Gifting Securities Can Save You Tax
Do you make large charitable donations? Do you frequently sell securities and realize capital gains on which you have to pay tax? If so, you may be able to reduce your capital gains tax by gifting these securities directly to a registered charity.
How is this possible?
The May 2, 2006 federal budget made it more attractive to gift securities to charities. Effective budget day, charitable donations of publicly listed securities to registered charities are exempt from capital gains taxation on gains triggered as a result of the gift. This change represents a significant improvement from the tax treatment of donations of securities that had been in place previously, where 25% (one half of the regular capital gains inclusion rate of 50%) of any capital gains triggered were taxed.
There was also good news for individuals exercising stock options. Since 2000, an individual who makes a qualifying charitable donation of listed publicly traded securities that were acquired with employee stock options was eligible for a special deduction that had the effect of taxing the associated employment benefit at a reduced capital gains inclusion rate of 25%. For donations of eligible securities made on or after May 2, 2006, the effective inclusion rate for such donations has been reduced to zero. To be eligible for the deduction, the shares must be donated in the year and within 30 days of the options being exercised. In addition, the existing conditions related to donations of publicly traded shares, eligible charities and stock option deductions must be met.
An employee may also be allowed to deduct a portion of their stock option benefit if the proceeds from the disposition of the securities acquired through the stock option plan are donated. To qualify for this deduction, the employee must direct a broker or dealer who is appointed by the grantor of the option, or by an entity not dealing at arm’s length with the grantor, to sell the securities immediately and donate all or part of the proceeds of the disposition to a qualifying charity. The deduction will be equal to the amount that would have been deductible had the securities been donated as described above, and prorated to reflect the proportion of the proceeds that are in fact donated.
What is a qualifying security?
Investments that will be eligible for this special tax treatment include:
- shares, rights and debt obligations (typically bonds or debentures) that are listed on a prescribed stock exchange,
- shares of a Canadian public mutual fund corporation and units of a mutual fund trust,
- interests in a segregated fund trust, and
- a bond, debenture, note or mortgage of the Canadian Federal or provincial governments.
Prescribed stock exchanges generally include the Canadian Venture (Tiers 1 and 2), Montreal, Toronto and Winnipeg stock exchanges and most major foreign stock exchanges such as New York and NASDAQ.
When does it make sense to gift securities?
There is a point you should keep in mind. You will only benefit from this tax measure if you gift shares that have an accrued capital gain. If your shares have not appreciated in value since you purchased them or have even declined in value, you will not save any capital gains tax by donating them to a charity. You will, of course, still get a charitable donation receipt for the value of the shares but it would be no different than donating cash.
If I donate securities, how will my taxes be reduced?
This is probably best explained by an example. Let’s assume you wish to make a gift to your favourite charity of $5,000. You are also going to dispose of the shares of a publicly traded company that you’ve held for several years. The shares, currently worth $5,000, were purchased by you several years ago for $1,000 and therefore have an accrued capital gain of $4,000.
Let’s compare the cost of the donation to you, assuming first, that you sell the shares and donate $5,000 in cash and second, that you donate the shares directly to the charity.
Under both scenarios, you will have a disposition of your shares for tax purposes at their fair market value of $5,000. Assuming your marginal tax rate is 46.4% (this is the top tax rate for an Ontario resident in 2006), you would have to pay the following tax:
Tax on Capital Gain |
|
Sell Shares /
Donate Cash |
Donate Shares
to Charity |
Proceeds of
Disposition |
$5,000 |
$5,000 |
| Cost of Shares |
(1,000) |
(1,000) |
Capital Gain
|
$4,000 |
$4,000 |
| Taxable Portion of Gain @ 50% |
$2,000 |
|
@ 0%
|
|
$0 |
Tax @ 46.4%
|
$928 |
$0 |
The difference in the amount of tax you must pay is directly the result of the difference in calculating the taxable portion of your gain!
Under both scenarios, you will still get a tax break based on the value of your donation. Assuming the individual pays tax at the top rate in Ontario, the tax savings from the gift will also be calculated at 46.4%. Therefore, the tax break will be 46.4% of $5,000 or $2,320, and your $5,000 donation will cost you the following:
Cost of Donation to You |
|
Sell Shares /
Donate Cash |
Donate Shares
to Charity |
Amount of
Donation |
$5,000 |
$5,000 |
Add: Tax on
Capital Gain |
928 |
0 |
Less: Value of
Donation Tax Credit |
(2,320) |
(2,320) |
Cost of Donation
to You |
$3,608 |
$2,680 |
By gifting your shares directly to your favourite charity rather than selling the shares, you will have saved $928 in tax on your capital gain. Generally, if you are going to make a donation and you are also selling securities, you should consider donating the securities to the charity instead.
How will the charity benefit from my gift?
Many charities actively pursue gifts of securities from donors. They work with brokerage firms to turn your gift into cash. Therefore, whether you give cash or securities, the charity will end up with the full amount ofyour donation to use in their programs.
Contact your BDO advisor if you have any questions on how to donate securities to your favourite charity.
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