I began writing this article several thousand feet above the ground while jetting home to see my family in Ontario stuffed full to the brim with Christmas spirit, although it’s taken me another few months and another plane trip to finish things off. I always applaud those of you with the means and inclination to donate your hard-earned cash to whatever charitable organizations resonate within you. To help in this pursuit, I am writing this article to either put more cash back in your pocket or to allow you to gift even more by explaining some tax-advantaged ways of best helping those in need.
To begin, here is a hopefully brief overview of the tax relief you get when you make personal tax donations to your charity of choice. In a Christmas-coloured nutshell, if you donate in B.C., you get 20.06% of your money back as a non-refundable tax credit on the first $200 you gift per year and 45.8% on the rest of your donation unless your income in the year of the gift (line 260 of your tax return) puts you in the highest federal tax bracket (about $210,000 for 2019). In that case, you get a 49.8% credit equal to the amount your taxable income exceeds that threshold. In plain speak, say you donated $50,000 in a year that your net taxable income was otherwise $250,000. You’d get a 20.06% credit on the first $200, a 45.8% credit for the next $9,800 and a 49.8% credit on the last $40,000 (i.e. $250,000 – $40,000) for total tax savings of about $24,486.
There are other rules that apply for donating at death or beyond the grave that have been covered by others that I won’t get into today, other than to say that the donation limit goes up to 100% of your income in the year of death, which can also be applied to your previous year’s tax return if necessary. You are also able to carry forward unused donations for up to an additional 5 years in some cases.
When looking at when to give, it’s important to remember that the deadline for personal donations is the calendar year end if you want to claim your refund as soon as possible. Thus, even though you have a few additional months each year to make RRSP contributions each year as December glides to an end, you have to get your act together by New Year’s Eve if you’re hoping to get your tax refund for new charitable donations around the same time as you have to pay for this year’s spring break.
With no further ado, here are some tips if you are looking to make donations personally during your lifetime. I’ll write another article (hopefully well before the next major holiday) talking about how things work if you donate corporately and some things to consider when debating between personal and corporate donations:
- As the charitable donation credit is, well, a credit, there is often no benefit to having the wealthier spouse claim the relief afforded by their combined largesse in most cases, as tax credits produce the same refund for either spouse, regardless of tax bracket if neither is in the top tax bracket. Thus, assuming the lower income spouse has enough taxable income to use up the tax credit (as this credit can only be used to reduce your tax bill to $0 rather than getting additional funds back beyond this point) and the total family donations that year weren’t more than 75% of the lower-income spouse’s income, it often makes sense for the lower income spouse to claim the tax reward if the plan is to reinvest. This is because any earnings on the invested refund will be taxed at a lower rate in that spouse’s hands. Thus, charitable donations can also be a tool for income splitting if the gifts are large enough. This is not a universal rule, however. For example, if having the higher income spouse make the donations would allow him or her to increase RRSP or Spousal RRSP contributions and get a bigger tax refund since (s)he is in a higher tax bracket, then the spouse with the bigger paycheque might want to claim the credit instead in some cases. Likewise, if the wealthier spouse is in the highest tax bracket and the other is not, then you might want the spouse with the higher income to claim at least as much of their combined donations that generate an extra 4% in tax savings.
- If you don’t need the credit to get your taxable income to $0 that year, don’t claim any more than you need to get to that point, as any excess amount donated will be squandered just like an unused holiday gift card.
- If you aren’t usually in the top federal tax bracket but are in 2019 or down the road, you’ll get an extra 4% in tax savings if you give in that year on whatever is less – the total amount of your donation that year above $200 or the amount your taxable income exceeds $210,000 (or whatever that number happens to be going forward) above $200 in that year. Thus consider making really big donations at that time, which for some of us might be death. Likewise, if you want to donate now when you’re not in the highest tax bracket but should be next year, consider not claiming all your donations until then if your income for next year minus any additional donations you plan on making then would still leave you in the highest tax bracket.
