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There can be tax advantages to donating money to a charity at death, but don’t let your clients waste those advantages.

A charitable gift in the year of death, including a gift made by will, can shelter up to 100% of net income earned that year.

By contrast, a gift made in any other year can shelter only 75% of net income.

Read: Use charitable life insurance to trigger a tax receipt

Plus, any tax credit left after sheltering net income earned in the year a client dies can be used to shelter up to 100% of net income earned the prior year.

However, there are two situations where clients risk wasting the tax credit associated with charitable gifts made by will.

They are:

  1. Executor’s discretion

    Take the case of Judy, a mother of three, (including one disabled adult child, Jordan). Judy’s will asks her executor to make a bequest of any amount to Judy’s chosen charity. The rest of the estate will be divided among her children.

    Since her executor can choose the amount of the bequest, the CRA considers the gift to be from the executor on behalf of the estate, and not from Judy.

    As a result, the resulting tax credit will not shelter any of Judy’s net income earned the year she died (or the year prior).

    Read: Tax returns reveal a lot about clients

    Moreover, only 75% of net income generated by the estate in that year can be sheltered by the donation tax credit. If the estate didn’t earn much income on its assets in the year Judy died, the donation tax credit is mostly wasted.

    While the unused credit can be carried forward for five years, this won’t help Judy’s estate, because her children can’t use the credit when the estate is wound up.

    This problem could have been avoided if Judy had specified a fixed sum or percentage of the estate to be given to charity.

  2. Trustee’s discretion

    Suppose Judy created a testamentary trust for Jordan. Her intent is to have whatever’s left after he dies go to charity. The charity would issue a tax receipt for the year of Judy’s death, based on the value of the charitable gift.

    That value would depend on a number of factors, including the amount in trust for Jordan, his life expectancy, the projected inflation rate over his lifetime, and the anticipated rate of return on the trust capital.

    If the will gives the trustee discretion to make capital distributions to Jordan, the CRA reduces the value of the charitable gift.

    Read: Talking charity

    In fact, if the trustee can make unlimited capital distributions to Jordan, the CRA values the donation at $0 because the charity may receive nothing when Jordan dies.

    What’s more, even if no capital is ever paid to Jordan, the capital distribution to the charity after Jordan’s death won’t be viewed by the CRA as a gift—and therefore won’t be eligible for a tax receipt.

    CRA only considers the gift made under the will—the remainder interest in the trust, which the CRA valued at $0—to be eligible for a donation tax credit.

Mythbuster

Tax rules mean clients need to predict when they’ll die. Not true. The Income Tax Act treats a charitable gift made in a will as a charitable gift made immediately before death.

Originally published in Advisor's Edge

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BRIAN.WEATHERDON.7

But remember also to apply excess donation credit to year preceding death. From CRA website:
“On the return(s) for the year of death, you may not be able to claim all of the gifts the deceased made in the year of death. In that case, you can ask us to adjust the deceased’s return for the preceding year to include the unused part of these gifts.”

Wednesday, Nov 7, 2012 at 3:22 pm Reply