Reduce Your Income and Estate Tax – Consider Donations of Marketable Securities

There was great news for registered charities in the May 2, 2006 Federal Budget that was recently passed in the House of Commons.  The capital gains inclusion rate on gifts of qualifying marketable securities has dropped from 25% to zero.  This will result in significant benefits for not only the registered charity, but the donor.

A positive result of the recent surge in the stock markets over the last couple of years has been the increased net worth of many Canadians.  Most of this capital appreciation is the result of the increase in value attributable to share and mutual fund investments.  The current Canadian income tax rules do not tax this growing investment value until the security is sold.  On this type of investment a capital gain is created when the proceeds of sale are in excess of the adjusted cost base.  50% of the capital gain calculated is included in taxable income (the other 50% is tax free) and is then taxed at the taxpayers marginal tax rate, which in Saskatchewan for an individual could be as high as 44%.  Since the capital gain remains untaxed until the security is disposed, there is an incentive to hold on to these types of securities and defer the tax until the taxpayer requires the funds.  In many cases these funds are ultimately intended for charity.  The tax rules in Canada are generous with respect to donations to charity, but the underlying tax liability on appreciated marketable securities was a deterrent in the transfer of wealth from Canadian taxpayers to registered charities that could use the funds for worthwhile causes today. 

A few years ago the Federal Government was concerned that many individuals and corporations who would otherwise gift to charity, were not, because of the requirement to pay income tax on the proceeds of selling the security before donating to charity.   A new tax incentive was introduced for qualifying gifts of appreciated marketable securities.  The capital gains inclusion rate for such gifts was reduced by half to 25% and the donation claim limit was increased.  This positive change has allowed registered charities to collect millions of dollars in donations that they previously would not have been able to collect until many years into the future. On the lobbying of charitable interest groups, the May 2, 2006 Federal budget reduced this capital gains inclusion from 25% to zero for qualifying gifts made after May 2, 2006.

The key to obtaining the tax advantage on gifting of marketable securities is to know the rules in advance.  The gift must be made of qualifying securities which include most shares, bonds, warrants and options if listed on a prescribed stock exchange. Also included are mutual funds, segregated fund units and certain prescribed debt obligations. The prescribed stock exchanges include the Montreal and Toronto exchanges, tiers 1 and 2 (but not 3) of the TSX Venture exchange, the New York Stock Exchange, Nasdaq and most major foreign exchanges. The gift must consist of securities transferred from the taxpayer’s brokerage account to the charity’s brokerage account and must not be made to a private foundation.  At no time can the securities be sold and cash realized by the taxpayer and then donated.  The donation must be to an official registered charitable organization. 

The following is a comparison of the net benefit of gifting qualified securities versus cash to your favorite charity.  The example assumes a marketable security with a fair value of $100,000, adjusted cost base of $10,000 and a Saskatchewan resident individual in the highest marginal tax rate of 44%.

The net tax benefit from the donation is $19,800 ($44,000 less $24,200) when qualifying securities are gifted rather than cash.  

If you are considering or have already provided for a charitable donation in your will, you should ensure that the charity is designated.  Provide a specific reference to the charity by name and the amount of the gift planned.    Consider a provision in your will to take advantage of this tax benefit and ensure that your executor is aware of these rules.

If you own a corporation with marketable securities, the tax benefit is likely even greater than calculated on an individual basis given high corporate income tax rates on investment income.  A properly designed corporate gifting plan can significantly reduce estate tax and probate fees.

This type of planning requires proper advice.  Investment markets change and each taxpayer’s situation is unique.  Consult with a Chartered Accountant in conjunction with your investment advisor to obtain the maximum tax benefit on a gift of qualifying marketable securities.   

Kelly Lutz, is a Chartered Accountant and Partner with Virtus Group Chartered Accountants and Business Advisors LLP in Saskatoon.  He is a director on the St. Pauls Hospital Foundation Board and sits on their Planned Giving Advisory Committee.