Much of the hoopla that followed the Liberals’ election victory was about the middle-class tax cut.

The federal rate on income from \$45,282 to \$90,563 is 20.5% for 2016, down from 22%. That reduction has been paired with a new 33% bracket for income above \$200,000. Establishing a new top rate required the government to tweak 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 that it forgoes tax revenue.

Consider a person who had \$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.

Had the government done nothing more than adjust bracket rates, our middle-class donor making the same donation in 2016 would receive an extra \$400 (33% – 29% = 4%; 4% × \$10,000 = \$400), 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 more than \$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 to donations up to \$200, and 29% generally applies thereafter. However, the higher 33% rate is available if a taxpayer makes more than \$200,000.

To illustrate how this will work, consider a \$10,000 donation made by a donor with taxable income of \$203,000. Of that \$203,000, \$3,000 of income is subject to the new 33% bracket; 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 donor example, the credit would have been \$2,872 (\$30 + [\$9,800 × 29% = \$2,842]).

So, for those at or near the \$200,000 income level, future years’ donations may require more strategic planning.

When a client’s income might fluctuate below \$200,000 in a year, they may want to consider delaying a donation so they can claim a higher credit in a future year, bearing in mind the time value of money and the charitable purpose behind the donation.