Charitable Gifts in Kind
What is the most tax effective way to make a simple gift to charity? On May 2nd of this year the federal government released its annual budget making the answer to that question clearer.
2006 Federal Budget
The most recent federal budget noted a few important changes relating to the donations of publicly listed securities to charities. In 1997 an incentive was introduced that reduced the capital gains inclusion rate on gifts of public securities from 50 per cent to 25 per cent. For donations of securities on or after May 2, 2006 any capital gains that may have resulted from the deemed disposition is reduced from 25 per cent to zero. This has made the strategy of donating securities more attractive than simply donating cash for two reasons, namely: the normal donation credits plus the elimination of the gain. Together these benefits can add up to a significant tax savings – no other simple gift compares.
Benefits of Donating Securities
Most well established charitable organizations have an account with a financial institution and accept donations of securities – known as a gift in kind. A gift in kind is assessed at its fair market value and is used for purposes of determining the tax credit of your donation. At the time of the donation you are deemed to have disposed of the position at its fair market value.
Public securities are those listed on Canadian and international exchanges and may include the following: stocks, income trust units, warrants, exchange-traded funds, mutual fund units and bond. Note: the donation must be a gift in kind of the security and not the cash proceeds of a sale of the security. Several other forms of gifts to charities, such as art and land, are also considered to be gifts in kind.
Three options of making a donation are: (1) donate cash to charity; (2) sell shares and donate the net proceeds (after tax); or (3) donate shares. The following are the assumptions used in the following three illustrations:
- initial amount is $10,000
- current market value of shares is $10,000
- book value of shares is $6,000
- marginal tax rate 43.7 per cent
Option 1 – Donate Cash to Charity
A cash donation of $10,000 would result in an individual receiving a donation tax credit of 15 per cent on the first $200 and 29 per cent on the remainder. The total tax credit is $2,872. The total out of pocket costs of this donation is $5,630 after factoring in both federal and provincial tax savings.
Option 2 – Sell Shares and Donate Cash
Selling shares for $10,000 with a book cost of $6,000 results in a capital gain of $4,000. One half of this gain is taxable at the marginal tax rate. Total tax on selling the position is $874. Net proceeds from the sell of the shares would be $9,126. Donating this amount results in a total tax credit of $2,619.
Option 3 – Donate Shares
Donating shares with a current market value of $10,000 and a book cost of $6,000 results in zero capital gain. The market value of the shares being $10,000 and the person donating the securities will obtain a tax receipt from the charity for $10,000 generating total donation tax credits of $2,872.
The main difference between Option 2 and Option 3 is that no capital gain will result if the shares are transferred to the charity. This strategy is extremely beneficial if an individual creates a plan with their advisor. With these recent changes investors may be more inclined to implement this into their charitable giving strategy.
Procedure to Transfer Shares
The transfer is best made electronically from the donor’s investment account to the charity’s brokerage account. To transfer securities electronically an investor will generally have to provide the financial institution with appropriate written instructions that may be referred to as a letter of authorization (LOA). Different firms may have additional or alternative requirements. Most advisors will be able to assist you in drafting your LOA. Generally, the LOA includes the following:
- Addressed to the firm holding your securities
- Instructions to transfer a number of shares (i.e. 100 shares) of a company (i.e. Royal Bank – RY)
- Your investment account number
- The charity or foundation name and their account number
- The address of the charity, administrator and contact information if possible
- Signed and dated by you, the account holder
Let’s assume that an individual owns 1,000 shares of a company with significant unrealized gains. The individual may choose to donate only a portion of these shares, say 100 shares. Alternatively the individual may decide to donate all of their shares over a number of years. This provides the ability to support a charity on an ongoing basis while dealing with a security that has a significant unrealized gain.
Most financial firms will complete in-kind security transfers to a registered charity on a complimentary basis (with no fees or commissions). If you are planning to sell some stocks, and if you are also planning to make donations, it makes sense to consider contributing shares in-kind to your favourite charity.
Before implementing any strategy noted in our columns we recommend that individuals consult with their professional advisors (insurance consultant, financial advisor, accountant and estate lawyer).