The federal government Budget of 2014 ended up having a potentially large effect on people’s tax returns when they die, and shortly afterwards.
We have previously talked about the elimination of the preferential graduated income tax rates for testamentary trusts after December 31, 2015. Estates will still be allowed the graduated tax rate for 36 months following the date of death, but then will be subject to the top tax rate on any investment income earned.
(This does not mean that inheritances have become taxable or that Canada has instituted a US-style estate tax, so don’t panic about that.)
On the potentially positive side, the same Budget has allowed deceased people (or at least their representatives) to make larger charitable donations through their wills and estates.
This will mostly affect those people who can afford to make large gifts in their estates or who are not leaving the bulk of their estates to their families, but the tax changes may also help people with low incomes, and open up flexibility with donating life insurance policies.
The old (current) rules state that an individual making a donation in his or her will is determined to have made the donation immediately before death. This includes gifts from the estate, or designation of a charity as beneficiary on a life insurance policy, RRSP, RRIF or TFSA.
The effect of this is that the donation tax credit can only be applied against the individual’s income and tax payable, and not to those of the estate. As well, the donation receipt can only be claimed in the year of death or the preceding year. The claimable donation is limited to 100% of net income for those two years.
Assuming the Budget legislation passes, then in 2016, donations described in a will can be deemed to be made by the estate, at the time of donation, instead of by the individual prior to death.
As well, the value of the gift or donation will be the fair market value at the time of the transfer to charity. The current rules instead make it the value immediately before the person passed away.
The real advantage here is that the executor of the estate will be able to allocate donation credits to any of the first three tax years of the estate, as well as for the last two tax years in which the person was alive. This should allow for better tax planning and less chance that a large gift’s tax credit will be partially “wasted” due to insufficient income in the year of death or the previous year.
Donating life insurance to charities can be very simple. With an existing policy, simply changing the beneficiary designation to name a charity does the trick. A donation tax credit will be issued based on the death benefit of the policy received by the charity.
The beneficiary of the policy can also be the deceased’s estate, with a direction in the Will to make the donation.
Alternatively, you can choose to receive tax benefits while alive. If either an existing or a new policy names a charity as both owner and beneficiary of the policy, then the donor will receive a tax credit for any premiums paid, or for the cash value of an existing policy at the time of transfer to the charity’s ownership.
As an example, a healthy 60-year-old couple could purchase a joint-and-last survivor permanent life insurance policy of $250,000 face amount, for under $300 per month. Either the premium could be claimed now as a donation and reduce taxes by about $1,600 per year, or the death benefit could be used to reduce taxes otherwise payable on the collapse of RRIF and other taxable accounts on death.
The new rules make it much more likely that the full tax credit for a life insurance policy death benefit can be used, given the option of spreading over more years.
It’s something to think about, as charities depend more and more on donations and less government largess.
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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
Please consult legal, tax and investment experts for advice on your unique situation.
David Christianson, BA, CFP, R.F.P., TEP, CIM is a financial planner and advisor with Christianson Wealth Advisors, a Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.