Maximizing Your Charitable Donations: Give Like Santa, Save Like Scrooge
Most of us that donate don’t do it for the tax savings. Although there are some tax benefits to funding cancer research or donating to a charity for disadvantaged youth, it’s seldom about the money; we give because we want to make a difference. On the other hand, if our government offers tax relief to reward our charitable intention, it seems to me a little churlish to not take them up on their offer. The rest of this article explains how to do just that.
When a person donates in Canada, our federal and provincial governments provide them tax relief in the form of a “charitable tax credit.” While most tax credits are really worth about twenty cents on the dollar, depending on where you live, the charitable donation credit is turbo charged. With the recent first-time donor’s credit, it may sometimes seem that it’s not like giving at all.
The basic rules are as follows:
- We receive a tax credit equal to the lowest combined provincial and federal tax rate in our province of residence on the first $200 we donate each year (i.e. around 20% generally).
- On any additional donations, the rate on donations is equal to the highest combined federal and provincial rate in that province, although this may exclude any provincial surcharges for high income earners. (i.e. although B.C. is creating a new tax bracket next year for incomes over $150,000 which means a combined federal /provincial rate of 45.8 %, the charitable donation credit remains frozen at 43.7%.)
- We can claim a credit equal up to 75% of our taxable income that year. (i.e. if you make $100,000, you can claim charitable donations of up to $75,000.)
- If you can’t claim on everything you donated this year, you can carry your donations forward for up to 5 years and use them up when you have additional taxable income to claim them against. ( i.e. If you donated $200,000 this year and earned $100,000 over each of the next 5 years, you could claim $75,000 in years one and two, then $50,000 in year three.)
- In your year of death, you can donate 100% of your taxable income. If you can’t claim it all at that time, you can carry it back in time to claim any leftover amount against 100% of your income in the year prior to your passing.
- As tax relief is in the form of non-refundable credits, it only makes sense to claim in years you actually have to pay tax. (i.e. if your other tax deductions and credits mean that you are already entitled to a refund of any taxes you’ve paid, then it is a waste to claim charitable donations that year, as you won’t receive any more money for doing so.)
- Couples can pool their charitable donations and decide which spouse claims. Assuming that both spouses have enough income to use up their credits, their tax savings are the same. It does make sense for both spouses to report their donations on one tax return in most cases because this means that more of the refund qualifies for the turbo charged rate. (i.e. if both spouses claimed $500 separately, their total tax savings would be around $342. If one spouse reported the whole $1,000, they’d get about $390 in savings in B.C.)
- Although you should report your charitable donations in the year you make them, you get to decide whether to claim them that year or carry them forward. Smaller donors may wish to stockpile several years of donations so that more of their tax credit is refunded at the turbocharged rate. (i.e. if you donate $200 per year for 5 years, your cumulative tax refund would be around $200. If you waited until your last year and claimed everything then, you would receive about $390, although you had to wait a lot longer to get it.)
- The government forgives capital gains on any publically traded securities (i.e. mutual funds, segregated funds, stocks and bonds) that are donated “in kind” (i.e. in their current form rather than in cash.) Moreover, your charity doesn’t have to pay the taxes, either. You also receive credit for the fair market value of the donated security at the time of donation. For example, if you donate $10,000 worth of shares that you purchased for $2,000, you still get a charitable donation credit for $10,000 and you avoid tax on the $8,000 increase in value along the way. In 2013, this translates in additional savings of up to $1,748 in avoided capital gains in B.C. If you claimed the whole charitable donation credit that year, you would be out of pocket less than $4,000 and your charity would still have $10,000. Of course, your charity has go through the hassle of selling the securities and converting them to cash.
The First-Time Donor’s Super Credit
The 2013 Federal Budget introduced a new incentive for people who haven’t donated in the last 5 years. This credit can be claimed from 2013 through 2017 on the first $1,000 donated by a single person or on the first $1,000 donated by a couple. In other words, couples need to share their $1,000 Super Credit as they don’t get separate $1,000 limits. Although it is a little difficult to explain, the Super Credit means that the Federal portion of the credit is bumped up from 15% to $40% on the first $200 donated and from $29 to $54 on the remaining $800.
Here’s an example. If Denise from Vancouver donated $1,000 this year, hadn’t donated in the last 5 years and was able to claim her whole donation in 2013, the $390 she would have normally received gets bumped up by her $250 Super Credit. Denise’s tax credit would now be worth about $640!
Thinking about saving even more by donating securities in kind? Unfortunately, this doesn’t work, as the Super Credit only applies to cash donations.
Charitable Donation Tips
There are a lot of charitable donation strategies floating around and I won’t be able to talk about them all today. Here are a few ideas or thoughts to consider:
- If It Looks Too Good To Be True, It Probably Is. There have been a lot of charitable donation strategies over the years that claim they can get you a tax refund that is actually bigger than the amount you donated. Don’t be sucked in by the glossy brochures, the claims they have a legal opinion backing their idea and a pot of money set aside to defend against legal challenges. Even though it make take several years for the CRA to get around to it, it regularly sets aside these so-called donations, which can have huge financial consequences to everyone affected. In the end, charitable giving should still mean that you’re still out of pocket, even after the tax incentives. That’s why they don’t call it “charitable getting.”
