Maybe you’ve heard the story of the charitable woman. She saw a poorly dressed man standing on the street below her apartment and noticed that several people were stopping to give him loose change.
Her heart went out to him, so she took a piece of paper, wrote “Take Courage” on it, then wrapped a toonie in the note and tossed it down to him. A few days later, when she was returning to her apartment, the man accosted her and said: “Lady, here’s your $48. ‘Take Courage’ won at 24-to-one.”
Many people believe that giving charitably results in more coming back to you – financially or otherwise.
And this is the time of year when many Canadians think about making gifts to help others.
Let me remind you that donating securities, rather than cash, can make a whole lot of sense.
When you make a gift of investments to a charity – or anyone else – you’re deemed to have sold those investments at fair market value (the exception is a gift to your spouse, which is deemed to be a disposition at your cost amount – that is, your adjusted cost base, or ACB).
So, gifting investments to a charity can trigger a capital gain or capital loss, depending on whether the investments have appreciated or declined in value. In the case of capital gains, one half of gains are normally taxable when those gains are realized, but thanks to changes introduced in 2006, any capital gain triggered by making a donation of publicly traded securities to a registered charity is eliminated under tax law.
The result? Today, it makes more sense to donate securities that have appreciated in value than donating cash of an equivalent amount.
Suppose you have investments – shares in XYZ Corp. – worth $100,000 with an ACB of $50,000, and you want to donate $100,000 to charity. If you were to sell the investments and donate the cash, you’d trigger a $50,000 capital gain, half of which is taxable, and you’d pay taxes of $11,500 at a marginal tax rate of 46 per cent. But you’ll save $46,000 in taxes from making the $100,000 donation in this example (actual savings varies by province), so you’d have net tax savings of $34,500 ($46,000 less $11,500).
Now, suppose you donate the $100,000 worth of XYZ shares instead of cash. In this case, you’ll pay no tax on the capital gain, and you’ll enjoy net tax savings of $46,000 thanks to the donation tax credit. You’d be better off by donating securities.
Donation of $100,000
and Donate Cash
Fair Market Value
Adjusted Cost Base
Taxable Capital Gain
Tax @ 46%*
Tax Credit @ 46%*
Net Tax Savings
Net Cost of Donation**
* Assume a marginal tax rate of 46%; varies by province.
** Cost of donation is $100,000 less the net tax savings
Suppose now that you have a desire to donate to charity, but you aren’t inclined to donate the full $100,000 worth of XYZ shares. Is it still possible to eliminate all the tax that might be owing on a sale of the XYZ shares? Sure. You can consider donating just part of the securities to charity.
Here’s what I mean.
Consider donating $20,000 of the XYZ shares to charity, sell the remainder and keep $80,000 for yourself. The result? You’ll face tax of $9,200 (at the same 46 per cent tax rate) on the $80,000 worth of shares when you sell. You’ll face no tax on the other $20,000 since you’re donating them to charity. In addition, you'll be entitled to a donation tax credit for the $20,000 donated, which will save you tax of $9,200. Bottom line? The tax savings from the $20,000 worth of shares donated will offset the tax on the $80,000 you kept for yourself.
Keep in mind, if you had kept the full $100,000 for yourself, you would have walked away with $88,500 after taxes. In this case, with the donation, you’ll keep $80,000 instead. So, you’re giving up $8,500 in order to give the charity $20,000. I like to call this a charitable arbitrage opportunity.
In this last example, how did I know that a donation of $20,000 worth of shares would create tax savings to offset the tax on the other $80,000 of shares sold? That is, how do you know what amount to donate and how much to keep for yourself? There's a formula that works in most provinces, at most income levels. Here it is:
The amount to donate equals: (FMV x [FMV - ACB])/([3 x FMV] - ACB), where FMV is the fair market value of your investment and ACB is your cost amount. In our example: ($100,000 x [$100,000 - $50,000])/([3 x $100,000] - $50,000) = $20,000, the amount of our donation.
This year, be generous and give securities to charity.