You’ve done well for yourself. You’ve worked hard and accumulated wealth – maybe more wealth than you need in your lifetime. At this time in your life, and particularly at this time of year, thoughts turn to giving, to how you can help others, and perhaps make a difference. You may wish to ensure the fruits of your life’s labour, after first taking care of your own personal needs and wants, are put to their best use, towards bettering the lives of your family, friends, and your community.
Giving While Living
Many people wait until their death to transfer wealth over to their desired beneficiaries, through wills that leave their legacy to friends, relatives, or charities. No doubt, good estate planning takes proper care of the distribution of your assets upon death. But what is often overlooked is the opportunity to give assets away prior to death. The distribution of assets while living may offer personal, tax, and other benefits.
Giving while living, allows you to experience first-hand the impact you have on those you care about most, offering greater meaning and personal fulfillment. First on our care list is often our struggling adult children. Making their way in the world today takes everything they’ve got. And giving them a break from all their worries sure would help a lot. They may not need help with dinner, dressing and driving, but a little help with life’s major expenses can certainly make their lives easier. Being there to see the impact you can have on their lives can be deeply rewarding.
Over and above the personal rewards, giving while living may make sense from a tax perspective too. Holistically, taking into account everyone who benefits from your wealth (in your lifetime and at death), retaining excess assets beyond a certain level could mean you are paying more taxes than necessary while you are alive and may reduce the potential size of your estate at death. The three layers of taxation to consider are: taxation of annual income earned, taxation upon disposition of assets (while living or at death), and probate fees on the value of your estate at death.
Taxation of Annual Income Earned – Income Sharing as Income Splitting
Annual income earned throughout your lifetime that is taxed at your higher marginal tax rates may more beneficially be taxed at the lower marginal tax rates of your adult children (or other desired beneficiaries). Where you are in a significantly higher tax bracket than your adult children (or other desired beneficiaries), transferring wealth while living may minimize taxes when considering all of you as a whole (subject to the attribution rules discussed below). For example, if you are at the top marginal tax bracket, you are losing 53.53 cents of every dollar you earn to taxes. If your adult children are in lower tax brackets, they are losing less – anywhere from 20.05 to 51.97 cents – of every dollar earned to taxes. This differential, between your and your child’s tax brackets, is the reason why income in your children’s hands, rather than yours, may reduce the overall tax burden from a family perspective. At opposite ends of our tax brackets, this rate differential is 33.48%. Putting that into numbers, a property producing $100,000 of annual income could have the family unit saving $33,480 of taxes annually.
Taxation upon Disposition of Assets
Upon death, you are deemed to have disposed of all your assets at fair market value. With a significant asset base, this can mean large capital gains on which your estate is subject to tax at the highest marginal tax rates. Giving away your assets before death would trigger this deemed disposition with tax implications earlier. However, the timing of when these assets are given away (for example, before significant appreciation has occurred) can minimize these tax implications. Alternatively, gifting cash with which your desired beneficiaries can purchase their own assets, is another option (subject to the attribution rules discussed below).
In addition, your estate is also subject to probate fees, which is an asset tax based on the value of your estate. Giving your assets away before you die avoids probate fees. Probate fees are calculated at graduated rates as follows:
- $5 per $1,000 of estate assets up to $50,000; and
- $15 per $1,000 of estate assets over $50,000.
‘Till Debt Do Us Part
Over and above the personal and tax benefits, giving while living may make sense from a holistic cash flow perspective too. Your adult children may have debt that often accompanies life’s different stages, such as student debt, home mortgage, credit card debt, and bank loans. The cost of personal debt isnon-tax-deductible interest, which is just lost money out the door – a cash outflow that may not make sense when you as a parent have excess cash.
The gifting of cash specifically to allow your adult children to reduce their debt and eliminate/reduce interest costs or the providing of an interest-free or low-interest loan to your adult children may be another giving strategy to consider. For example, instead of paying non-deductible interest to a third-party lender, you could gift cash to your adult child in order for them to pay down their third-party debt. Alternatively, if you are concerned with maintaining control over the use of your cash gift or protecting yourself against a potential future marriage breakdown of your adult child, you could take back a registered mortgage on your child’s home, charge no interest, and have the option to forgive their mortgage down the road.
Different Ways to Give
Cash is King
The most straightforward, and tax-free, way of giving is through a cash gift. There is no gift tax in Canada. You can give cash to any adult, related or not, with no tax consequences to them or to you (subject to the attribution rules discussed below). Neither you nor the recipient pays taxes on this gift and you do not receive a tax benefit (deduction or credit) for this gift. There are also no reporting implications to making a gift of cash.
