In my last article, I spoke at length about how to maximize the tax benefits of your personal charitable donations so your money goes further. Today’s offering takes this one step further – what if you’re actually better off having your company make the donation instead? Read on and see for yourself.
Unlike when you donate personally, corporate donations generate a tax deduction rather than a tax credit. Thus, the amount you give to good causes in any tax year is deducted from that company’s taxable income rather than generating a non-refundable tax credit, which is how things work if you give out of your own pocket rather than through the corporate coffers.
How that translates towards your bottom line depends on a bunch of things. First, if your company is an active small business taxed at the small business rate, which might be as low as 11%, then you’re only essentially getting back $11 per $100 donated. On the other hand, if your company is making money hand over fist and you are earning in excess of the small business limit ($500,000 in most provinces, although this limit may be reduced if you are earning investment income in excess of $50,000 under the new passive income rules), your deduction may climb to 27%, which is the current B.C. rate.
Finally, if you donate through a holding company instead, you might reap your biggest savings of all, as investment income is taxed at over 50% in most provinces (i.e. 50.67% in B.C. and Alberta at the date I type these words). Admittedly, a good chunk of that 50% is potentially refundable anyway if you flow out enough in taxable dividends to shareholders, but you would have still lost about 20% to the tax man all the same, plus whatever extra tax gets paid personally by the people receiving those dividends.
As an added wrinkle, the government also forgives any unrealized capital gains on publicly traded investments your company donates in-kind, just like they do if you donate those securities personally. What many people don’t realize however, is that there is an additional tax advantage your company reaps by donating appreciated securities in-kind that can vastly compound your savings.
For those of you who have survived my previous articles on small business taxation (see my website at colinsritchie.com if you’re a glutton for punishment or are one of those people like me who are strangely obsessed with all things taxation), you might remember something called the “capital dividend account” or the “CDA” if you have a thing for acronyms. The CDA is a notional account tracked by the government (and hopefully your accountant) that tells you how much money your company can pay out to you as tax-free capital dividends. In the normal course of things, 50% of any capital gains realized inside your company can be paid out to you directly through the CDA minus any capital losses from that year. If you donate an appreciated security to the Save the Large Mammals Fund or a similar charitable entity instead, however, 100% of the gain goes into the CDA instead, rather than just 50%!In other words, if donating a $25,000. security with $10,000 in unrealized gains, you get:
- a $25,000 charitable donation deduction that could reduce your holdco’s tax bill by perhaps $12,500 or more;
- forgiveness of $10,000 in capital gains, which might represent a further savings of about $2,500, minus any portion that is later refunded to the company if it pays out enough taxable dividends to others, although those people will also need to pay tax on those dividends;
- the right to pay out $10,000 rather than just $5,000 from your company to yourself or other shareholders as a tax-free capital dividend, which could potentially offer further tax savings of almost 45% of this additional $5,000 in B.C. or $2,232 if the person getting this payment would otherwise be in the highest tax bracket.
Crunching the numbers, this translates into about $17,200 in upfront combined personal and corporate tax savings. Moreover, donating corporately also reduces the potential tax bill on death for your holding company (or your active business as well, for that matter) and allows you to use more of your personal money for other things or perhaps means that you don’t have to flow out as much in dividends or salary in order to fund a personal donation.
There are some limits to what you can donate corporately, however. In particular, your company cannot deduct more than 75% of its income for that year, although any unused contributions can be carried forward and deducted over any of the ensuing 5 tax years. Accordingly, if you have your heart set on a large donation in one particular year inside your holdco but don’t have the taxable income to write it all off, you might consider triggering a bunch of additional capital gains inside the company that year if possible. This can create the additional taxable income you need to claim a larger deduction asap and, as an added bonus, you can pay out 50% of the extra gains you trigger tax-free as a capital dividend. As the cherry on top, this also helps reduce your eventual corporate tax bill at death by decreasing what’s left inside your company at death by taking out extra money now.
As a final thought, for those of you who haven’t read my previous article on personal donations, check out organizations like CHIMP or ask your stock broker if they have any donor-advised funds they offer. Both allow investors to donate in-kind to a new investment account and receive a donation receipt at the time the money is transferred into the account. Once inside this new account, the donors can make cash donations to their charities of choice when the time is right. Donors still get credit for their donation based on the value at the time of transfer into the new account, plus forgiveness of the unrealized capital gains. This may be particularly useful for donors who plan on making numerous gifts over the course of a year to several different charities for either smaller amounts or to charities that don’t have the infrastructure to handle in-kind donations!
