Many Canadians make ample room in their annual budget to make regular donations to charitable organizations whose causes they are passionate about. Canadians may also wish to make donations under their Will to continue benefiting these organizations after death. As donations of certain types of property can provide beneficial tax treatment under the Income Tax Act (the “ITA”), Canadians can work with their estate planning lawyer to ensure that their intentions are properly reflected and that their Wills allow for maximum tax savings.
In 2016, changes were made to the ITA that have a significant impact relating to charitable donations made on death. While the new rules allow for greater flexibility for allocating the tax credit for donations and gifts by direct designation (e.g., RRSPs or life insurance proceeds), existing estate plans that were developed prior to 2016 may have to be reviewed.
The ITA Rules: Pre-2016 and Post-2016
Under the old rules, gifts made by Will were deemed to have been made immediately before the testator’s death. The donation tax credit was available in the year of death to offset taxes triggered on the deemed disposition, or it could have been carried back to the preceding year.
When the new rules came into effect in 2016, estate donations were no longer deemed to be made by the deceased individual immediately before death. Instead, they are now deemed to be made by the estate (i.e., at the time donations are transferred to a charity), or, if certain conditions are met, by the individual’s graduated rate estate (“GRE”).
Under the new rules, estates that qualify as GREs are able to maximize available tax credits.
Characteristics and Benefits of a Graduated Rate Estate
To qualify as a GRE, the following conditions must be met:
- 36 months or less must have elapsed since the date of the testator’s death;
- The estate must be a testamentary trust under the ITA;
- The estate must designate itself as a GRE by filing a T3RET (T3 Trust Income Tax and Information Return) for its first taxation year; and
- No other estate can designate itself as a GRE of the deceased individual.
GREs can use the donation credit to offset the following: (1) taxes owed by the deceased individual in the year of death or the preceding year; or (2) by the GRE in the year of donation, in any prior year, or in any of the following five years. This flexibility provides welcome options for tax credit allocation.
Issues for Estates that Do Not Qualify as Graduated Rate Estates
Whether or not it is a GRE, an estate can claim a charitable donation tax credit for an estate donation in the year in which the donation is made or in any of the five following years.
However, an estate that does not qualify as a GRE cannot allocate a donation made by the estate to a previous tax year of the deceased individual or an earlier year of the estate. Therefore, certain plans may no longer be tax-efficient.
In particular, gifts made by trusts where the settlor retains a life interest (e.g., alter ego trusts, joint partnership trusts, spousal trusts, etc.) may no longer be tax efficient as the tax year-end will occur in the trust at the date of death of the settlor or spouse, and the tax triggered on the deemed disposition of the trust’s assets will be borne by the estate of the deceased settlor or spouse. This situation creates a timing issue – since the donation will be made by the trust at a later date, the tax liability triggered on death can no longer be sheltered by carrying back the donation tax credit.
The 2016 change in rules creates practical concerns for existing estate plans that include charitable donations. Therefore, it is important to review your plan with a tax and estate planning expert in order to ensure that your intentions will be manifested.
Feel free to contact us for more information or if you have any questions about your current estate plan.