Gifts of Property
Another way of giving is through a gift of property, such as an investment portfolio or a home. In contrast to gifts of cash, gifts of property normally do have tax and reporting implications.
When you gift property, you are deemed for tax purposes to have disposed of the property at fair market value. This disposition of a property is required to be reported on your personal income tax return and you are required to pay tax on any resulting increase in value of the property over your cost base (‘capital gain’). 50% of any capital gain is taxable to you at your marginal tax rate. Future income on this property and future appreciation of this property (upon disposition) would be taxed in the recipient’s hands at his/her marginal tax rate.
The immediate tax cost to you of the deemed disposition must be weighed against the annual tax savings (tax rate differential between your and the recipient’s marginal tax bracket) obtained from the annual income produced from these properties. As well, to minimize the tax cost of a deemed disposition of property, consider gifting property that has not appreciated significantly (or has depreciated) in value, leaving any future appreciation to be taxed in the lower-tax bracket hands of the recipient.
For example, if you originally purchased a condo for $150,000 and, at the time you gifted it to your adult child, it was worth $300,000, your taxable capital gain is $75,000 (50% of $300,000 less $150,000). If you were at the top marginal tax rate, you would be liable for tax in the amount of $40,148 (53.53% of $75,000) in the year the gift was given. Your child’s tax base would then be $300,000, and s/he would only be liable for tax on any future increase in value above $300,000 upon disposition as well as on the future income produced from the property. If this property produced $50,000 of rental income a year,and your child was at the lowest tax bracket, the tax rate differential of 33.48% (by being taxed at your child’s marginal tax rather than at yours) would mean an annual tax savings of $16,740.
But Life’s Complicated
In the perfect world, gifting your wealth to your adult children makes your and their lives more enjoyable and less taxing and you all live happily ever after, holding hands and dancing into the sunset. In reality, because we humans are a fickle, imperfect breed, money can often make relationships even more complicated. Strategies that seem to make sense on paper, may not hold water in the real world.
Adult children receiving unearned wealth can handle this wealth irresponsibly, develop an unmanageable sense of entitlement, make poor decisions regarding its guardianship, spend it all, invest it poorly, not to mention further issues with sibling rivalry, perceived sense of fairness and children’s potential future marital breakups. They may not use the money in the ways you want them to and your intention of making their lives better may backfire and make everyone’s lives worse.
However, there are other strategies that can allow you to enjoy the benefits of giving, while avoiding the potential related pitfalls. You may consider gifting them small amounts to begin, with clear directions on what it is to be used for, observing behaviour and assessing their fiscal responsibility, and then increase (or not) accordingly. You may consider gifting them something you can share together, like a family vacation. This kind of gifting allows you to share your wealth in the most meaningful of ways, by spending time together.
When You Don’t Have Trust, Set One Up
Another way to tackle the delicate complexities of generosity is to establish a trust where your adult children (or others) are the beneficiaries. A trust allows you to control the timing and use of your money, while taking advantage of the tax benefits of gifting. It allows you to establish the terms of your gift, specifying how much your beneficiaries get, when, and for what. A trust can even be used to pay directly for expenses, so that the cash never touches your beneficiaries’ hands– for example – a trust set up to pay for college/university expenses. In this way, it can be used to encourage specific desired behaviours (stay in school, buy a home).
A family trust (or personal trust) is created by an individual (the ‘settlor’) for the benefit of family members (or for other personal purposes). An inter vivos family trust is created during the settlor’s lifetime and the terms are specified in a trust deed (in contrast to a testamentary trust which takes effect upon the settlor’s death).
Similar to direct gifting of cash, gifting of cash through a trust has no tax effect to you since there is no disposition of property. Money can then be invested in a vehicle of your choice within the trust and income accrued can be designated to beneficiaries and taxed in their hands at their marginal tax rates (subject to the attribution rules discussed below). Similar to direct gifting of property, gifting of property through a trust will trigger the disposition of property at fair market value and a tax liability on any taxable capital gain. Future income earned by the property in the trust and allocated to the beneficiaries will be taxed in the beneficiaries’ hands at their marginal tax rates.
A trust is an extremely complex instrument and should only be set up with the guidance of your professional advisors. A trust is considered an individual for the purposes of the Income Tax Act and is taxed at the highest marginal tax rates on income that is not distributed to its beneficiaries. The year end of a trust is December 31 and it is required to file an annual return. Beneficiaries are taxed on income that is paid to or for them or that is payable to them, even though they may not have received the money in the year.
