Ten years ago, in 2016, the introduction of the Graduated Rate Estate (GRE) regime turned Canadian estate planning upside down. The sidebar to the GRE rules were rules for “estate donations”. These Income Tax Act provisions in Section 118.1(5.1) altered the administrative and tax treatment of gifts by will, as well as direct designation gifts of life insurance, RRSP/RRIFs, and TFSAs. A decade later, how are charities and executors managing?
I’d say the experience is mixed.
Estate Donation Features
Let me first focus on gifts by will. The “estate donation” provisions changed fundamental attributes of gifts by will.
- A gift is a donation of the estate, not of the donor during his/her lifetime.
- Donations are claimable on up to seven (final two lifetime returns and five estate T3 returns). Previously, there were two returns (final two lifetime T1 returns).
- The executor needs to transfer funds to the charity, which then issues a receipt for fair market value. The executor files the donation tax receipt to claim the donation tax credits for the estate. Pre-2016 regime, gifts were deemed to be made just before death. This timing coincided with the deemed disposition of taxable property. Previously, gifts could be claimed without property being transferred to the charity.
- After the date of death, the estate has 60 months to make the donation. Thereafter, the donation tax receipt cannot be claimed. Previously, there was no transfer deadline or claim period.
- The estate can donate property owned by the estate from the deceased, but not substituted property.
What we’ve learned
I actively collect stories about the regime from charities and executors. The are a few recurring themes:
- Executors are making larger distributions to charity upfront to file the tax receipt on the terminal T1, which in some situations eliminates all tax owing. Failure to do so mean there may be a significant tax liability in the terminal T1, lead to interest charges or CRA late penalties. In other words, an estate may be owed significant tax savings from a donation, but until the donation is transferred the estate owes taxes at death. This fact is helpful to charities and may ensure money is received faster.
- Executors also have an incentive to distribute illiquid in-kind property to charity quickly. Examples of illiquid property include private company shares and art. Again, the goal is to get immediate tax relief, but that assumes the charity is capable of receiving the property in-kind. In one situation, the urgency to distribute property in-kind was due to the closing of the 60-month distribution window. After 60 months, the donation would not be eligible for any tax relief.
- Charities that receive residual bequests have stories about the “estate donation loop”. That is, every distribution triggered a donation tax receipt necessitating the refiling of T1s and T3s. Every refiling generated more funds for distribution to the charity. In this case, the loop process happened three times before everyone decided enough is enough.
- Charities and executors are negotiating the number times the estate refiles tax returns to maximize donation tax credits. One charity with a 100% residual interest in an estate shared how they had to push an executor to refile tax returns after the initial distribution gift had been made after two years. The result was $300,000 a tax refund for the charity. (Charities, make sure executors file tax receipts, otherwise you may be leaving money on the table. But be reasonable and clear about expected benefit from the extra cost and effort.)
What we’ve lost
- There are no estate tax benefits for a testamentary charitable remainder trust. Under the 2016 rules, a testamentary trust – even if it irrevocable with a charity as a remainder beneficiary and no power to encroach on capital – is not considered by CRA to be an estate donation due to the substituted property prohibition.
- The once popular “donate to eliminate” will clause is broken. This clause provided the executor with discretion to donate just enough to charity to eliminate (or mostly eliminate) the tax on the terminal T1. Due to the estate donation loop and the effect of refiling, there is no single formula that enables the executor to make a single discretionary donation to offset all taxes.
Please share
These are just a few issues and practice adjustments arising from the estate donation rules. If you have more stories to share, please leave a comment. It would be helpful to hear what others are experiencing.