- No more capital gains forgiveness on flow-through shares. If you don’t know what this is, then don’t worry about it, as this loophole has now been shut. If you have, then it is time to move onto other ideas.
- Consider Donating Unneeded Life Insurance Policies In Kind. There are two ways to gift using life insurance. The most common is naming a charity as the beneficiary of a life insurance policy and receiving a tax credit equal to the size of the death benefit when you die. In other words, this credit can be used against the enormous tax bill that can come at death. The other way is to either buy and donate a new policy immediately or to transfer ownership of an existing policy to the charity. You get a donation credit for the value of the policy at the time of the donation at that time and, if you keep paying the premiums after the transfer, you get a new credit each year equal to what you put in.
The twist comes when you donate existing policies which are assessed on their fair market value at the time of donation. Even if your insurance company says a term policy is worthless if you cease payments or says that the cash value of a permanent insurance policy is only a small fraction of the eventual death benefit, this isn’t necessarily what your policy is worth. Think of it this way: what would you sell your $1,000,000 term insurance policy for if you probably only had 6 months left to live?Although the situation isn’t so stark for most of us, sometimes some insurance policies can be worth a shockingly high amount in some cases. A word of caution, however: if you donate policies with a cash value, your tax refund may be reduced by the policy gain you trigger when transferring ownership of your insurance.
Not all existing policies will be worth the effort of paying an actuary to value them. I suggest first talking to your insurance advisor to help you decide whether to take the next step. Some of the things to look at when making this decision are:
- Your health and age at the time of donation. The closer you are to meeting your maker, the more valuable your policy becomes;
- How old is the policy? The older, the better, except in cases where your insurance premiums go up each year and there is not a lot of extra money inside the policy to pay them;
- How are your premiums assessed? If your premiums are level for the life of the policy or are “paid up” in a set number of years, this adds to your policy’s value, especially if it has been around for a while.
- What is the cash value of your policy and are there any guaranteed increased in the value going forward? For example, a policy that has no cash value for 20 years but $400,000 after year 20 will probably be extremely valuable in year 19.
- Are there any special features to the policy? For example, some permanent policies pay dividends that can eventually pay each year’s premiums without fresh contributions or even increase the death benefit. I have seen policies that have a face value of $10,000 but, when you add in all the extra insurance purchased by these policy dividends, offer 5 times as much.
- Donate and Replace Your Winning Investments. One of the most common objections I hear when people talk about donating investments in kind or selling stocks to fund a charitable gift is that they want to keep that particular stock or fund for the long term. This shouldn’t be a deterrent. As explained earlier, if you donate a security with a capital gain, the government forgives the tax bill and still credits you with the value of that security at the time of donation. If you were going to make a donation anyway, why not just donate such an investment and use the cash you would have donated to buy it back on the stock market? You will have effectively swapped a security with a high unrealized capital gain for one that is equal to market value, which means less tax down the road.
- Sell Your Losing Investments and Donate In Cash. If you donate securities that have cost you money in kind, you won’t get credit for these losses for tax purposes. Accordingly, you need to sell them and use the cash for the donation instead. Still believe in the stock’s long term value? If you are willing to wait 31 days for you or your family to repurchase that stock, you can simply buy it back on the open market then. Be careful about repurchasing the stock within the 31 day waiting period: this rule applies to RRSPs, companies and trusts, among things, in addition to your open accounts.
- Donate Personally Rather than Corporately. The tax benefits of donating personally versus corporately are calculated differently. In a nutshell, especially if the alternative is donating using money within a small business taxed at the small business rate, it is usually better to gift with personal money rather than corporate dollars.
- Synchronize Your Donations and Your Income. As stated earlier, you can only donate up to 75% of your taxable income each year, although you can carry donations forward for up to 5 years. For people making larger donations, it is important to ensure that you will be able to use up all your donations within this 5 year period. In some cases, it might make sense to make smaller gifts over longer periods or to have both spouses gift some of the amount rather than have one spouse make the entire gift if he or she doesn’t expect to have enough income over the next 5 years to claim back the entire deduction.
- Look at Donating Using Corporate Class Shares. These are a special type of mutual fund that is designed to convert most types of income or gains into deferred capital gains. This is particularly effective for within holding companies or for the cash accounts of people who want to defer their day of reckoning until they are either dead or in a lower tax bracket. As an added feature, some of these funds allow you to withdraw your original capital along the way as tax free “return of capital,” although this will increase your capital gain when you eventually do sell. Accordingly, these shares (as well as shares you may have received from companies like Sun Life and Manulife when they demutualized whose entire value is taxed as a capital gain) are ideal ones to donate.As a more complicated donation strategy, consider using the return of capital portion of corporate class shares to fund a life insurance policy that you will donate at death and donate some of the corporate class shares in kind when you have drained most of the original capital from them.
Obviously, this is not an exhaustive list of all your charitable gifting options, but I do hope that it is a good start. As I stated before, charitable gifting isn’t about the tax benefits. On the other hand (excuse the bad pun), why look a gift horse in the mouth? Although tax considerations should only be a secondary consideration, it does seem a shame to leave money on the table, especially if this increases what you can donate next year!