News Article

Charitable Bequests: How Do the New Rules Work?

Posted: April 19, 2017 By: Walter Harder
Posted in: Breaking News

Filing a 2016 tax return for a deceased taxpayer? Then be aware that as of January 1, 2016, new rules apply to charitable donations made by will.

For deaths before 2016, donations made by will were deemed to have been made immediately before death and were thus claimed on the final return of the deceased, or carried back to offset taxes payable for the year prior to death. If the deceased had a spouse, the donation credit could be used by that spouse also in the year of death or the subsequent four years. If there was no surviving spouse and the donation credit was not used up on the final return or the immediately preceding return, the credit was lost.

In an effort to minimize this waste of donation credits, the rules have been changed. Under the new rules, the donation is no longer deemed to have been made immediately prior to death but is recognized only when the donation is actually transferred to the charity. The donation credit is then claimable by the estate.

However, if the donation is made within 60 months of the date of death either by the graduated rate estate for the deceased or its successor trust, the trustee has many options for claiming the donation credit. They may claim the credit:

  • On the trust return for the year of the donation (up to 75% of the trust’s net income)
  • On a trust return for a prior year (up to 75% of the trust’s net income)
  • On the final return of the deceased (up to 100% of the deceased’s net income)
  • On the return for the year prior to death (up to 100% of the taxpayer’s net income for the year)
  • On any of the trust returns for the subsequent four taxation years (up to 75% of the trust’s net income)

These new rules offer more opportunity to use up the donation credit, but only if the estate earns income. The only loser in this change is the surviving spouse, who can no longer use the donation credit for the bequest.

Here’s an example of how this will work.

   

Esther is a widow and died in March 2017. In her will she left $250,000 to the Canadian Cancer Society.

Esther’s net and taxable income in 2017 was $30,000, consisting of OAS, CPP, investment, and RRIF income. However, an additional $200,000 had to be added to her income on the final return because of accrued capital gains in her non-registered investments and her RRIF balance at death.

Her net and taxable income for 2016 was $120,000 (from the same sources).

Assume her estate continued to earn income from Esther’s non-registered investments and RRIF proceeds of $40,000 annually and the trustee transfers the $250,000 to the Canadian Cancer Society in 2020.

For 2017, Esther’s final return will show taxable income of $230,000 with taxes payable of $87,584. These taxes will have to be paid from the estate as the charitable donation credit is not available by the time the return is due.

Each year, the estate will file a tax return to report the $40,000 income (assume no allocation to heirs is possible). In 2020, when the trust transfers the $250,000 donation, the donation tax credit becomes available. The trustee can then apply the rules detailed above to allocate the donation to the years where it is most beneficial.

The best case for Esther’s estate is to apply $180,900 of the donation credit to the final return. This reduces her federal taxes to zero, leaving the OAS repayment payable and some provincial taxes. The result is a refund of $84,925 when the final return is adjusted. The remaining $69,100 could be applied to any of the available years as the credit rate would be the same. However, the most efficient method would be to allocate the entire remainder to the 2016 return resulting in a further refund of $31,929. The cost of splitting the donation credit among more years is $41 for each year because the first $200 credit is at a lower rate.

The following table summarizes the taxes before and after the donation is made.

Year Taxable Income Taxes as Filed Max Donation Allocation Allowed Donation Applied Taxes after Donation Credit Tax Savings
2016 $120,000 $41,666 $120,000 $69,100 $9,737 $31,929
2017 $230,000 $89,672 $230,000 $180,900 $4,747 $84,925
2018 $40,000 $8,240 $30,000 $0 $8,240 $0
2019 $40,000 $8,240 $30,000 $0 $8,240 $0
2020 $40,000 $8,240 $30,000 $0 $8,240 $0


These new rules will make decisions on the final return more complicated if there is a bequest and a surviving spouse. For example, if Esther had not been a widow but was married at the time of her death, the additional $200,000 income could have been eliminated by transferring the RRIF to her survivor and transferring the capital assets to her survivor at cost.

In this case, the estate would have no income to use up any credit and the donation credit could only be applied to the $120,000 in 2016 and $30,000 in 2017. The result would be a waste of $100,000 of the donation credit. To benefit from the credit, more than $100,000 would have to be included on the final return by not transferring the full amount of the RRIF and/or not transferring some of the non-registered investments at cost.

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