Prisha and Ishaan live in Ontario. Prisha still works and has no intention of slowing down, while Ishaan is semi-retired. They support several charities in their community, donating 10% of their incomes each year. However, they have never fully understood how income tax credits for charitable donations work, and decide to do some research.
The first thing they realize is that the system is complex.
Once a taxpayer reports the eligible amount of a charitable gift on their tax return, the amount is used to calculate a non-refundable tax credit, which varies based on three factors: the province where the taxpayer lives, the amount donated and the taxpayer’s tax bracket. Adding to the complexity is that the tax credit is a function of the applicable provincial rate added to the federal rate.
In Ontario, where Prisha and Ishaan live, there are three tiers of tax credits, as shown in the table below.
Table 1: Three tax tiers for charitable donations with corresponding tax rates
|Total annual donations up to $200||15%||5.05%|
|Total annual donations over $200 when taxable income is less than $221,709||29%||17.4%1|
|Total annual donations over $200 when taxable income is more than $221,708||33%||17.4%1|
1Includes Ontario surtax, which only applies after Ontario tax of $4,991 (20%) and $6,387 (36%)
Applying the system to Prisha and Ishaan
Prisha and Ishaan are curious and decide to re-examine their 2021 tax returns to determine the income savings from their donations. They calculate their taxes without any charitable gifts and compare them to their actual returns claiming the charitable gifts.
Table 2: Tax comparison based on charitable donations
|No charitable gift||Charitable gift|
|Charitable tax credit generated by the gift||$0||$0||$2,291||$16,571|
|Tax owing||$8,002||$137,825||$5,711 ($8,002–$2,291)||$121,254 ($137,825– $16,571)|
|Total household tax owing||$145,827||$126,965|
Had they contributed nothing to charity, their combined taxes would total $145,827. However, they actually owed $126,965, a difference of $18,862. Looking at it another way, their generous gifts, which totalled $38,050, cost the couple $19,188 on an after-tax basis.
As happy as they are with their research, they find a way to be even more tax-efficient in their gifting. Spouses may share tax receipts, and it’s often beneficial for the higher-income spouse to claim all the donations. In this case, it would have been slightly beneficial to have Prisha claim all donations.
Table 3: Tax comparison based on which spouse claims charitable donation receipts
|Ishaan claims all charitable receipts||Prisha claims all charitable receipts|
|Charitable tax credit||$17,603||$0||$0||$19,117|
|Total household tax owing||$137,825||$126,710|
If Prisha had claimed all donations, she and Ishaan would have saved an additional $255 in tax ($126,965 – 126,710).
If Ishaan had claimed all the donations, the couple would have paid more tax. This is because a non-refundable tax credit can be used only to eliminate tax owing, not to create a tax refund.
There is also a limit to how much a taxpayer may claim, equal to 75% of their net annual income each year. In Ishaan’s case, this means he would have been unable to claim the entire household’s donations as they exceeded 75% of his income.
The couple’s research also uncovers the tax-efficient nature of a charitable gift as part of an estate plan. At death the contribution limit is higher. A charitable gift made in a will or through a life insurance policy, RRSP or RRIF can be claimed against up to 100% of net income in the final two years of the taxpayer’s life and up to 75% of income over the next five years of the estate. Also, taxpayers who donate certain kinds of capital property in kind — including public securities, mutual funds, cultural properties and ecologically sensitive land — are exempt from the capital gains tax normally owed on disposed property.