There have been a number of recent amendments and proposed amendments to the Income Tax Act that may significantly impact estate plans involving charitable gifts made in an individual's will or pursuant to the terms of an alter ego, joint partner or spousal trust. It is important to be aware of these new rules to ensure that estates and trusts can maximize the tax benefit of any charitable donation tax credits.
Charitable Gifts made by Will
Prior to 2016, any charitable gifts made in an individual's will were deemed to have been made by the individual immediately before death. The donation tax credits that arose from the charitable gift could be used in the deceased's terminal tax return or the immediately prior tax return. These rules did not allow any excess credits to be used by the estate to offset any income that was earned by the estate. Also, if it was determined that the charitable gift was made by the estate rather than the individual in his or her will (for example, because the executors had discretion to determine the amount of the gift), the donation tax credits that resulted from the gift were not available to offset the tax liability that arose on death.
Recent amendments to the Income Tax Act have added some flexibility so that donation tax credits can be used by the deceased, or by the deceased's estate. For deaths that occur on or after January 1, 2016, the individual will no longer be deemed to have made the charitable gift immediately before they died. Instead, their estate will be deemed to have made the gift at the time the property is transferred to the charity, and the donation tax credit will be available to:
- the estate in the taxation year in which the gift is made;
- the estate in an earlier taxation year;
- the estate in the five subsequent taxation years;
- the deceased in the year of death; or
- the deceased in the year prior to the year of death.
These changes will provide greater flexibility so that donation tax credits can be allocated to the year in which the estate or deceased individual has the greatest taxable income.
However, this additional flexibility will only be available where the charitable gift is transferred to the charity while the estate is a "graduated rate estate". An estate can only qualify as a graduated rate estate of a deceased individual if the estate meets certain requirements under the Income Tax Act, including that it has not been more than 36 months after the individual's death. This means that if an estate is administered over a period of four years, and the charitable gift is not made until the fourth year, the new rules will not apply to the gift. Instead, the estate will only be able to claim the charitable donation tax credit in the year the gift was made or in any of its five subsequent tax years. This can present difficulties for estates that are more complex and cannot be administered within the 36-month period, or where there is ongoing litigation that delays the administration of the estate.
Fortunately, the government recently released legislative proposals aimed at addressing this problem that would apply to the 2016 and subsequent tax years. The proposals, if passed, will extend the time period in which the estate needs to make the donation from 36 months to 60 months, if the estate still meets the other requirements to qualify as a "graduated rate estate" at the time the donation is made. However, if a donation is made between 36 months and 60 months of the date of death, the proposals do not provide as much flexibility with respect to the allocation of the donation tax credit. The donation tax credit will be available to the deceased in the year of death or the immediately preceding year, and to the estate in the year the gift is made, but it will not be possible to carry back the credit to a prior year of the estate. STEP Canada has made written submissions to the Minister of Finance requesting that the proposals be amended to address this concern.
Charitable Gifts made by Life Interest Trusts
Joint partner, alter ego and spousal trusts (often called life interest trusts) are deemed to dispose of their property as a consequence of the death of the specified beneficiary of the trust (either the settlor, spouse or surviving spouse depending on the type of trust). If the trustees make a charitable donation in the year in which the deemed disposition arises, the trust can use the donation tax credit to offset the taxes payable by the trust.
As a result of recent amendments to the Income Tax Act, in addition to the deemed disposition that is triggered, there is also a deemed year end triggered by the death of the specified beneficiary, and the trust income for that year (including capital gains triggered as a result of the death) will be deemed to have become payable to the beneficiary. These amendments created two issues for charitable gift planning involving trusts. The first is that the donation tax credit arising from the charitable gift will not be available to offset the tax arising from the deemed disposition (which will now be taxable in the hands of the estate of the deceased beneficiary). The second issue is that as a result of the deemed year end, donation tax credits arising from gifts made by the trustees after the beneficiary's death cannot be claimed in the trust's taxation year in which the death occurs.
Fortunately, the government has proposed additional amendments to the Income Tax Act that will address these issues. Subject to a limited election being filed by the trust and the estate of the beneficiary, the tax liability arising on the deemed disposition of trust property will remain payable by the trust. The changes will also allow the trust to allocate the donation tax credit arising from a charitable gift made by the trustees after the beneficiary's death to the trust's taxation year in which the death occurs, as long as the donation is made on or before 90 days after the end of the calendar year in which the death occurs.
In light of these changes, we recommend reviewing existing estate plans involving charitable donations to ensure that donation tax credits will be available to help offset the anticipated tax liabilities of the estate or trust.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.