Getting the most out of your donations
When you give to charity there's a wonderful payoff. You have the reward of knowing you're giving back to the community by helping those in need and at the same time, the donation tax credit provides a benefit to you.
Donating to causes you care about doesn't have to be limited to writing the occasional cheque. There are more ways to effectively use the resources you have. Giving, when properly planned, will not only reduce the taxes you pay this year and next, but can also preserve more of your estate years from now.
Donations and taxation
The tax credit on any amount after the first $200 you donate is valued at the highest marginal tax rate (44%). That means here in B.C., after your first $200, you'll cut approximately $440 in income tax for every $1,000 gift you make. You save and the charity gains funding, it's a win-win scenario.
How much can you give? Normally, you can't claim donations exceeding 75% of your net income. One exception is on the year of your death when donations up to 100% of your net income are credited.
What if you make a particularly large donation? Even if you're not able to claim the whole amount this year, you can still save tax.
As with RRSP contributions, charitable donations that aren't fully used can be carried forward, in this case for five years, so you can reduce your taxes in the future. At death, any excess donations can also be carried back and applied against 100% of the preceding year's income.
Tax rules also allow married or common law couples to combine their individual donations and claim them under one spouse's return. This potentially increases the value of a couple's donation tax credit in situations where either party hasn't donated enough to receive the maximum credit on their own.
Exploring your options
Charitable acts can affect you personally and financially, so it's important to make those decisions with your broader financial plan in mind. How much you give – even how you give – can affect your lifestyle, tax situation and estate planning.
Giving cash might be the most obvious way to donate, but it's not always the best. Our tax laws allow you to lever your resources in a number of ways to get the most out of your charitable donations.
1. Qualifying Securities
When donating assets other than cash, the donation generally equates to the fair market value of the asset. But because assets are considered disposed of when transferred, making these "gifts in kind" can trigger capital gains tax. Fortunately there are exceptions that open up planning opportunities.
When you donate qualifying securities like publicly traded shares, mutual funds or segregated funds you get a tax savings boost over giving cash. Unlike what normally happens when you sell an investment, any capital gains aren't taxable. This makes it more tax efficient to give rather than sell and then donate the proceeds.
Will that be Cash or Shares?
Mary is thinking about giving shares of ABC Corp to her favourite charity. She originally paid $50,000 for the shares now worth $100,000. Mary wonders, is it better to donate the shares directly or sell them first and give the cash?
After reviewing the situation with her advisor, Mary learns that by donating the shares rather than selling them first, she'll save an extra $11,000 in taxes.
|Option 1||Option 2|
|Sell Shares, Donate Cash||Donate Shares|
|Donation - Value of Shares||$100,000||$100,000|
|Cost of Shares||$50,000||$50,000|
|Taxable Portion||$25,000||$0 (Exempt)|
|Donation Tax Credit||$44,000||$44,000|
|Tax Savings from Donation||$33,000||$44,000|
|Cost of Donation (after tax)||$67,000||$56,000|
|Extra Tax Savings from Donating Shares||$11,000|
|*Assumes Mary is in the top tax bracket in B.C. (44% marginal rate). Because she donated $200 earlier in the year, her share donation is credited at the top marginal rate.|
The bottom line? There's more benefit to you, and your charity, if you give shares directly rather than selling them first and donating the cash.
Other assets also qualify for special tax treatment. Donating cultural property like works of art or giving away ecologically sensitive land generates a credit up to 100% of your net income, free of capital gains tax.
2. Life Insurance
You probably know that life insurance† protects income and wealth. But, did you know it can also be a tax-effective way to give?
The key benefit of donating life insurance is it lets you spend a little to give a lot.
When you die the charity receives the tax-free proceeds from what might be a sizeable policy, at a relatively small cost to you: your regular premiums. Here's how you can use life insurance to create tax savings while helping others.
Put a policy in the charity's name. You can choose to buy a new life policy in the charity's name or transfer what you already have.