- Continuing with my gift card analogy, if you don’t have enough taxable income to use up your full donation credit that year without triggering additional taxes, such as by making extra RRSP withdrawals, it could save you more in the long run if you carry the credit forward instead of triggering extra income this year at a really high rate. A charitable donation credit is like a gift card for a flat amount – if you use both strategically, you can maximize your savings. Just like you can perhaps have enough of a $500 gift card left over to purchase an extra sweater set or leopard-print boxer shorts if you shop during a Christmas blowout, you can often stretch the value of your charitable donation credit if you use it strategically rather than just creating extra income asap just to use it up. Think of $50,000 in charitable donations as the right to get back about $24,486 in taxes using the example I provided earlier for a Vancouver donor. By using up the credit while in lower tax brackets, you may be able to ultimately pull out more money from your RRSP, RRIF, corporation etc. tax-free even though you might have to wait a bit longer to get your savings. On the other hand, if you can trigger extra capital gains, pull out more RRSP/RRIF money or get extra salary or dividends from your company without going into a significantly higher tax bracket than you expect to see over the next few years, then go for it so you have more to reinvest as soon as possible.
- Donate in-kind rather than in cash. Many generous investor types already know that the government forgives the unrealized capital gains bill when you donate publicly traded securities from non-registered accounts rather sending money to your charity instead. Moreover, you’re still credited with a donation equal to the fair market value of your donated security on the date it is gifted. Accordingly, even if you love everything in your portfolio, consider donating shares with high unrealized capital gains to your charity of choice rather than stroking a cheque. You can always use the cash you would have otherwise gifted instead to buy back that cool junior mining stock your brother told you about. When the dust settles, your charity would still have funds equal to the value of your shares upon donation minus perhaps some admin fees, you’d have a tax receipt for that same value as if you’d paid cash. Even better, if you have repurchased your mining shares with the cash you would have otherwise given, these shares no longer have any unsightly unrealized capital gains attached to them. This strategy works particularly well for any shares you may have received “for free” for an insurance company when it demutualized, since the entire value of the shares might otherwise be taxed exclusively as a capital gain.
- If gifting over the long term, consider making deferred capital gain investments now to be donated down the road. If you’re looking to take the donate in-kind strategy one step further, consider buying investments like REITs and corporate class mutual funds that pay mostly return of capital. Return of capital or (“ROC”), which is treated like a refund of some of your original investment for tax purposes and is tax-free until you’ve received back all of your original investment. Thus, you can keep all or almost all of any payments you receive along the way but also avoid that day of reckoning that often comes with these investments later by donating them once you’ve gotten back most of your original investment. In the normal course of things, investments that pay ROC usually have big capital gains looming at sale, even if they haven’t really increased significantly in value, as each ROC payment along the way is subtracted from the original purchase price for determining the capital gain upon sale or disposition. As a result, a $10,000 investment that pays $600 in ROC each year and doesn’t increase in value would otherwise be subject to a $6,000 capital gain in 10 years ($10,000 value at purchase minus 10 years of $600 payments or an adjusted cost base of $4,000). Donating these shares or units instead could mean making a 6% yearly profit for a decade without ever paying a penny in tax, since the capital gain is forgiven at donation!
- Consider donating through organizations like CHIMP, through a donor-advised fund or similar entities. Although donating in-kind directly to your charity of choice sounds good in theory, it might not always work so well in practice if your charity doesn’t have the infrastructure to sell your donated shares or if your donation strategy focuses on gifting smaller amounts to many organizations rather than writing larger cheques thus making the “hassle factor” of making many donations in-kind becomes larger than the benefits. By the same token, investors donating in-kind can miss out when their charity needs money now but the stock they were planning to gift has suddenly decreased in value by 20%.
