Donating Marketable Securities – Altruism and Tax Savings Rolled into One!

As the year winds down, many people consider making charitable donations for income tax purposes or because the holiday season is approaching and they feel altruistic. Whatever the reason, I applaud them; although based on this Globe & Mail article, Canadians as whole are not donating as generously as our American friends.

With the strong markets of the last few years, many people have large unrealized capital gains in their portfolios and may be considering locking in some of those gains given the recent turbulent markets.

A great way to benefit both a charity and your own tax situation is to make a donation of qualifying marketable securities that have increased in value. By doing such, you enrich a charity, obtain a personal charitable donation credit and you do not have to pay any capital gains tax on the donation of the marketable security.

The above is best reflected by an example:

Assume that you purchased 100 shares of ABC Corp. for $10 and the stock price is now $20. The shares are qualifying public marketable securities.

Assume you wish to make a $2,000 donation this year to your favourite charity.

Assume you are a high-rate taxpayer.

Please note the initial posting contained a calculation error that has been corrected.

Donation with Personal Cash

If you make your donation with $2,000 of personal funds you have in your bank account, the charity will receive $2,000 and you will receive a charitable credit. That credit is worth approximately $1,000 on your 2018 tax return. Thus, you are out of pocket approximately $1,000.

Donation with Sale of Stock

If you sell your shares of ABC Corp. to fund the donation, the proceeds from the sale of stock will be $2,000. However, you must account for the taxman and you will owe approximately $250 in tax (again assuming you are a higher rate taxpayer) on the capital gain and thus, the maximum donation you can make is $1,750 (unless you top it up with $250 of personal cash) and the tax savings on your 2018 tax return in relation to the donation credit will be approximately $875. Thus, net-net, you are out of pocket $1,125 and only made a $1,750 donation as opposed to the $2,000 donation you wanted to contribute.

Donation of Stock

Alternatively, if you donate your shares of ABC Corp. directly to a charity (instead of first selling the shares), the charity receives a $2,000 donation (the charity can then sell or hold the shares), you receive a $2,000 charitable donation receipt and receive a tax credit worth approximately $1,000 on your 2018 tax return. Thus, as with the donation of personal cash, the charity received $2,000 and you are only out of pocket approximately $1,000.

However, you will not have to pay the $250 in capital gains tax that you would on a typical public market sale, since the Income Tax Act exempts the gain from capital gains tax when qualifying shares are donated directly to a charity. If you are feeling really altruistic, you can then donate the $250 tax savings from your personal cash.

Qualifying Securities

To make the donation the investment must be a publicly traded security. The most common publicly traded securities are shares, debt obligations, and mutual funds that are listed on designated stock exchanges.

Practicalities

You should first confirm with the charitable organization that they accept donations of marketable securities and try to give yourself some time for the transfer and paperwork to occur. You should try to do this by early December at the latest. Each organization has their own paperwork and rules, but in the end, many can arrange electronic transfers.

Corporations

Corporations can also donate shares and eliminate their capital gains tax. In addition, the gain can often be added to the tax-free capital dividend account (see this blog post on capital dividends).

Since corporations can be taxed in various manners depending upon the type of income and their corporate status, you need to run the numbers with your accountant to understand the specific benefit to your corporation, but in some cases the savings are even better than for an individual.

If you have marketable securities with unrealized capital gains and wish to make a donation, I would suggest donating the securities to a charitable organization is the most tax efficient way to make the donation while achieving your altruistic objectives.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

The Family Tax Cut - Should Joint Filing be Next?

In late October, while I was vacationing in South Africa, details of the proposed Family Tax Cut were announced by Prime Minister Stephen Harper. Since the financial press was all over this, I will provide a quick recap below. Then for a fun (hey I am an accountant, I know fun!) mental exercise, I will compare the income tax burden for a family that maximizes the income splitting benefits of the Family Tax Cut in Canada, to that of a comparable U.S. family that files a joint income tax return.

Family Tax Cut

In Canada, we are required to file our own personal tax return; there is no concept of a joint family filing. Thus, in many cases, where one spouse earns significantly more income than the other spouse (either the second spouse is a stay at home spouse or just makes less money), that family unit often pays more income tax than a two-earner couple that has the exact same family income, but has two working spouses making roughly the same money.

This is because our tax rates are graduated and two spouses making the same income may both be in the 25% tax bracket, whereas a large single earner may be in the 35% tax bracket.

