Much of the hoopla following the Liberal election victory was about the middle-class tax cut. The federal rate on the second income threshold, $45,282 to $90,563, is 20.5% for 2016, down from 22%. That reduction’s paired with a new 33% bracket for income above $200,000.
Establishing a new top rate required the government to tweak the donation tax credit rules. If it hadn’t, all taxpayers below the top bracket would have received an unintended windfall.
Charitable credit structure
Up to now, the charitable donation credit has been 15% on the first $200 of annual donations, and 29% on amounts over $200. These percentages corresponded to the lowest and highest tax brackets. The higher rate on donations over $200 applied regardless of whether the donor’s income is actually in the top tax bracket.
A two-tier credit structure encourages people to donate more than $200. The trade-off for the government, of course, is forgone tax revenue.
Say you earned $80,000 of taxable income and made a $10,000 donation in 2015 (limiting the analysis to federal taxes). The credit is $30 on the first $200, and $2,842 on the remaining $9,800, for a total of $2,872.
Sidestepping unintended consequences
Had the government done nothing more than adjust bracket rates, middle-class donors making the same donation in 2016 would receive an extra $400 (33% – 29% = 4%; 4% × $10,000), reducing tax revenue by the same amount.
At the same time, if the second tier of the credit isn’t in line with the new top bracket rate of 33%, those earning over $200,000 may be less inclined to make large donations.
Multi-step credit calculation
The government’s solution modifies the second tier of the credit calculation. The 15% rate still applies up to $200 in donations and 29% generally applies thereafter. However, the higher 33% rate is available if a taxpayer makes above $200,000.
To illustrate how this will work, say you make a $10,000 donation and have a taxable income of $203,000. Of that $203,000, $3,000 of income is subject to the new 33% bracket, and therefore $3,000 of the donation is entitled to the 33% bracket.
- The first $200 receives a credit at 15% as before. Of the remaining $9,800 to be claimed, $3,000 is entitled to the 33% credit rate and $6,800 is claimed at 29%, for a total of $2,992 ($30 + $990 + $1,972).
- If taxable income had been over $209,800 ($10,000 less the $200 subject to a 15% credit), the credit would have been worth $3,264 ($30 + [$9,800 x 33%= $3,234]).
- On the other hand, if taxable income had been below $200,000, as in our $80,000 example above, the credit would’ve been $2,872 ($30 + [$9,800 × 29% = $2,842]).
So if you’re at or near the $200,000 income level, future years’ donations may require more strategic planning. When income fluctuates below $200,000 in a year, you might consider delaying a donation so you can claim a higher credit in a future year, bearing in mind the time value of money and the charitable purpose behind the donation.