Organizations like CHIMP or donor-advised funds can help solve these problems. They act as “middlemen” – instead of gifting directly to charities, donors give their stocks to these organizations instead and they provide donors with the immediate charitable receipt equal to the investment’s value at that time, and capital gains relief. The gifted securities donated go into a new account the donor manages through CHIMP and can either be immediately be converted to cash and forwarded to your charity or charities of choice, or it can stay invested. You might like this second option if:
- the market is at a high and you feel like now is the best time to maximize the size of your donation by disposing of the stock now even if you aren’t sure how you wish to distribute the money. Once inside an organization like CHIMP, you could also rebalance into something less volatile as well in order to protect your gains. In other words, if worried about a correction, you could rebalance this part of your portfolio after it is in the middleman’s hands so that this can be done capital gains free but so the capital is still protected from a stock plunge;
- you want a large tax credit this year but would rather pay the money to charities in chunks over perhaps the next 5 years. Accordingly, rather than converting the donated investment to cash, you may want your investment to keep growing going forward so that there is more to donate when it is finally time to give; and
- You want the convenience of perhaps making a single in-kind donation once a year but having a ready supply of tax-advantaged assets you can quickly liquidate and use to gift to multiple smaller charities when appropriate while still having your money generate income and gains for your charities along the way;
It is important to realize that there will likely be (usually minor) transaction costs for transferring the asset through an organization like CHIMP. Moreover, you do not receive any more tax credits for any income or gains earned by investments once they are in the middleman’s hands – you only get credit for the value at the time of donation, but the benefits of both being able to donate in-kind rather than cash and the ability to get your tax credit perhaps years sooner than when your charity actually gets the full value of your gift can usually easily offset these drawbacks.
- Consider buying a life insurance policy for your charity of choice and donating it to them at death. This strategy doesn’t get you any write-off now but does provide a heck of a refund when the death benefit is paid out at your passing, as the full amount paid gets tax relief. This strategy keeps your options open should you want to change charities down the road, if you want to leave the money in full or in part to family instead or need it for other purposes. For many of us, the biggest tax bill will come at our death or the death of our spouse, if later. As I explained in laborious detail earlier, you might get an extra 4% deduction at that time if you aren’t otherwise someone who is in the highest tax bracket, noting that many of us visit this unhappy place only during the year of death. Our biggest tax bills usually come in the year of our death or, if we have a spouse, when the last of us dies. Accordingly, arranging to have a humungous tax credit at the same time as when faced with a gigantic tax bill can be a wonderful thing, particularly if it provides you with an extra 4% in tax savings. Some people target having enough insurance to wipe the truly daunting tax bill that can also go along with large RRIF balances at death.
- Donate old and unnecessary life insurance policies during your lifetime. Have a policy taken out decades ago to protect your spouse and family that is no longer necessary and / or too expensive? Want to fund a large gift to your charity later but get tax relief now? Consider donating it a new or existing life insurance policy to a charity. You will get a charitable receipt equal to its fair market value today, which could be a lot more than its cash value, if donating a policy that has been around for a long time, particularly if you are in poor health. Think of it this way – if a stranger has a life policy that pays $1,000,000 at death, a $40,000 cash value, and that poor soul will likely only live for 3 years, what would you pay to buy that policy as an investment, knowing that a million dollars tax-free would be coming your way likely within the next 36 months? I strongly suspect a lot more than just the $40,000 you’d receive if the policy was cashed in early. In any event, at the time of donation, the donor gets a tax receipt for the policy’s fair market value but only pays tax on the taxable portion of the $40,000 cash surrender value, using the $1,000,000 policy from my example. The taxable portion will vary from policy to policy and determined by your life insurance company. Just keep in mind that once you’ve donated the policy, it’s no longer in your control.
If our fictional policy had a fair market value of $600,000, then the donor could potentially use the credit to withdraw the rest of his RRIF tax-free and perhaps better enjoy the remainder of his retirement and his charity would still get $1,000,000 tax-free at his death, although it would need to either pay any remaining premiums owing on the policy unless the donor continued to do so directly, and getting an additional tax credit for doing so, or perhaps using some of the existing cash value of the policy to keep the policy in force even if this reduced the eventual payout at death. Although this donor wouldn’t get as big of a tax credit than if he gifted at death, perhaps a smaller tax credit now would be more useful for him, assuming he didn’t just cancel the policy for the $40,000 cash surrender value instead!
Ultimately, we don’t donate for tax reasons but because we want to make a difference in the world around us. Accordingly, many of us do not take tax considerations into account when giving, let alone taking the time to understand the tax nuances. It is my hope that this article helps fill in a few of the blanks, whether you ultimately give a little more because you can do so more tax-efficiently or whether you use the money saved for your own family.