The proposed Family Tax Cut attempts to fix this family income inequality, by allowing the higher-income spouse to transfer up to $50,000 of taxable income to a lower income/lower tax bracket spouse for federal tax purposes. The maximum tax benefit available to a qualifying family is $2,000. Amongst the various conditions to claim the tax credit is that you must have at least one child who is under the age of 18 at the end of the year and who resided with you or your spouse throughout the taxation year. More details can be found here.

Department of Finance Example

In the backgrounder to the Family Tax Cut press release, the Department of Finance provided the following example of the family tax cut:

“Pat and Chris are a two-earner couple with two children. Pat earns $60,000 of taxable income and Chris earns $12,000, for a combined taxable income of $72,000. Pat faces a marginal federal tax rate of 22 per cent. Chris is in the first tax bracket, where income is taxed at 15 per cent. Since the value of his non-refundable tax credits is greater than the tax on taxable income, Chris does not pay federal tax.

For federal tax purposes, under the proposed Family Tax Cut, Pat would be able to, in effect, transfer $24,000 of taxable income to Chris. This would bring their taxable incomes for the purposes of calculating the credit to $36,000 each, which puts both of them in the 15-per-cent tax bracket. In addition, Chris would be able to use up his unused non-refundable tax credits with the notional transfer of income. As one person in the couple may claim the Family Tax Cut, they decide that Pat would do so. The Family Tax Cut would reduce Pat’s tax payable by about $1,260 in 2014, taking into account both the reduced tax on their taxable incomes, and the additional value of the non-refundable credits that Chris is able to use.”

Greater Detail

I ran some numbers for Pat and Chris and determined that they would pay approximately $10,900 in tax in Ontario before the Family Tax Cut. Thus, after the Family Tax Cut they would owe around $9,640 ($10,900 less $1,260 Family Cut Savings).

Since the Conservatives initially announced this income splitting initiative a couple years ago, I have wondered (often aloud or in writing) why they chose an income splitting option as opposed to moving to a U.S. style joint return? If philosophically the government is concerned about inequities in dual family incomes, why not just file as a family and put all couples, on the same tax footing?

I thus thought it would be interesting to compare how much tax Pat and Chris would owe if they lived in California, or if they lived in Michigan. I asked a CPA friend in the U.S. to run some numbers for me. He told me that if Pat and Chris lived in California, they would owe approximately $4,700 in U.S. federal and California state tax. If they lived in Michigan, they would owe approximately $6,130 in U.S. federal and Michigan state tax. Since I always thought California was a high taxing state, I asked him how this happened and he said it was because California has graduated tax rates, while Michigan has a flat rate.

The numbers reflect that, the Canadian Pat and Chris would owe approximately $5,000 more than if they lived in California (keeping in mind that the CA state rate would increase at higher income levels) and $3,500 more in tax than if they lived in Michigan. This comparison assumes the same exchange rate.

As I am comparing Canadian apples to U.S. oranges, this comparison can be misconstrued, but it does reflect that the Family Tax Cut does not save Canadians as much as if they went to a comparable U.S. joint return, with similar U.S. federal and state tax rates.

There are various macro factors as to why Canada has a higher tax rate. As demonstrated above, most U.S. citizens pay far less tax than the equivalent Canadian. However, the U.S. imposes estate tax for wealthier citizens when they die. We can characterize the Canadian tax system as a “pay me now”, while the U.S. is more of a “pay me later” tax system.

As I stated at the outset, this post was sort of a fun mental exercise for me and does not prove much of anything. However, I would suggest that since we are now into family income splitting, it would probably make some sense to move to a joint return filing system in Canada in the near future.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Salary or Dividend? A Taxing Dilemma for Small Business Owners -2014 Update

Effective January 1, 2014 the personal income tax rate on non-eligible dividends paid by private corporations will increase. As result of this uptick in rates, the absolute income savings that were available in most provinces in 2013, when small business owners paid themselves by dividends (as opposed to salary) have been virtually eliminated.  

With these changes, the government has achieved almost perfect integration, at least in my home province of Ontario. By integration, I mean a person will be indifferent as to whether they receive a dividend or salary from a private corporation, since the ultimate income tax cost (total of both corporate and personal taxes) is exactly the same.  

