Charitable donations are an effective way for people to reduce their tax bills while alive and at death. Last year’s budget changed some of the donation rules, and this article will examine how these changes will impact estate planning.
The old rules
Prior to Budget 2014, if someone made a charitable gift in her will, or donated in the year of death, the donation was deemed to have been made immediately prior to her death. As a result, the value of the donation tax credit was based on the value of the gifted asset at the time of death, even if the value of that asset was different when actually received by the charity.
The effect of this rule, which also applied when a donation was made by beneficiary designation from an RRSP, RRIF, TFSA or life insurance policy, was that an estate could not benefit from an increase in value of the donated asset between death and distribution.
The donation tax credit could be used in the deceased’s final tax return to a maximum of 100% of net income in the year of death, or the previous year if the full amount was not used on the final tax return. This limited the ability of some estate trustees to be able to take full advantage of the charitable tax if the estate donation was not structured properly in the will. The old rules also created complexities around valuation of the asset gifted to charity.
For example, say John died in April 2012 and he wanted to donate $110,000 from his non-registered account upon death. When the donation was actually made in March 2015, the value of the account was $130,000. Under the old rules, the donation was valued at the date of death amount — $110,000 – not $130,000, and John’s estate was not able to benefit from the appreciated value of the asset.
The new rules
Budget 2014 proposed rules that improved the flexibility of estate donations, especially if the value of the donated asset increased between date of death and date of donation. Bill C-43 enacted these proposals (with slight variations) on December 17, 2014.
First, for deaths that occur in 2016 and subsequent years, donations made by will or by beneficiary designation from an RRSP, RRIF, TFSA or life insurance policy will no longer be considered to have been made immediately prior to death. As a result, the actual value of the donated asset at the time the gift is received by the charity will form the basis for calculation of the charitable tax credit.
Second, and again effective for 2016, the estate trustee will be able to allocate the donation tax credit among the following:
- the taxation year of the estate in which the donation is made;
- an earlier taxation year of the estate; or
- the last two taxation years of the deceased person.
An estate is still able to claim donations in the year they are made, or up to five years after the donation.
These changes will allow for greater flexibility when donations are made upon death. For donations not made directly by designation, these new rules only apply if the donation is made from a Graduated Rate Estate (GRE). Bill C-43 introduced the GRE, which is established as the consequence of someone’s death and qualifies as a testamentary trust.
There are quite a few rules to be aware of:
- the GRE will only be eligible for graduated tax rates for 36 months;
- the deceased can only have one GRE; and
- donations can only be claimed in the GRE.
As a result, if you have clients who may have more than one trust or estate upon death (which may arise for example in the case where a client has more than one will) it will be important to determine which estate will be designated as a GRE to ensure that all donation tax credits will be utilized. This rule adds a layer of complexity to estate planning and is definitely something you should be conscious of when speaking with your clients.
How will the changes affect your clients?
On the positive side, it gives an estate trustee more flexibility when determining where it makes most sense to use the donation tax credit. If the estate owes a high amount of tax, the estate trustee can use the donation tax credit to offset that tax liability. If it makes more sense to use the credit in the deceased’s final return, that’s also possible.
In many situations, the donation tax credits are best used in the deceased’s final tax return, since that is where much of the tax liability is triggered. This is because of the deemed disposition rule as well the tax implications on RRSPs / RRIFs where no tax deferral opportunity exists.
Since the estate trustee has more flexibility in using donation tax credits, it is no longer imperative to ensure the will is worded in such a way that clearly indicates whether the gift is made by will or by the estate (that was an issue that created all sorts of confusion under the former regime).
A new rule that your clients should be aware of is that as of 2016, gifted property must have been received by the estate as a result of someone’s death. What this means is that if funds within an estate are tied up for more than 36 months, the estate trustee is not permitted to borrow money to make a donation under the new rules. If the donation is made after 36 months, the donation tax credit is only available to the estate in the year the donation is made.
It is important for you and your clients to be aware of these changes so you can plan accordingly and ensure donations are done in a way that best benefits your clients and their estates.