The government's budget proposal to eliminate capital-gains tax on the
donation of publicly traded securities, including mutual funds and segregated
funds, to registered charities, has been lauded in the charitable community. It
also presents some interesting investment and tax-planning opportunities for
philanthropic investors.
But first, let's review the donation rules.
Donations to a registered charity in Canada are eligible for the donation tax
credit. For the first $200 worth of donations made by an individual in a year,
the federal donation credit for 2006 is equal to 15.25% of the amount given.
The provincial credit on the first $200 varies by province and ranges from 4%
to 11%. A British Columbia donor, for example, would get an additional 6.05%
credit on her first $200 of donations, for a combined total credit of
approximately 21%.
It gets better. Once you've made at least $200 worth of donations in any
year, the donation credit jumps to 29% federally, plus between 11% and 20%
provincially, depending on your income tax bracket.
So, for donations in excess of the first $200, you would get back a minimum
of 40% of the amount you donate, regardless of your province and your income
level. That's because you are getting a tax credit (a reduction of tax owing)
with respect to your donation, as opposed to a tax deduction (a reduction of
taxable income).
As a result, the credits are basically worth the same for low-, middle- and
high-income earners (ignoring provincial surtaxes).
Nearly 10 years ago, the government introduced additional tax benefits for
donations of publicly listed securities to charities by halving the capital
gains inclusion rate on such donations.
In other words, instead of the 50% capital gain rate triggered by the
donation of those securities to charity, only 25% needed to be reported in the
individual's income.
The recent budget announced that this inclusion rate will be reduced to zero
for donations made on or after May 2, 2006. In other words, the Conservatives
have eliminated any capital-gains tax arising on the donation of securities to
charity.
To understand the impact of these new rules, let's assume that Brian
currently owns mutual funds that have a fair market value of $10,000 that he
purchased years ago for $2,000. He is considering donating these mutual funds to
charity.
If he simply sold the mutual funds first, he would realize a capital gain of
$8,000, taxable at 50%, and pay tax of about $1,800 on the gain (assuming a top
marginal rate of about 45%). His net benefit, taking into account the value of
the donation credit ($4,500), minus the tax on the capital gain, would be about
$2,700.
Under the new rules, since the capital-gains tax would be eliminated on the
donation of the mutual funds to charity, and since Brian would still be entitled
to his full tax receipt for the $10,000 contributed, his net benefit would be
$4,500.
Finally, if you believe that your mutual funds will continue to appreciate in
value, you always have the option of donating them to charity and then
repurchasing the identical funds again on the open market. By doing so, not only
will you get your donation credit, you won't pay capital-gains tax on the
disposition and your adjusted-cost base will be bumped up to the current fair
market value, reducing any future capital-gains tax on their ultimate sale.
GRAPHIC: Black & White
Photo: Getty Images; Those who decide to donate mutual funds to charity will
find they'll get a large part of their worth back at tax time.