Although the government has effectively removed any absolute income tax savings, a significant income tax deferral is still available where corporations earn active business income. For example, if a corporation earns active income in Ontario, the corporate tax rate is only 15.5% as opposed to a personal tax rate of 46.41% (on taxable income over $136,270). This means to the extent that a small business owner does not need all their corporate earnings to live on and can leave funds in their corporation, they are deferring 30.91% in taxes (34.03% if they are a super-tax rate taxpayer paying 49.53%).  

Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC, recently released a report titled “The Compensation Conundrum: Will it be salary or dividends?”  This is Jamie’s third report in an excellent series on owner-manager remuneration, the first two being “Rethinking RRSPs for Business Owners: Why Taking a Salary May Not Make Sense” and “Bye-bye Bonus! Why small business owners may prefer dividends over a bonus”.

The chart below, taken from Jamie’s most recent report, reflects the impact of the dividend tax changes on small business owners, who distribute their income as non-eligible dividends instead of salary; where their corporations are eligible for the $500,000 small business deduction limit (“SBD”). The absolute tax rates which Jamie denotes as tax rate (dis)-advantage reflect significant decreases from 2013 to 2014, while the tax deferral advantage is either unaffected or has grown larger in almost all provinces. For example: In Ontario, in 2013, there was an absolute tax savings of 3.21% if a small business owner received non-eligible dividends instead of salary. However, in 2014, that benefit is now only .12%. The tax deferral remains the same at 34.03%.

Tax rate (dis)advantage and tax deferral advantage

on SBD Income in 2013 and 2014

                                             2013                                                     2014

                       Tax Rate                    Tax                    Tax Rate                    Tax

                          (Dis)-                  Deferral                  (Dis)-                  Deferral

Province   advantage          Advantage          advantage          Advantage

AB                    1.17%                   25.00%                 (0.69%)                 25.00%

BC                     1.04%                   30.20%                 (0.56%)                 32.30%

MB                   0.56%                   35.40%                 (0.89%)                 35.40%

NB                    1.65%                   29.57%                   0.91%                   31.34%

NL                     1.84%                   27.30%                   0.94%                   27.30%

NS                    4.54%                   35.50%                   2.40%                   36.00%

ON                   3.21%                   34.03%                   0.12%                   34.03%

PE                   (0.18%)                 32.73%                 (1.95%)                 31.87%

QU                  (0.25%)                 30.97%                 (1.26%)                 30.97%

SK                     2.00%                   31.00%                   0.27%                   31.00%

Chart reproduced with permission from Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC from his recently released report “The Compensation Conundrum: Will it be salary or dividends?” December 2013.

For active business income (“ABI”) in excess of the $500,000 small business deduction limit (i.e.: taxable income from $500,001 upwards) the dividends distributed are considered eligible dividends and thus the absolute tax savings and tax deferral advantage are largely unaffected as noted below.

Tax rate (dis)advantage and tax deferral advantage

on ABI Income in 2013 and 2014

                                             2013                                                     2014

                       Tax Rate                    Tax                    Tax Rate                    Tax

                          (Dis)-                  Deferral                  (Dis)-                  Deferral

Province   advantage          Advantage          advantage          Advantage

AB                   (0.47%)                 14.00%                 (0.47%)                 14.00%

BC                   (1.19%)                 17.95%                 (1.42%)                 19.80%

MB                 (4.15%)                 19.40%                 (4.15%)                 19.40%

NB                    0.63%                   19.06%                 (0.13%)                 19.84%

NL                   (2.65%)                 13.30%                 (2.65%)                 13.30%

NS                   (5.88%)                 19.00%                 (5.88%)                 19.00%

ON                  (1.85%)                 23.03%                 (1.83%)                 23.03%

PE                   (3.44%)                 16.37%                 (3.44%)                 16.37%

QU                  (2.68%)                 23.07%                 (2.68%)                 23.07%

SK                   (1.11%)                 17.00%                 (1.11%)                 17.00%

Chart reproduced with permission from Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC from his recently released report “The Compensation Conundrum: Will it be salary or dividends?” December 2013.

Last January I wrote extensively about the decision of whether to pay a salary or a dividend and the benefit of accumulating a “retirement fund” inside your corporation by taking advantage of the income tax deferral. Part 1 discussed conventional wisdom in respect of the salary versus dividend issues, Part 2 demonstrated the numerical benefits of deferring income and Part 3 discussed the various issues that can impact that decision. I do not have the time or the energy to redo these posts and much of what I said is still relevant or covered by Jamie's new report. However, I would suggest there are two key changes.

