Donations by Will
It is very common for Will-makers to include charitable bequests in their Will.
The executors of the estate may not be in the position to fulfill the wishes of the deceased in a timely manner because the estate funds are not readily available.
It may take a few years before the donation can be made by the estate, and when all is done, the question is . . . who can claim the charitable donation tax credit?
Prior to 2014, if someone made a charitable gift in his Will, or donated in the year of death, the donation was deemed to have been made immediately prior to his death. As a result, the value of the donation tax credit was based on the value of the gifted asset at the time of death, even if the value of that asset was different when actually received by the charity.
That rule also applied when a donation was made by beneficiary designation from an RRSP, RRIF, TFSA, or life insurance. The negative effect of the rule was that an estate could not benefit from an increase in value of the donated assets between death and the actual distribution.
Budget 2014 changed the rule; for deaths that occur in 2016 and subsequent years, donations made by Will or beneficiary designation from an RRSP, RRIF, TFSA, or life insurance will not longer be considered to have been made immediately prior to death. Instead, those donations will be deemed to have been made by the individual’s estate.
The result of the revised rule is, the actual value of the donated asset at the time the gift is received by a qualified charity, will be the basis for the calculation of the charitable tax credit.
For example, the beneficiary of a RRIF is a charity; at the time of death, the value of the RRIF is $100,000 and, at the time of distribution, the value is $120,000. The value of the donation would be $120,000. Under the old rule it would have been $100,000.
If the estate is a graduated rate estate (GRE), the estate’s legal representative will be able to allocate the donation tax credit to:
- the estate in the year the donation is made;
- an earlier taxation year of the estate;
- the last 2 taxation years of the deceased person.
Any unused donation amount can be carried forward for up to 5 years from the year in which the donation is made and claimed by the estate. It is important to understand what a graduated rate estate is, to take advantage of the added flexibility allowed by the new rule in allocating the donation provided for in the Will. The concept of a GRE was introduced on December 31, 2015. A graduated rate estate of an individual at any time is the estate that arose on and as a consequence of the individual’s death; it is a Testamentary Trust and it is eligible for graduated rates only for 36 months from the death of the individual.
Only one graduated rate estate for the individual is allowed so it is important that the GRE is designated on the first T3 estate income tax return.
The graduated rate estate is taxed at the normal graduated tax rates. After the 36 months from the date of death if the estate is not wrapped up, it will be subject to the highest marginal tax rate, currently 49.80 per cent.
If the donation is made after the estate ceased to be a graduated rate estate, 36 months after the date of death, the donation can be claimed only by the estate. If the estate has no income in the year the donation is made, then the benefit of the charitable donation credit is lost.
It is important to know that gifted property must have been received by the estate as a result of someone’s death. If funds of the estate are held up for more than 36 months, the legal representative is not allowed to borrow money to make the donation when the estate is still considered a GRE.
Due to the deemed disposition rules at time of death, the final tax return may be subject to higher tax because the value of RRIF and RRSP is 100 per cent taxable and any accrued value of investments portfolio and real estate is 50 per cent taxable.
Under the new rules, the tax credit from donations will not be available in the final tax return until the donations are actually made. In most cases, the donations will be made after the grant of probate is received and the estate may have little if no income at all. The estate’s legal representative will be allowed to carry back the donation credit to the final tax return and recover the tax paid.
Because the value of the charity tax credit is based on the value of the gifted asset when donated, it is possible for the estate to realize a gain on the increased value of the asset from time of death to date of distribution.
Under the new rule, the legal representative has the flexibility to decide how to allocate the donation in the most tax-effective manner.
For example, the Will stipulates that a property with the original cost of $100,00 is to be donated to a qualified donee. At time of death, the property market value is $200,000; therefore the deceased will be subject to tax on 50 per cent of the $100,000 capital gain.
The estate is wrapped up 30 months after date of death and the property donated and transferred to the donee, at which time the property’s market value is $280,000. The estate will be subject to tax on 50 per cent of the $80,000 capital gain.
The legal representative will have the flexibility to claim part of the donation tax credit in the estate tax return to offset the tax on the $40,000 taxable capital gain, and carry back the remainder of the tax credit to the deceased’s final tax return.
If the marginal tax rate was higher in the final tax return of the deceased than the tax rate of the estate, the legal representative can opt to pay the lower tax on the estate return and carry back all the donation tax credit to the final tax return of the deceased. Unless the legal representative is an accountant with income tax experience, this task may be overwhelming for any trustee.
In the event the estate is more complicated and funds are not available for distribution for a longer time, it is very important to ensure funds are distributed to the charity before the estate ceases to be a graduated rate estate, which is 36 months after time of death.
Andréa Agnoloni, CPA, CGA, Notary Public, is a Principal with EPR North Vancouver, an Independent Member Firm of EPR Canada Group Inc.
Posted in Personal Planning