Minimizing Donor Tax to Maximize Donor Gifts, courtesy Frank Arnold

Minimizing Donor Tax to Maximize Donor Gifts

I am proud to be paying taxes... The only thing is - I could be just as proud for half the money. Arthur Godfrey

by Frank Arnold, The Pinch Group
for Give Green Canada


For many donors, there are plenty of opportunities to receive additional tax relief, which means they can give more to their favourite charity or land trust. Being an investment advisor, my area of expertise is with gifts of publicly traded securities, and to a lesser extent, gifts of life insurance.

What are publicly traded securities?

- Publicly traded stocks and bonds (e.g. - Telus Corp stock)
- Mutual funds (e.g. - Templeton Growth Fund)
- Segregated funds (like mutual funds but issued by insurance companies)

Why give securities?

Simply put, the donor gets all the tax break of a regular donation, but bypasses the capital gains tax if the security is worth more than the original cost. Normally, when a security is sold for more than its original cost, the difference is called a capital gain, and half this must be included as income. Donating the security before instead of selling it avoids the capital gains tax.

A quick example, using a $10,000 gift of a security with an original cost price of $4,000, and assuming the donor is in a middle tax bracket (30%, but this varies by province):

Tax Benefit of Donating Securities
Option 1
Option 2
Sell Security and give cash
Donate Security "in kind"
Market Value of Security
$10,000
$10,000
Cost Base
$4,000
$4,000
Capital Gain
$6,000
$6,000
Taxable Capital Gain (50%)
$3,000
$3,000
Tax Due on gain at 30%
$900
$0
Tax Reciept for gift
$10,000
$10,000
Value of tax reciept at 44%
$4,400
$4,400
Net Tax Savings
$3,500
$4,400


Essentially, the donor saves $900 by donating the security rather than selling it first. If the donor is in a higher tax bracket, the tax savings would be even greater. Now, this assumes the donor has investments which are still worth more than s/he paid for them - a non-trivial assumption at this point in time!

Here are some areas to pay special attention to:

- income trusts,
- long-held stocks
- flow-through shares

Income Trusts

An income trust is a Canadian company that exists as a trust, rather than a corporation. In this structure, the trust pays little or no tax itself, but instead passes the tax burden directly onto shareholders.

The trust pays an income stream to its shareholders, but typically only a portion of this income is taxable - the rest is deemed to be "return of capital". Return of capital is not taxable in the year it is received, but it has the effect of reducing the cost price to the investor.

As a result, the longer an investor holds an income trust, the lower their cost price for calculating taxes usually becomes. This is fine so long as the investor plans to continue holding the trust for a long time.

But, as many of you know, a couple years ago the federal government amended the tax rules so that most (*) income trusts' income will essentially be taxable from 2011 onwards.

This tax change is forcing the income trusts of Canada to consider their options over the next couple years. Many have already reverted to corporations instead of remaining income trusts, which the government allowed will be tax deferred. Many trusts have been taken over by other companies or other trusts. Some have gone private.

In any event, these transactions are usually taxable when they occur, and many more such transactions will occur over the next couple years. One obvious way for your supporters to avoid a capital gain of this nature is to donate their income trust securities before they merge or revert back to corporations.

(*) I said most because real estate investment trusts were specifically exempted from the new income trust tax rules. Therefore, they will not be forced into mergers or incorporation like the other income trusts. However, real estate investment trusts generally pay out the largest portion of their income as "return of capital", which makes them an ideal candidate for donation in kind.

Long-held stocks

Many investors employ a buy and hold approach, which often means they hold some stocks for 20, 30, or even 40 years. Commonly, bank stocks and blue-chips like Bell Canada are bought and held for periods of time like this. This is a great strategy for reducing taxes each year that you don't sell the stock, but the usual result is a very low cost price - perfect for a donation "in kind".

"What if I still like this stock I am donating?"

If the donor owns a publicly traded security that:

a) is worth more than their cost price, and
b) they still like, and would rather continue owning, then

it still makes sense for them to donate it. They can donate the security today, avoid the capital gains tax, and buy it back tomorrow, thereby locking in a high cost price, and ensuring they pay less capital gains tax on it in the future (i.e. - the $10,000 example I used above still holds).


Major Hurdles

Market Meltdown

Stock markets dropped about 50% from peak to trough, and are still down about 35% from their highs.

In general, stocks had their worst year since the 1930’s and are back to where they were 10 years ago, with corporate bonds, mortgages and real estate all falling last year. This presents three major problems for charities:

o Globally, approximately $50 trillion in wealth (stock market, bond market, and real estate) has been destroyed in the past 12 months, translating into substantially less money available from donors and foundations.
o Even if donors came out of this relatively less scathed, the current recession, together with the fear and uncertainty brought on by all this will likely reduce the inclination for larger donations
o While virtually all donors give for the sake of giving, the tax advantage of donating securities is enhanced when they are worth more than the original cost. Thus, donors can donate more to the charity for the same after-tax cost to the donor. Last year’s market tumble essentially erased the previous 4 years of gains, and likely removed the need to worry about capital gains for the next few years. Translation: expect fewer gifts of securities.

Tax Free Savings Accounts (TFSAs)

Longer term, expect the new TFSAs to be a hurdle to larger, tax-preferred donations. In a nutshell, all the interest, dividends and growth within a TFSA are tax-free, as is taking money out of a TFSA. This will not impact gifts of securities this year or next, considering contribution limits are just $5,000 per year. However, over the next 10-20 years, a substantial portion of the non-registered (i.e. - money outside RRSPs and RRIFs) will be moved into TFSAs, removing the extra tax incentive of donating funds from these plans.

Donor-advised funds

One area where advisors are having more involvement with their clients' philanthropy is donor-advised funds. Donors are increasingly wanting to be more hands-on within the philanthropic process, rather than just writing a cheque and being done with it.

Donor advised funds allow the donor to have their own personal private foundation, all under the umbrella of a larger public foundation such as the Vancouver Foundation or Tides Canada.

Financial institutions are seeing demand here and so they are jumping in too - most of the banks now offer them, as do some fund companies like Mackenzie Financial and Dynamic Funds.

For you, rather than getting a cheque for say, $25,000, if the supporter instead contributes to a donor advised fund, the money goes into an account that then pays out an annual income to the charity or charities of the donor's choice.

Generally, the income is about 4% or so of the value of the donor advised fund.

The biggest consideration of these funds, using the example of a $25,000 contribution, is that now you would be receiving $1,000 a year rather than $25,000 up front. Also, the donor can always change where s/he wants to direct the income each year.

On the plus side, a stream of long term income for many charities is preferred over one-time infusions of cash.

Also, they could act as a bridge to the investment advisor community, if the advisor gets to keep managing the money, as is often the case. Finally, if your supporter sets up a donor-advised fund at Tides Canada Foundation (in Vancouver), view this as an opportunity to showcase what you do to this important public foundation - Tides is Canada's public foundation focussing on environmental charities, so it is always a good idea to be on their radar.

Conclusion

I have gone over some of the more common situations where charities can pass along enhanced tax savings to their donors. It is useful to be aware of the areas where opportunities exist, as well as some of the pitfalls. The goal is for this to be mutually beneficial for donors and worthy non-profits - the easier the process and the more tax saved, the more donors can use their money for good.

Frank Arnold
The Pinch Group at Raymond James Ltd.
250-405-2420 or 1-866-515-2420
frank.arnold@raymondjames.ca


Last modified: Monday, 4 February 2013, 10:07 AM