When an individual taxpayer dies, their assets are deemed disposed at fair market value and any inherent capital gain must be reported in the taxpayer’s terminal tax return. This often results in a substantial tax burden, which can defeat an estate. In order to ensure the maximum amount is available for family or other beneficiaries, careful estate planning to mitigate this tax burden is required. Today, most Canadians consider philanthropy or charitable gifting in their estate plan. This article will discuss some of the tax advantages of charitable gifting. Some of the planning challenges are discussed in a separate article.
Commencing on January 1, 2016, where a charitable gift is a “gift by will” made by “direct designation” or made by the estate, it is deemed to have been made by the estate at the time the property is actually transferred. Where a charitable gift is made by a “Graduated Rate Estate” or GRE (generally, this means the gift is made by an estate within 36 months of death and prior to the funding of any testamentary trusts), the Income Tax Act permits the tax credits resulting from the gift to be used against tax payable in any of the following:
- Any year of the estate up to five years after the year in which the gift was made; or
- The last two years of the deceased taxpayer’s life.
In other words, subject to a limit of 100% of net income for the year of the deceased’s death or the year prior, the donation can be applied as a personal tax credit reducing tax payable on the deceased’s terminal tax return for the year of death or the year preceding death, or can be carried forward for use in the estate.
These changes have created some key planning issues:
Flexibility and claim room
Prior to January 1, 2016, donation tax credits could only be allocated against the deceased’s income (unless the gift was considered to have been made by the deceased’s estate) as the gift was deemed to have been made immediately prior to the donor’s death. However, the new rules provide an estate trustee with the ability to assess where the donation tax credit may be applied to realize the maximum benefit where the estate is a GRE. The donation tax credit can be applied against the deceased’s tax liability as indicated above, or can be carried forward for use in the estate for up to five years, ensuring maximum flexibility and benefit.
Prior to January 1, 2016, the value of any charitable gift was deemed to be the fair market value immediately prior to the individual’s death. As of January 1, 2016, the property is valued at the time the property is actually transferred to the charity by the estate. This will simplify the process for charities as they will no longer be required to look back to value property. However, it may also obligate the estate trustee to look forward to determine the anticipated value of the donated property to ensure maximum benefit is received.
Thirty-six month limit
Again, effective January 1, 2016, the charitable donation must be made by a GRE to benefit from the new flexibility. Therefore, any charitable gift should be made within 36 months of death to realize full flexibility. If the gift is transferred after that 36-month period or after any testamentary trust is funded, the tax credits can only be used by the estate or testamentary trust and cannot be used to reduce the deceased’s tax payable prior to death.
A charitable gift as part of an estate plan has important advantages from a tax perspective. Under the new rules, estate trustees will generally have greater flexibility when utilizing tax credits generated from charitable donations. Although these changes are welcome, they will put a greater onus on executors when it comes to the valuation and timing of such gifts.