Making a charitable bequest is great way to leave a lasting legacy. A charitable bequest, or a gift made through your will, allows you to leave a gift to support charitable causes that you are passionate about. While there may be many personal, non-tax benefits to making a charitable bequest, it can also be used to reduce income tax arising on or after your death. Let's take a closer look at what you need to consider before setting up a charitable bequest.
What are the income tax implications of making a charitable gift through your will?
Charitable bequests are deemed to be made by your estate at the time that the gift is transferred to the charity as opposed to the date of death. Under Canadian income tax rules, a donation tax credit (DTC) may be claimed for qualifying charitable gifts that are made by an individual either through their will, by their estate, or by direct designation, if certain conditions are met. The DTC can be allocated to maximize the benefit of the gift by applying it against income taxes payable associated with the estate or the deceased taxpayer in the most beneficial manner possible. Provincial or territorial DTCs may also be available.
Provided the charitable bequest is made by an estate that qualifies as a Graduated Rate Estate (GRE), there is significant flexibility as to how the DTC can be claimed to reduce taxes. In addition to other benefits, GREs are eligible to apply graduated rates to income that is taxed in the trust. To qualify as a GRE, an estate must meet the following conditions:
- the estate must arise on and as a consequence of the individual's death;
- the estate must be a “testamentary trust” at all times during the 36-month period;
- the individual's social insurance number must be provided in the estate's first tax return;
- the estate must designate itself as the GRE of the individual in its first tax return; and
- no other estate may designate itself as the GRE of the individual.
Care must be taken to ensure that GRE status is not inadvertently lost before the end of the 36-month period. Should an estate cease to be a GRE for any reason, then not only will the estate lose access to graduated tax rates, it will also become ineligible for other beneficial tax treatment associated with GREs, including access to the flexible donation rules.
Are there any advantages to your estate making a charitable bequest?
As mentioned, special rules may apply that provide added flexibility with respect to the allocation of the DTC where a charitable bequest is made by will, as long as it is made by a GRE. Since the GRE can only exist for 36 months following the death of the individual, the donations made by the GRE within this period will qualify for these rules. Donations made by an estate that would otherwise qualify as a GRE (but for the 36-month requirement) within up to 60 months after an individual's death may also qualify for the more flexible donation rules.
Under these rules, the legal representative of the individual's estate can allocate the DTC to either:
- the taxation year of the GRE in which the donation is made;
- an earlier taxation year of the GRE; or
- the last two taxation years of the deceased individual.
Any estate can claim a DTC for a donation in the year in which the donation is made, or in any of the five subsequent years. However, if the estate does not qualify as a GRE, the DTC cannot be applied to an earlier taxation year of the estate or to any of the individual's last two taxation years.
What type of assets can you donate?
A charitable bequest can be a gift of money or other property. The type of asset that you choose to donate can impact how the donation is treated for income tax purposes. For example, where a gift of qualifying securities made by the GRE, an exemption may be available from capital gains taxation that would otherwise apply. Qualifying securities generally include publicly traded shares and units of mutual fund trusts. Under this rule, the capital gain realized on the disposition of such property will not be subject to tax, while the fair market value of the property donated can generally be claimed as a donation credit. A similar rule applies to gifts of ecologically sensitive land. Be aware that where there is an advantage associated with the gift (e.g., partial consideration is received in some manner), then only a portion of the capital gain may be eligible for the zero capital gains inclusion rate.
Where a registered retirement savings plan, registered retirement income fund, tax-free savings account, or life insurance proceeds are donated by making a direct beneficiary designation to a charity on death, a DTC may be claimed by the estate, assuming all other conditions are met.
What do you need to consider before making a charitable bequest?
Charitable bequests should be planned in advance to ensure they are made in the most tax-efficient manner possible. Keep these key considerations in mind when making a charitable bequest:
- Ensure the estate maintains its GRE status — As mentioned, to benefit from the more flexible tax rules associated with making a charitable bequest, the estate making the gift must be a GRE. This means avoiding any transactions that may cause your estate to lose its status as a GRE. This can be difficult in cases involving complex estates or those under litigation.
- Matching the donation credit to a tax year with taxable income (and taxes payable) is crucial — As a DTC can only be utilized in a tax year where there are taxes payable, planning must be done prior to death to ensure the credit claim will be available in the appropriate year. For example, consideration must be given where a spousal rollover, a capital gains exemption, or a nil inclusion rate on capital gains applies in a tax year. The result may be little to no taxable income, while a donation on death results in a sizable donation credit. Your BDO advisor can assist with the planning to ensure the donation credit is not lost.
- Determine if you wish to give a certain amount or a percentage of your estate – If a driving force of your donation is to reduce tax, then the exact amount of the donation required to reduce as much tax as possible will be somewhat of a moving target. If you donate a predetermined sum (for instance $100,000) in your will, then you will need to review your will more often to determine if this is enough or too much. On the other hand, gifting a percentage of your estate could allow for some flexibility as your asset values fluctuate.
- Consider gift timing – f your goal is to ensure your family is supported while also making a gift to charity, you may want to consider revisiting your financial situation to determine whether making a gift during your lifetime, rather than after your death, is possible.
Putting it all together
When done properly, charitable bequests can benefit both the donor and the causes they care about. It's clear that planning your donations in advance will ensure the most beneficial tax outcomes. A well drafted will—that considers your specific assets, beneficiaries, and the tax implications to your estate—will help your family deal with your estate and carry out your wishes during a very difficult time. Contact your BDO advisor to assist you when planning to make a charitable bequest.
The information in this publication is current as of May 4, 2022.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.