The Human Family
If your generosity extends beyond (or just skips over) your family and friends to the greater human family, there are plenty of opportunities to make an impact on the lives of others through charitable giving.
The donation of your personal time offers the most intimate and direct connection to the rewards of giving. Personally getting involved can take a myriad of forms as vast as your imagination and inclination. Whether it is volunteering at a soup kitchen, running for a cause, collecting supplies for women’s shelters, or keeping the elderly company, the direct involvement offers you opportunities for deep fulfillment and connection with your fellow humans.
The donation of cash or property to a registered charity (or qualified donnee) can be fulfilling and impactful as well, while offering lucrative tax advantages. Qualified donations (to a registered charity) generate non-refundable tax credits, which can be used to offset your income tax otherwise payable. These donation tax credits are available at the following combined (federal and Ontario) rates:
- 20.05% on the first $200 donated; and
- 40.16% on amounts over the first $200 donated; and
- 44.16% to the extent that income is taxed at the highest tax bracket (beginning in 2019).
These tax credits can be carried forward for up to five years from the date they are made. Donations in a year are limited to 75% of your net income for the year. In the year of death and the year preceding death, donations are limited to 100% of your net income for the year.
Donations of Shares or Other Capital Property
An especially tax advantageous way of giving is through the donation of certain types of capital property, which offer a triple advantage. First, a donation tax credit is available based on the amount of the donation, which is deemed to be the fair market value of the property donated. Second, when donating capital property, your total donations limit is increased by 25% of the taxable capital gain on gifts donated, up to a maximum total limit of 100% of your net income. Third, when capital property is donated, there is a disposition for tax purposes where the fair market value of the property donated is used as the proceeds of disposition, which may trigger a capital gain. However, capital gains can be eliminated by donating certain types of capital property (qualified investments, prescribed debt obligations, or ecologically sensitive land) to qualified donnees (organizations that can issue official donation receipts, such as a registered charity). The taxable capital gain is effectively eliminated for this type of donation.
Go Big or Go Home
For the bolder or more passionate, you could even set up your own not-for-profit organization. If you have a special cause dear to your heart, starting a not for profit organization, charity or foundation may be a way to leave a lasting legacy and impact. With the help of professional advisors, the setting up of a not-for-profit organization can be a viable avenue for giving back.
Some Words Of Caution
When considering the above gifting strategies to family members, care should be taken to ensure any income earned on cash/property transferred to your family members is not attributed back to you, thus nullifying the tax benefits of gifting.
The Income Tax Act provides for various attribution rules to prevent income or capital splitting arrangements in order to pay less tax by having income which would otherwise be subject to tax at a high marginal rate, subject to tax at a lower marginal rate of another family member.
The most commonly known type is attribution of income where property is transferred or loaned by an individual to his/her spouse or common-law partner, minor child, minor niece or nephew or to a trust for these relations (a minor is described as being an individual under the age of 18). If caught in these rules, any income earned would be attributed back to that individual. Below is a summary of how different types of income are treated based on the attribution rules (‘yes’ denotes that attribution rules will apply and ‘no’ denotes they will not apply):
For loans to spouses or minor children, an exception applies if interest is charged at the lesser of the prescribed rate (currently 2%) or a commercial rate at the time the loan is made. Interest must be paid within 30 days of year end. This may be a good income splitting tool where the rate of return on the investment is expected to be greater than the interest rate charged on the loan.
These attribution rules are not applicable on gifts to adult children. Guidance should be sought from your professional advisors before undertaking any gifting techniques.
Watch your TOSI
Gifting strategies where shares of a private corporation are involved must also factor in the possible applicability of the recently introduced rules with respect to tax on split income (‘TOSI’). The TOSI rules are outside the scope of this article and guidance should be sought from your professional advisors.
Put Your Oxygen Mask On First
Before considering any significant level of gifting, make sure you have enough wealth set aside for yourself. Ensure you have a sound financial/retirement plan in place that reflects your desired future quality of life and standard of living, factoring in a good cushion for unforeseen or unpredictable emergencies and health challenges. A good retirement plan developed with your accountant or financial advisor is a good starting point.
The holiday season is a time of gratitude and giving. For those of us in the later seasons of our own lives, giving while living can be an especially fulfilling and rewarding experience, and one which can also offer some tax benefits. Consult with your professional advisors on how you can best plan for and structure a giving while living strategy.
This article has been written in general terms to provide broad guidance only. It should not be relied upon to cover specific situations and you should not act upon the information contained herein without obtaining specific professional advice. Please contact our office to discuss this information in the context of your specific circumstances. We accept no responsibility for any loss or damage resulting from your reliance on the information in this article.