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Tax Matters

How to multiply the power of your charitable donation Add to ...

'Tis the season to give. And while you're contemplating the gifts you're going to give to family and friends this year, don't forget about giving to those charities that are aligned with your values. And if you're going to give to charity, why not do it in a manner that really multiplies the dollars you are donating, to have an even greater impact?

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Charitable Arbitrage

What I'm talking about here is charitable arbitrage. That is, creating a gift to charity that costs you much less than the dollars actually received by the charity. Now, make no mistake, simply the act of claiming a donation tax credit (or tax deduction in the case of corporations) provides a certain level of charitable arbitrage. Consider this: You make a donation of $1,000 to a registered charity. You claim a donation tax credit for the $1,000 gift and save, say, $450 in taxes as a result (roughly the Canadian average for someone in the highest marginal tax bracket).

The end result? The charity receives $1,000 in cash to use, while it cost you just $550 ($1,000 less the tax savings of $450). By claiming the donation tax credit you're causing the federal and provincial governments to partner with you in making that gift.

Are there other ways to create more cash for charities than it will cost you out-of-pocket? Sure.

Donating Flow-Throughs

Consider donating flow-through shares to charity. (Flow-throughs are a special class of share issued by junior mining companies that give investors an immediate tax deduction.) Suppose, for example, that you invest $10,000 in flow-through shares. You'll generally be entitled to a tax deduction for $10,000 in this case, with the deduction coming largely in the first year, and the small balance generally in year two. This will save you $4,500 assuming a marginal tax rate of 45 per cent. Under our tax law, your adjusted cost base in the shares will be deemed nil in this case (so you will have a capital gain later when you sell).

Now, if you were to donate those flow-through shares to charity for the same $10,000 value after receiving the full value of the tax deductions (generally after two years), you would trigger a capital gain, but our tax law will set the taxable capital gain at nil because you have donated the shares to charity.

You'll also be entitled to a donation tax credit for the $10,000 value donated to charity in this example. This will save you $4,500 in taxes at a marginal tax rate of 45 per cent thanks to the donation tax credit. Your total out-of-pocket cost? A mere $1,000 ($10,000 less $4,500 from the deduction and another $4,500 from the donation) but the charity receives $10,000.

Donating Insurance

Here's another idea that can make sense. Consider the Joneses. This couple are both 65 years of age, in good health and in a comfortable financial position. The Joneses will purchase a term-to-100 life insurance policy jointly on their lives. The policy will pay out $100,000 upon the death of the second one. Assume the policy will have premiums of $1,425 annually, payable until they are both gone. After paying the first year's premium, they will donate that policy to their favourite charity (there is no tax credit for this gift because there is no cash surrender value in this case). Since the charity owns the policy now, the charity knows it will always be the beneficiary of the policy and will collect the $100,000 death benefit when the second one dies.

Next, the Joneses are going to donate $23,500 to the charity, which the charity will use to purchase a life annuity on the couple's lives. This annuity will pay out $1,425 annually, exactly what is needed to pay for the life insurance policy the charity now owns. The couple will receive a donation tax credit for the $23,500 gift, which will save them about $10,575 at a marginal tax rate of 45 per cent. The out-of-pocket cost to the Joneses is $14,350 in this example ($23,500 less the tax savings of $10,575 plus $1,425 for the first year premium).

In the end, the charity receives a fully funded, irrevocable future gift of $100,000 (albeit in the future) that cost the couple $14,350. The Joneses are able to make a commitment to the charity today so that it can acknowledge the gift, they receive some tax savings today, avoid probate fees on the insurance proceeds, and set up a planned gift with a one-time transaction that avoids future payments and administration for the couple.

To borrow a line from Canadian Tire, this year you can give like Santa, and save like Scrooge by using charitable arbitrage.

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