If you transfer your policy to the charity, you can claim an amount equaling the cash surrender value of the insurance (after adjustments like accumulated dividends, interest and any policy loans outstanding). There can be tax implications when donating an existing policy so don't forget to contact your advisor for guidance beforehand.
When you make premium payments to keep a donated policy in force, those payments become eligible for the donations tax credit.
Name the charity your policy's beneficiary. Alternatively, you can retain ownership of the policy and simply name the charity the beneficiary, either by direct designation or through your will. When you die your estate will receive a tax receipt for the death benefit paid. However, your ongoing premium payments won't qualify for the tax credit.
3. Registered Plans
Funds transferred to charity from an RRSP or RRIF qualify for the donations tax credit. If you've been diligently contributing over the years, your registered savings can be substantial, helping you make a larger donation than you otherwise could.
As with life insurance you can name a charity as your registered plan's beneficiary. When your savings are eventually transferred, you're entitled to a tax credit for the value of the plan's assets. Although the donation must be included on your final tax return, the credit can offset any tax liability created by the transfer.
In the meantime, if you have a RRIF you don't have to wait to use it to help charity. Just make a donation with some of the income you regularly draw and receive a tax credit.
Having a spouse or dependent children means there may be tax tradeoffs in donating your RRSP or RRIF. Upon your death your registered assets are eligible to be transferred to your spouse or a dependent child, tax-deferred. If you donate these assets now your family can lose an important tax advantage later. Ask your advisor to help you weigh your options.
Avoiding the traps
Charitable giving may be rewarding, but it can turn out just the opposite if not planned properly.
Here are some common traps to watch for.
- Donating more than you can afford. Before making a large donation, ask yourself, "can I afford it?" Your generosity could lead you to give away more than you should, leaving you with less of a cushion to take care of your own needs.
One way to keep your giving in check is to donate through your will. Delaying your gift until after death ensures you won't give away too much too soon. Through your will you have the opportunity to direct how your legacy is to be used. And, if your intentions, or resources, change, you can simply update your instructions.
- Donating more than you intended. Volatile markets, shifting real estate values and life's twists and turns mean your net worth can change unexpectedly. This makes it risky to leave a specific dollar amount to charity.
Here's an example of what can happen. In your will, say you want $500,000 of your $1 million dollars in assets to go to charity. Years later when settling your estate your heirs find that your net worth hasn't grown. Worse, it's shrunk to $800,000, because the charity has been given a set amount, your estate's drop in value solely impacts your children's inheritance – probably not what you would have wanted. The solution? Make your donation a percentage of your estate instead.
- Not fully utilizing the tax credit. If you're planning a large donation, do some tax planning beforehand to see whether you'll be able to use up the tax credits you'll receive.
To be tax efficient with your donations, your net income and taxes owing must be high enough to 1) fully utilize the donations credit this year, and 2) maximize the credit from any excess donations carried over to other years. Anything less and part of your tax benefit is wasted.
An alternative approach is to spread out your gift over several years through smaller annual donations, making it easier to take full advantage of the tax savings.
- Triggering alternative minimum tax. Alternative minimum tax(AMT) becomes an issue when you have a high income but are making heavy use of tax deductions and credits. Declaring income from a gift of property in a year where you already have significant capital gains, for example, could trigger AMT. Ask your advisor to help you work through the numbers before you donate. Otherwise you might be surprised to find that instead of saving tax, you're paying more.
Want to do more?
If you have substantial assets to give, want to take a more active role in managing your donation or wish to leave an enduring legacy, creating a donor advised fund or private foundation can be rewarding alternatives. Speak with your advisor to learn more.
Charitable giving is something most of us want to do. But how you give can go a long way to maximizing value for you and your charity.
Like any part of your financial plan, your donations strategy has to be flexible to adapt to your changing circumstances and desires, and should be reviewed regularly. Proper planning is the key.
If you're thinking of giving this tax year, you must do so by December 31st. Don't wait to get started. Work with your BlueShore Financial advisor and get the most out of your charitable donations.