Donations and your estate

Now that the calendar has flipped to May, accountants in public practice have an opportunity to reflect on the past busy season.

Each year, our office files a significant number of “terminal returns.” These are the last income tax returns for deceased taxpayers, reporting earnings from January 1 of the year of death up to the date of death. If there is a surviving spouse, the deceased’s terminal return is usually straight-forward with few tax consequences; most assets will transfer to the surviving spouse automatically thanks to section 70 of the Income Tax Act.

When there is no surviving spouse, tax consequences, and sometimes a significant amount of tax payable, can occur. Often, this is an unwelcome surprise for the unsuspecting executor.

Income tax at death

At the time of a person’s death, if there is no surviving spouse, the deceased is deemed to have sold all assets for their current market value, and any increase in value must be reported on the final tax return. Generally, the increase in value is calculated as an asset’s current market value minus its cost. 

For the most part, personal use properties, such as household possessions and vehicles, will not have appreciated, and market values will be less than cost. If that is the case, there is nothing to report. Major assets, however, such as real estate and investments, will likely have appreciated in value, and that increased value must be reported at the time of death.

Real estate

If a person purchased a cottage for $100,000 and the value grew to $200,000 at the time of that person’s death, there would be a $100,000 increase to report on the deceased's final tax return. Usually, this profit is considered a capital gain and only half of the amount is subject to income tax.

Non-registered investments (shares, mutual funds, etc.)

If a person purchased shares, mutual funds or other investments outside of their registered accounts for a cost of $100,000, and those investments were worth $150,000 at the time of death, there would be a $50,000 increase to report. Again, this profit is usually considered a capital gain and only half of the amount is subject to income tax.

Registered investment accounts (RRSPs, RRIFs, etc.)

If a person had an RRSP or RRIF account worth $300,000 at the time of death, there would be a value of $300,000 to report on the deceased's final tax return. As the original funds were deducted as an RRSP or RPP deduction on previous income tax returns, the entire amount is subject to income tax upon death.

Remember, these value increases are reported in addition to any regular income earned during the period before death. Thus, if a taxpayer died toward the end of a calendar year, there could already be significant income to report.

Consider the example above, where the taxpayer had taxable income resulting from the deemed disposition of the real estate, non-registered investments and registered investments. If the taxpayer was a resident of Saskatchewan and there was no other income to report, the tax owing on the $450,000 of profits would be $150,000 (an effective tax rate of 33 per cent). You can imagine the shock of the executor when we inform them of the tax bill.

Charitable donations

Making a charitable donation can reduce tax payable on the terminal return. The donation tax credit is more lucrative than other non-refundable tax credits. While most non-refundable tax credits in Saskatchewan are calculated at 26 per cent, donations over $200 give rise to a 44 per cent tax credit:¹

• $1,000 medical expense tax credit = $260 of tax savings
• $1,000 donation tax credit = $440 of tax savings

As most taxpayers do not pay an average tax rate of 44 per cent, a taxpayer could eliminate their tax bill completely without donating all of their income. If taxable income was $100,000 on the terminal return, a donation of $60,000 would nearly eliminate all income tax:²

Donations of non-registered investments (shares, mutual funds, etc.)

A donation of publicly traded securities to a charity has additional tax benefits beyond a cash contribution. In certain circumstances, one can donate their publicly traded securities directly to a registered charity (the investment brokerage can administer this transaction), and avoid paying income tax on the appreciation of that investment.³ This benefit is thanks to section 38 of the Income Tax Act, which eliminates the capital gain on the disposition of the property without affecting the value of the donation receipt, which remains equal to the full fair market value of the donation.

In the example of non-registered investments above, we looked at an investment account that cost $100,000 and grew to be worth $150,000 at the time of death. Assuming the investments were publicly traded securities, by donating the investments (as opposed to cash), the taxpayer could avoid reporting the $50,000 increase in value on their terminal return and also have the benefit of a $150,000 donation:

Taxpayers who are interested in these tax savings that can be realized on donations should consider donating to a registered charity through a bequest in their will. Every taxpayer’s circumstances are unique; contact your Baker Tilly advisor for help in maximizing the tax savings for your estate.

^{1 If taxable income exceeds $210,371, the tax credit is enhanced to 48 per cent in Saskatchewan.
2 For tax returns other than terminal returns, the donation credit is limited to 75 per cent of the taxpayer’s net income.
3 In addition to publicly traded securities, the same preferential tax treatment is given to the donation of ecologically sensitive land and Canadian cultural property.}