The federal government’s proposed changes to the capital gains inclusion rate (CGIR) should prompt clients intending to make charitable donations in their wills to revisit their estate plans.
Per the budget, the CGIR for individuals will jump to two-thirds from 50% for annual gains above $250,000, beginning June 25. All capital gains declared by trusts and corporations will be taxed at the two-thirds inclusion rate from the same date. As of press time, Parliament had yet to table enabling legislation.
Adam Aptowitzer, national leader of the charitable and not-for-profit practice with KPMG Law LLP in Ottawa, said donations of capital property with a non-zero inclusion rate become less attractive under the CGIR changes. Such property includes private company shares, real estate and works of art, and donors must pay capital gains tax on the deemed disposition of this kind of property.
“The big thing is on death,” Aptowitzer said, when the deceased is deemed to have disposed of all assets in their estate, making them more likely to hit the $250,000 threshold for individuals. “That’s really where this is going to start applying.”
The CGIR changes will increase the total amount of capital gains tax payable on gifts, while the tax credits generated by donations will remain the same, reducing the overall amount of the offsetting credit available to donors.
“If people would have used the [tax credit] to protect the taxation of certain types of property, it’s going to require a re-evaluation of what’s going to the charity to make sure the numbers still work out,” Aptowitzer said.
Aptowitzer often helps clients who have unique collectibles to donate them and generate excess tax credit amounts that can be applied against the capital gains tax due on a family cottage or other capital property that will be deemed disposed on death.
Those collectibles could include “a model railroad, or somebody may have antique fire hydrants that might be of interest to a particular museum,” he said, adding that loyalty points, such as Air Miles, or comic book collections could also qualify for tax receipts.
Under the new CGIR regime, charitable donations like these will generate lower amounts to offset taxes payable.
For example, assuming a donation tax credit rate and marginal tax rate of 50%, a taxpayer who donates a $10,000 comic book collection that’s accrued $5,000 in capital gains would currently be taxed on $2,500 (half) of the gain, resulting in $1,250 in taxes payable. The gift would also generate a donation tax credit of $5,000, leaving $3,750 in credits to apply against the taxes due on the deemed disposition of the cottage.
When the CGIR rises to two-thirds, not only does the amount owing on the deemed disposition of the cottage increase, but the taxes payable on the donation also rise to $1,667, leaving only $3,333 to apply against the overall tax bill.
“So, the family may in fact have to find some cash to pay the tax on the cottage, or they have to donate more or bigger collections to pay for it,” Aptowitzer said. “Or they may have to realize that this [donation] strategy is less effective overall, and they simply can’t keep the cottage.”
Henry Korenblum, vice-president of sales and tax planning with Oberon Capital Corp. in Toronto, said charities could also suffer indirectly because of the federal government’s decision not to grandfather unrealized capital gains accrued before the June 25 cutoff.
Business owners who have performed an estate freeze or other planning to try to predict their tax bill on death may rethink the distribution of their assets now that they face a larger than expected liability, he said.
“All other things being equal, you’re going to have a potentially higher tax bill in the year of death,” Korenblum added. With more cash needed to fund that higher bill, “charitable giving is one of those things that may suffer.”
Taxpayers should think carefully before accelerating donations or sales of capital property simply to beat the June 25 deadline, Korenblum said. That’s in part because the situation is complicated by the impending new alternative minimum tax (AMT), which kicks in when a taxpayer’s regular income tax calculation comes in too low.
Clients “need to get tax advice and model it out,” he said. “You have to weigh the pros and cons of triggering a tax bill today, as opposed to owing future taxes at a higher capital gains inclusion rate.”
The AMT rate is set to rise to 20.5% for 2024, up from 15%, while the exemption amount rises to $173,205 from $40,000. The AMT base will also include 100% of taxpayers’ capital gains for the year, up from 80% under the existing rules.
Meanwhile, the amount of the charitable donation tax credit that can be applied against the AMT is dropping to 80% from 100%. Korenblum said that represents a partial victory for taxpayers: the AMT changes floated in the 2023 budget called for a 50% limit on the donation tax credit, prompting charities to warn the move would disincentivize large donations.
Danger still lurks. While the CGIR for donated publicly traded securities remains zero for the purposes of a regular tax calculation, the new AMT rules impose a 30% inclusion rate, meaning that a donation of public securities with large unrealized capital gains could trigger the AMT.
As long as taxpayers are mindful of triggering the AMT, in-kind gifting of publicly traded securities with large unrealized gains remains an attractive strategy, said Abby Kassar, vice-president of high-net-worth planning with RBC Wealth Management in Toronto.
Furthermore, a donor with a corporation could consider making the donation from there, rather than individually, as corporations are not subject to the AMT.
“The corporation does have the same benefit of eliminating the taxable capital gain on donated securities, so that’s a great advantage,” Kassar said. “You’re also able to add the value of the eliminated gain to its capital dividend account.” The CDA is a notional account that allows private corporations to pay tax-free dividends to shareholders.
Donations from an estate in the year of death can also be an effective mitigation strategy, given the AMT does not apply in the year of death, she added. In addition, up to 100% of net income can be offset by donations on the terminal tax return, as opposed to the 75% limit typically in place during a person’s life.
Still, Kassar said taxpayers may wish to split a large donation across several years to strike the appropriate balance between funding their spending needs while they’re alive and creating tax efficiency on death.
“Sometimes what I have come across is a large donation in the estate that generates tax credits that exceed the taxes payable,” she said. “Some planning may be considered … to look at making donations to reduce the annual taxes payable, so there aren’t any leftover credits not being applied in the year of death.”
Capital gains tax-free donations
Donations of qualifying environmentally sensitive or Canadian cultural property do not yield taxable capital gains under the alternative minimum tax or for regular tax purposes due to their capital gains inclusion rate of zero, said Adam Aptowitzer of KPMG Law LLP.
The Ecological Gifts Program is administered by Environment and Climate Change Canada, and allows individuals to donate land that has been certified as ecologically sensitive to qualified recipients without paying taxes on the disposition. Any unclaimed amount can be carried forward up to 10 years.
As for Canadian cultural property, no capital gain is reported on donations to a designated institution of paintings, sculptures, books, manuscripts or other objects certified by the Canadian Cultural Property Export Review Board.
The donation tax credit
The federal donation tax credit is 15% on the first $200 of donations and 29% (33% to the extent income exceeds $246,752 in 2024) thereafter. The provinces and territories also offer donation tax credits at different rates for donations below and above the $200 threshold.
Depending on the jurisdiction, the total federal-provincial credit can represent more than half of the gift amount once total donations exceed $200 in a calendar year.
This article will appear in the forthcoming June issue of Investment Executive.