Tax-efficient gifts: sharing donation credits at death

Donating to charity can be rewarding, both personally and financially. Donation tax credits vary depending on the donor’s province of residence, ranging from 40% in Ontario to 53% in Quebec (not including the 16.5% federal tax abatement for Quebec residents).

The tax system’s flexibility allows families to maximize the value of their donation credits. Donations made by an individual can be claimed in the current year (up to 75% of net income for the year) or can be carried forward and claimed in any of the next five years. In addition, CRA administrative practice is to allow donations made by an individual to be claimed by either the individual or her spouse or common-law partner (CLP) for the year the donation is made or any of the next five years, subject to net income limits.

Read: Tax benefits of new donation rules

This flexibility carries over to the year of death: Donations made by will (or by beneficiary designations on RRSPs, RRIFs, TFSAs or life insurance) are deemed made by the deceased immediately before death, allowing either the deceased or the deceased’s spouse or CLP to claim the tax credit. Consider the following example:

Fred, a long-time volunteer at his local hospital, recently died. In his will, he made a significant donation to the hospital, a registered Canadian charity. The donation was deemed made by Fred immediately before death, allowing his executor the option to claim the resulting tax credit on Fred’s terminal tax return (or his return for the year prior to death) subject to net income limits. Alternatively, the credit could be shared with Susan, Fred’s wife and executor. Susan chose to claim the donation credit on her tax return for the year of Fred’s death. This made the most sense for the family because Fred died earlier in the year and did not have enough tax liability for the year of death (or year prior) to apply the credit against.

The 2014 federal budget announced new rules designed to add flexibility to donations made at the time of death. Instead of donations by will (or RRSP, RRIF, TFSA or life insurance designations) being deemed made by the deceased immediately before death, as of 2016, the donation will be considered made by the deceased’s estate.

This change will allow the donation credit to be claimed by the estate (a separate entity from the deceased and his terminal return). Alternatively, if the donation’s made within 36 months of death, the executor can allocate the donation to the deceased for the year of death or the year prior. In other words, while the current rules mean only the deceased (or his spouse or CLP) can claim donations made by will or plan designation, the new rules make it possible for the estate to benefit from the donation where appropriate.

Read: Make sure clients understand Graduated Rate Estates

While the change adds flexibility, it also compromises some planning opportunities available under the current rules. Specifically, the ability to share donations at death with a spouse or CLP will no longer be available beginning in 2016. Because donations at death will be considered made by the deceased’s estate (rather than the deceased, as under current rules), the opportunity to share credits with a spouse or CLP will no longer be available, even if the donation is allocated to the deceased for the year of death. CRA confirmed this in an interpretation document issued in January of this year (2014-0555511E5). With this in mind, we’ll recast Fred’s situation as follows:

Fred, a long-time volunteer at his local hospital, recently died. In his will, he made a significant donation to the hospital, a registered Canadian charity. Because the donation was considered made by his estate, and also because the donation was made within 36 months of Fred’s death, his executor had the flexibility to allocate the donation among any of: the estate for the year the donation was made; an earlier taxation year of the estate; or to Fred for the last two taxation years of his life, subject to net income limits. Because the opportunity to share resulting credits with a spouse or CLP was not available, Fred’s executor, Susan, allocated and claimed a portion of the credits on Fred’s terminal tax return. But, because Fred did not have enough tax liability for the year of death (or year prior) against which to apply the credit, excess credits not claimed by Fred or his estate went unused.

Advisors, clients and executors should understand the new estate donation rules that take effect on January 1, 2016. Those who are familiar with the rules are best positioned to take advantage of the benefits while also avoiding, to the extent possible, the downside of the new rules.