Incorporated business owners who wish to donate to charity often wonder whether the donation should be made by the business or by the shareholder personally. To advise them properly, there are several factors you should consider and discuss with clients.
It’s important to note that regardless of whether the charitable donation is made personally or by the corporation, there is a limit to the amount that may be claimed. Individuals can claim a non-refundable tax credit on up to 75% of net income. The limit is increased to 100% in the year of death and in the year preceding death. For corporations, the same 75% limitation applies; however, the donation is claimed as a tax deduction against taxable income.
For both people and corporations, if the donation cannot be used in one year, it can be carried forward for up to five years.
Let’s consider three examples to see whether it’s better to donate personally or through a corporation.
Your client is an incorporated business owner who has $10,000 to donate to charity. The corporation is an Ontario-based Canadian-Controlled Private Corporation (CCPC) eligible for the Small Business Deduction, so a $10,000 charitable donation will reduce the corporation’s tax by $1,550 ($10,000 x 15.5%).
If, on the other hand, the client makes a $10,000 donation personally from cash on hand, the tax savings is approximately $4,600 ($10,000 x 46%), ignoring the lower tax credits on donations up to $200. Based on these assumptions, the after-tax cost to the corporation of donating $10,000 to charity is $8,450, compared to a cost to the individual of only $5,400. As a result, it may be more advantageous for the business owner to donate to charity with personal sources of cash.
We assumed the business owner had the money on hand to donate to charity. How might things change if the business owner had to take income from the corporation in order to be able to donate? Let’s look at that situation in more detail.
For your business owner client to have cash to donate to charity, she needs to receive a salary or dividend. Let’s look at a salary example first. In order to withdraw $10,000 from the corporation, the business owner will pay income tax on this additional income. Assuming a 46% tax rate, the business owner will be liable for approximately $4,600 of personal income tax.
Based on our assumptions above, the $10,000 donation to charity will generate a tax savings to the business owner of approximately $4,600. As a result, the additional taxes owing on the salary is offset by the tax credits from the charitable donation. Therefore, if the business owner needs to pull additional salary out of the corporation in order to make a donation, she may be better off simply by having the corporation make the donation. In addition, the donation creates a cash flow problem, since the business owner will have to come up with additional sources of cash in order to contribute the full $10,000 to charity.
Is it more beneficial for the business owner to take dividends? If dividends are paid out of the business, the business owner will end up with approximately $5,370 after the corporation and shareholder pay tax on the income, representing an overall tax liability (46.3%) similar to that of salary being paid to the shareholder (46.4%). In this situation, as above with the salary example, because the business owner will receive a non-refundable tax credit of approximately $4,600, the net tax savings from this strategy would be negligible. As a result, it may be better for the client to make the donation directly from the corporation rather than paying out income to donate.
Opco or Holdco donation?
Another factor to consider is whether the corporation has active business income, or whether it is an investment holding company. We’ve seen that in the case of active business, it may make more sense for the client to make the charitable donation with personal sources of cash (Example 1). However, what if the corporate dollars comes from a holding or investment corporation? In that case, it may make sense to have the holding or investment corporation make the charitable donation instead of a personal donation. Why? Because taxation of investment income within a corporation is typically much higher than active business income in a CCPC.
Let’s look at an example. If $10,000 is donated through an investment/holding company, the corporation’s tax will fall by $4,617. As you can see, the end result is essentially the same as if the business owner were to donate personally as outlined in Example 1. Therefore, the decision whether to donate personally or through a holding or investment corporation is indifferent from a tax perspective. As a result, there are two non-tax questions to answer:
- where does the business owner have the money to donate, in the corporation or personally? and
- does she want the donation in the name of the corporation, or in her name?
When a business owner asks you the best way to make a charitable donation, determine the most cost-effective way method. It’s not always best to donate personally.