If your remuneration strategy was to pay yourself a salary to the RRSP limit and then pay yourself a dividend on any amounts over the RRSP limit, the increased tax rate on non-eligible dividends means that in many provinces, there will be little to no benefit to remunerate yourself in this manner in 2014 (EHT should be considered in this analysis).

If you leave after-tax corporate funds to grow in your company, you will now pay more income tax on the eventual withdrawal of those funds, to the extent the funds are withdrawn as non-eligible dividends.

With the change to the taxation of non-eligible dividends, small business owners need to consult their accountants early in 2014 to determine if they need to consider changing the manner in which they are remunerated.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

Confessions of a Tax Accountant-2012- Week 1

The Children’s Arts and Fitness Amounts

The federal government in its infinite wisdom has now added a Children’s Arts Amount credit to the Children’s Fitness Amount credit. From an accountant’s perspective, these credits are a nuisance. Already early this tax season, there has been much confusion with my clients because of the overlap of these credits and how these credits integrate with making a child care claim. Thus, I thought today, I would try and clarify the confusion surrounding these credits.

The maximum eligible expenses for each of the Fitness Amount and the Children’s Art Amount are $500. The first misconception most people have is that they think they save $500 dollars for each of these amounts or that each amount is worth a $500 deduction.

However, both the Fitness and Arts Amounts are actually tax credits worth at maximum, $75 each per child federally. The federal credit is calculated as $500 x 15% refundable credit=$75. There may also be a provincial credit for these amounts. For example, in Ontario, there is a Children’s activity credit worth $50.90 ($509x10%), that is a hybrid of the fitness and arts credit-i.e. both fitness and arts program are eligible for the credit.

Thus, the maximum tax savings per child who undertakes both eligible activities for fitness and the arts in Ontario is $209 ($75 fitness amount, $75 arts amount and $50.90 activity credit).

Children’s Arts Amount

The CRA discusses the details of the Children’s Arts Amount at this link.

You can claim a maximum of $500 in eligible expenses per child for fees paid in 2011 relating to the cost of registration or membership of your child in a prescribed program of artistic, cultural, recreational, or developmental activity. The cost covers registration for each child under the age of 16 at the beginning of the year. To qualify for this amount, a program must:

Be ongoing (either a minimum of eight consecutive weeks long or, in the case of children's camps, five consecutive days long) and be supervised and be suitable for children.

The program also has to meet one of the following criteria:

1) It contributes to the development of creative skills or expertise in an artistic or cultural activity;
2) It provides a substantial focus on wilderness and the natural environment;
3) It helps children develop and use particular intellectual skills;
4) It includes structured interaction among children where supervisors teach or help children develop interpersonal skills; or
5) It provides enrichment or tutoring in academic subjects.

The art's amount is entered on line 370 of Schedule 1, to a maximum of $500 per child.

There will be situations where an amount paid will qualify for both the Fitness and Art’s amounts. However, the CRA states in the notes on eligibility that amounts that can be claimed as the federal children’s fitness amount cannot be used for the Arts credit and thus, any excess amount over $500 already claimed for the Fitness Credit cannot be claimed for the Art’s amount. This was confirmed by calls our firm made to the CRA.

If you have paid an amount that would qualify to be claimed as a child care expense and that amount also qualifies for the children's arts amount, you must first claim this amount as a child care expense (as per the notes to this link). Any amount in excess of the child care claim may be claimed as a children's arts amount as long as the requirements are met, but the same amount may not be claimed once as child care and once as an art's credit.

Children’s Fitness Credit

As this credit has been around for a few years, I will not go into much detail about this program. Essentially the Children’s Fitness Amount, is a non-refundable credit and allows parents to claim a maximum of $500 paid towards an eligible program. The cost covers registration for each child under the age of 16 at the beginning of the year. It does not cover the costs of things such as equipment or travel expenses.

Details of the program are available here.

As per the CRA in its notes to the Fitness Tax Amount, if you have paid an amount that would qualify to be claimed as child care expenses, and the children's fitness amount, you must first claim this amount as child care expenses. Any unused part can be claimed for the children's fitness amount as long as the requirements are met.

So in summation, where an art's or fitness amount qualifies as child care, it must first be claimed as child care and any excess amount may then be claimed as an art's or fitness credit if the expense qualifies for either of the credits. Where an amount meets the criteria for both the art's and fitness credits, you can only make one claim, either the art's credit or the fitness credit, but you cannot claim both.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.