Donation Incentives: The Canadian Advantage
Canada has the most generous tax incentives for charitable giving in the world, but their nature and extent are largely unknown to Canadians. Why does this paradox exist? There are practical issues that shape our understanding of charitable tax incentives and some practical benefits.
For starters, it is helpful to understand that the Canadian tax system is grounded in unspoken social policy: we all must contribute to society, but there is a choice whether you do so by paying taxes or giving to charity. It’s a concept that places great value on the contribution of charities.
Historically, you would get your taxes back through the charitable tax credits, but still be out of pocket. Since 2016, due to federal tax increases, top marginal tax rates in six out of 10 provinces are now greater than 50%. A higher tax rate produces a larger tax credit. Now, with 50%+ rate rates, there may be little financial difference between donating and paying taxes.
Despite the generous savings, why is our system of donation tax benefits so poorly understood? At the top of the list is a positive factor: most donors are primarily altruistic. We donate to support important causes and to address needs in society. Our giving is an outgrowth of values, beliefs and community commitments. Tax savings enable giving, but do not motivate it.
Another reason is the opaque nature of the Canadian system. When we do try to calculate tax credits in advance, or at tax time, it is difficult. Despite the prevalence of online calculators, the Canadian tax system is complex. Even Canada Revenue Agency’s new donation calculator is incomplete and requires extensive footnotes.
Tax credits
Let’s start with the basics. Canadian registered charities issue donation receipts, which the taxpayer reports on his or her tax return. Spouses may share receipts. A receipt generates refundable tax credits that are claimed against net annual taxable income. Credits, however, vary by province, the amount donated, and the taxpayer’s tax bracket and income.
Credits are different than deductions and better for most taxpayers. A deduction reduces gross income and the benefit will always equal the taxpayer’s average tax rate. A tax credit is claimed against net income, that is, the taxable income that remains after deductions are applied. Tax credits are more beneficial for most taxpayers because they are tiered. It is possible, especially for Canadians who give more than $200 per annum, to receive a tax credit at a higher rate than their average tax rate. A taxpayer may get back more in tax per dollar than they are paying.
How much more? That depends on the province. There are federal and provincial donation tax credits. On the first $200 of total annual donations, the rate is 15% federally. Provincially it is between 5.05% (Ontario) and 20% (Quebec). The combined rates are therefore 20.5% to 35%. Anything more than $200 in total giving automatically jumps to a tax credit at the highest provincial tax rate in most provinces and to 29% federally. Tax savings are between 40.1% and 50% for donations more than the $200 threshold. This is higher than the average tax rate of middle income Canadians.
Ontario and Alberta are exceptions. Ontario tax credits increase to 40.16% for more than $200 and then climb to 50.41%, just less than the highest marginal rate of 53.8%. Alberta has the most generous rate, which jumps to 50% for every taxpayer – higher than the top marginal rate of 48%.
As of 2016, tax credits have increased with tax rates for the highest income Canadians. The fine print is that Canadians can only claim the top donation credit rate against income of more than $200,000. The combined federal and provincial top marginal rates are between 47.7% and 54%, although the tax credit is often slightly less.
Exceptional gifts
There are three other donation incentives worth mentioning that make Canada a leader. These incentives are generally unavailable for everyday or ordinary donations from income. Instead, they exist for exceptional donations, i.e. larger than average gifts made from the asset or capital pocket (i.e. life savings). Most donors are unaware of these incentives because they only apply to gifts that may be made once or twice in a lifetime. There are three main incentives in this category:
Claim limits
Donors may claim donations equal to 75% of their net annual income each year. For example, if you earn $100,000, you could make and claim gifts of up to $75,000 in a year. At death the claim limit is higher. There is a new category in the tax system called “estate donations,” which includes gifts by will, life insurance policies, and RRSP/RRIF. At death, gifts can be claimed against up to 100% of net income in the final two lifetime years and against up to 75% of income over five years of estate returns. In effect, with proper estate planning, a Canadian taxpayer may eliminate taxes at death by giving to charity and in most cases not disadvantage family heirs.
Claim period
Closely related to claim limits are claim periods. For example, if you donate part of an inheritance and can’t claim it in a single year, you may carry forward the receipt for up to five years against 75% of annual net income. The lifetime claim period is six years in total. As mentioned above, the claim period for an estate donation is up to seven years.
Capital gains exemptions
There is a second tax saving for donors who give certain types of appreciated capital property, such as public securities, cultural properties and ecologically-sensitive gifts. When eligible property is donated in-kind (i.e. not cash) to a charity, the taxpayer is exempt from the capital gains tax normally owed at disposition by sale or personal gift. This incentive can provide up to 27% in additional tax savings, although it is more typically in the 5% to 15% range due to the value of the capital gain.
Add it all up and Canadians have a rich array of donation tax incentives that together surpass other developed countries in the world, even the United States. The greatest incentives are for exceptional gifts of capital, which require both high philanthropic commitment and customized financial and estate planning. These are also the gifts that require financial, estate and/or tax advice.