Corporate vs. Personal Donations – Which is Better?
Should you donate personally or corporately? Ultimately, as us lawyers and financial types like to say, it depends. If you are personally in a relatively low tax bracket, particularly if you don’t have a lot of corporate assets, you are likely still better off donating personally. That’s because 45.8% donation credit you get personally in B.C. on all but the first $200 of your donation is probably more than the tax rate you pay on your last dollar of income that year. Thus, even if you have to flow out more salary or dividends in order to come up with the cash for your donation, the extra tax you pay on the additional withdrawals will be lower than your charitable donation credit. In other words, claiming a 11% or 27% deduction in your operating company instead getting a 45.8% donation credit personally makes donating corporately not such a wonderful thing in that scenario.
If you donated from your holdco rather than an active business instead, you still might be better off donating personally if you’re personally in the lower tax brackets. Although there is that 50.67% investment tax rate on interest income and the 50% taxable portion of capital gains, along with a 38.67% tax on investment dividends in B.C., all but about 20% of the 50.67% is refundable, along with 100% of the 38.67% provided that enough taxable income is paid out to shareholders that year. Noting that shareholders do get credit for the investment tax paid corporately through both the small business and enhanced dividend tax credits, at the end of the day, the total tax bill paid corporately and personally on the investment income earned inside the company is designed to be about the same or slightly more than if the shareholder earned that income directly and was taxed on it accordingly. As a result, if the 45.8% personal donate credit is higher than your marginal tax rate for interest or salary (not dividends) after you’ve withdrawn enough corporate dollars to fund your gift, then you are often better donating personally.
When trying to figure out what’s best for you, here are some of the key factors to consider:
- Is the combined tax rate you and your company pay on the income it needs to pay you to make the gift less than the 45.8% charitable donation rate (or whatever is the going rate in your province) you can claim if donating personally. If you are in the highest bracket in at least some provinces, your personal donation rate climbs to 49.8% on the amount of your income that would be taxed at this high rate. If you are over 65, you will also need to determine how much of your OAS pension you might lose if you need to increase your income to fund the gift;
- Do you have substantial unrealized gains in your company or personally? Which of your investments have the highest percentage gains, as those investments will often be the ones that you can save the most by donating? All the same, you would still need to compare your personal and corporate tax rates at that time and also take into account the extra money you can pull out from your company tax-free through the CDA when donating corporately when making this decision;
- How much do you have in your holding company and are you expecting a big capital gains bill on your company shares at death? If so, you might wish to donate corporately when planning ahead, particularly if you donate investments with large gains in-kind so you can withdraw additional tax-free capital dividends as a result of your donation;
- Would reducing the size of your corporate investment portfolio help any active business you still own get more of its income taxed at the small business rate (i.e. perhaps 11% instead of 27% for B.C.)? Now that any investment income exceeding $50,000 will reduce how much active income gets taxed at the small business rate as a result of the Liberal’s new passive income rules, donating corporate securities producing a lot of taxable investment income or which would otherwise be subject to a big capital gains bill when you sell might have the added benefit of saving your active business some extra dollars either in the following tax year or further down the road.
- Do you have enough income personally or corporately to allow you to deduct your planned gift that year? Whether if personally or corporately, you can only get credit for donations up to 75% of the taxable income of the person or corporation making the donation. Of course, it is possible to donate a bit from both sources if necessary. Just be careful about pushing yourself into a higher personal tax bracket in order to be able to deduct your gift asap, as that often is a mistake;
- What are your general plans for your money going forward? I also view personal money as more valuable than corporate dollars, as it is more flexible and can be accessed and gifted far more easily and with less tax consequences a lot of the time.
At the end of the day, charitable gifting is far more about helping those in need than in saving money. Ultimately, regardless of how you structure your gift, you will still be out of pocket as a result of your generosity. If someone presents you with a fancy brochure that says otherwise, run for the nearest exit! All the same, gifting intelligently can help you to give more or reduce the financial toll of your good deeds. A few extra moments now can have a huge impact on you and your charities’ bottom line, both now and for years to come.