds of the disposition for the gift would be determined under subsection 148(7) and deemed to occur at the greater of the policy’s ACB, CSV or fair market value of consideration, if any, given to the donor by the charity for the policy. To the extent that the proceeds of the disposition exceed the ACB, a taxable policy gain is reported on a T5 to the policy holder/donor in respect of the transfer. Taxable policy gains are ordinary income like interest income.
When the gift is made by a partnership, the CRA views subsection 98(2) to be more specific than 148(7) and would therefore see the proceeds of the disposition to occur at the policy’s FMV.
Alternative minimum tax (AMT)
A large charitable gift arising from a gift of a life insurance policy may attract AMT. See our discussion: Alternative minimum tax – Where are we now? – Tompkins Insurance
Continuing premiums are a gift
Where the policy requires further premiums and are paid by the donor, these premiums would qualify as a charitable gift. The premiums could be paid to the charity and allow the charity to pay the premiums under the policy or the donor may pay the premiums directly to the insurer.
Practicalities for charities
Charities may have procedures concerning the acceptance of life insurance gifts. Some charities may not accept life insurance gifts at all or limit the types of life insurance gifts accepted. Others may require that a professional valuation be performed in respect of the gift of a life insurance policy. Since the gift of life insurance may be seen as an onerous gift, that is, the policy may require continuing premiums be paid for the policy to remain in force, charities may also require the donor to pledge to make premium payments or enter a donation agreement concerning the maintenance of the policy. Alternatively, charities may limit acceptance of in-kind life insurance gifts to permanent policies that are paid-up or requiring no further premiums.
Complexities simplified
This primer merely scratches the surface and deals only with in-kind gifts of life insurance. Alternatives that may be considered and approaches to funding charitable gifts using life insurance death benefit proceeds will have to be topics for another day!
FOOTNOTE:
This publication is protected by copyright. Tompkins Insurance is not engaged in rendering tax or legal advice. TOMPKINSights contains a general discussion of certain tax and legal developments and should not be construed as tax or legal advice.
Should you wish to discuss this or any other TOMPKINSights article, please contact
florence@tompkinsinsurance.com
