I published a version of this blog three years ago to address the many questions on Canadian tax incentives for donations that I receive. Since the questions keep coming here is a revised and updated version.
Generous but Complex and Opaque
Canada has the most generous tax incentives for charitable giving in the world, but few Canadian donors understand what they save and how the system works. Why the paradox? Here’s a longer-than-usual blog providing an overview that I hope will help demystify the topic.
For starters, it is helpful to understand that the Canadian tax system is grounded in unspoken social policy. We all must contribute to society, but there is a choice whether you do so by paying taxes or giving to charity. It’s a system that values the contribution of individuals to charities.
Historically, you would get your taxes back through the charitable tax credits, but still be out of pocket. Since 2016, due to federal tax increases, top marginal tax rates in most provinces are now greater than 50%. A higher tax rate produces a larger tax credit. With 50%+ rates, there may be little financial difference between donating and paying taxes.
Despite the significant tax savings, why is our system of donation tax benefits so poorly understood? Simply, it’s opaque and complex. Our federal-provincial tax system varies by province and is not well explained in standard resources.
How complex? Even Canada Revenue Agency’s donation calculator is incomplete and requires extensive footnotes. It has since been retired and not replaced. I don’t know of any publicly available calculator that addresses all provinces and tiers.
How opaque? Ontario has a five-bracket personal tax system with two surtaxes that affect donation tax credits. The Ontario Government website, however, doesn’t mention charitable donation tax credits among its list of “credit, benefits and incentives”. Its tax chart does not factor in savings from surtax rebates.
What’s a donor — or even an advisor — to do?
Let’s start with the basics for individual taxpayers. Canadian registered charities issue receipt for income tax purposes in recognition of donations received in accordance with a CRA prescribed form. The taxpayer reports the eligible amount of the donation on his or her tax return. Spouses may share tax receipts, and it is typically advantageous for the higher income spouse to claim all donations. A receipt generates non-refundable tax credits that are claimed against net annual taxable income (see below for amounts). Credits, however, vary by province, the amount donated, and the taxpayer’s tax bracket and income.
Since 2016, there are three tiers of donation tax credits that are anchored by the three federal brackets: 15%, 29% and 33%. Tier 1: credits on total annual donations under $200. Tier 2: credits on total donations over $200. Tier 3: credits for donations made by donors with more than $221,780 in annual net income who can claim donations on income over $221,780 in net income.
Credits are better than deductions for most individual taxpayers. A deduction reduces gross income and the benefit will always equal the taxpayer’s average tax rate. (Corporate donations produce deductions.) A tax credit reduces taxes payable on a personal return and are claimed against net income. Tax credits are more beneficial for most taxpayers because they are tiered. It is possible, especially for Canadians who donate more than $200 per annum, to receive a tax credit at a higher rate than their average tax rate.
How much more? That depends on the province.
Donation Tax Credit Tiers
There are federal and provincial donation tax credits. (With the exception of Quebec, the provinces defer to the Feds for administration.) Tier 1, which applies to the first $200 of total annual donations, the federal rate is 15%. Provinces range from 5.05% (Ontario) to 20% (Quebec). The combined rates are therefore 20.5% to 35%.
Anything more than $200 in total giving automatically jumps to the Tier 2 tax credit rate, which is the highest provincial tax rate in most provinces plus 29% federally. Tax savings are between 40.16% and 50% for donations more than the $200 threshold. This is higher than the average tax rate of middle income Canadians.
Ontario and Alberta are exceptions. Ontario tax credits has three tax brackets and two surtaxes that apply to donations over $200, which produces a combined tax credit ranging from 40.16% to 46.4%. The Ontario surtax system stealthily increases the provincial rate to 13.39% for taxpayers with net annual income over $100,392 (to 42.39% total) and to 17.41% over $155,625 (to 46.41% total). Alberta has a second tier donation credit rate of 50% versus 44% tax rate.
The third tier of donation tax credits can be claimed against net income in excess of $221,780. Except for New Brunswick, Quebec, Ontario and Alberta the tax credit rate is equal to the highest marginal rate in the third tier, which ranges from 47.7% to 54%. Alberta has the most generous rate, which jumps to 54% for every taxpayer – higher than the top marginal rate of 48%. In Ontario, taxpayers with net income greater than $221,780 receive a combined credit of 50.41%, less than the top tax rate marginal rate of 53.53%.
In order to claim a donation tax credit at the top rate there must be sufficient net income over $221,780 to claim against. For example, to claim donation of $100,000 at the top rate the donor would need a net income of at least $321,780. That is, $100,000 more than the top tier of $221,780. If there is insufficient income, it is claimed at the next lowest rate.
Taken all together the lack of a good online donation calculator becomes more understandable. It’s complex.
There are three other donation incentives worth mentioning that make Canada a donation incentive leader.
These incentives are designed to encourage exceptional donations, i.e. larger than average gifts made from assets or capital (i.e. life savings). Most donors are unaware of these incentives because they only apply to gifts that may be made once or twice in a lifetime. There are three main incentives in this category.
Donors may claim donations equal to 75% of their net annual income each year. For example, if you earn $100,000, you could make and claim gifts of up to $75,000 in a year.
At death the contribution limit is higher. Since 2016, there has been a category of charitable gifts called “estate donations,” which includes gifts by will, life insurance policies, and RRSP/RRIF. At death, estate donations can be claimed against up to 100% of net income in the final two lifetime years and against up to 75% of income over five years of estate returns. In effect, with proper estate planning and the right province, a Canadian taxpayer may eliminate taxes at death by giving to charity. Moreover, in many situations, an estate donation will not disadvantage family heirs.
Contribution limits increase under certain conditions. For example, donations of certified cultural property and ecologically-sensitive land can be claimed against up to 100% of next income for six and ten years respectively. Donations of ordinary capital property are eligible for a “bump up” in the rate to ensure the donor is not out of pocket in the year of gift. The bump up is 25% of value of the donated property, which gets added to lifetime 75% contribution limit.
Closely related to contribution limits are claim periods. For example, if you donate part of an inheritance and can’t claim it in a single year, you may carry forward the receipt for up to five years to claim against 75% of annual net income. The lifetime claim period is six years in total. As mentioned above, the claim period for an estate donation is up to seven years.
Capital gains exemptions
There is a second tax saving for donors who give certain types of appreciated capital property, such as public securities, cultural properties and ecologically-sensitive land. When eligible property is donated in-kind (i.e. not cash) to a charity, the taxpayer is exempt from the capital gains tax normally owed at disposition by sale or personal gift. This incentive can provide up to 27% in additional tax savings, although it is more typically in the 5% to 15% range due to the value of the capital gain.
Add it all up and Canadians have a rich array of donation tax incentives. Together these surpass other developed countries in the world, even the United States. The greatest confusion relates to donation tax credits. The richest incentives are for exceptional gifts – frequently made from capital or assets — which require high philanthropic commitment. These are also the gifts that require financial, estate and/or tax advice.