The Accidental Philanthropist® – Mark Halpern
By Mark Halpern, CFP, TEP, MFA-P
No one likes bad news, whether it comes in the form of a stock market correction, a rise in inflation or a drop in interest rates that cuts cash flow for retirees living on a fixed income. But the bad news that often gets the most passionate negative reaction is an increase in taxes — so it isn’t surprising that many Canadians have been talking about the increase in the capital gains inclusion rate announced in the 2024 federal budget.
The budget proposes that starting on June 25, 2024, individuals will pay tax on 50 percent of the year’s realized capital gains up to $250,000 — and 66.67 percent of the year’s realized capital gains above $250,000. Corporations and trusts must use the 66.67 percent inclusion rate from the first dollar now of any capital gains realized during the year.
Anyone who owns an asset with a large unrealized capital gain — such as a substantial investment portfolio or real estate beyond a personal residence — will be affected. How much will the new inclusion rate cost taxpayers? Let’s say that, during the second half of 2024, someone realizes $250,000 in capital gains from investments and sells a cottage that has appreciated in value from $200,000 to $1.2 million, resulting in a $1 million capital gain. At the highest combined federal-provincial marginal tax rate in Ontario (53.53 percent), tax on that $1 million capital gain would be $267,650 with a 50 percent inclusion rate, but $356,885 with a 66.67 percent inclusion rate. That’s a difference of $89,235 — hardly small change. And of course it’s much worse for corporate holdings.
I always like to look for the silver lining. In this case, because these budget changes have captured our attention, many people are more motivated than ever to learn how to minimize taxes on capital gains. As a result, we’ve been sharing a range of strategies with our clients and professional colleagues, including ideas that transform tax into legacy-building philanthropy that benefit both foundations and the charitable causes they support.
1. Averaging down each year’s capital gains tax
There’s a simple way to take advantage of the fact that the first $250,000 in capital gains earned by an individual will continue to benefit from the 50 percent inclusion rate. Between June 25 and December 31, 2024, and every year thereafter, an individual can plan to realize $250,000 in capital gains — essentially harvesting the amount that can be taxed at a lower rate.
Also, consider selling depreciated stocks, bonds, mutual funds, or EFTs for capital losses to offset against any capital gains now or in the future. This strategy is known as tax-loss selling. Be aware that there’s a 30-day period during which an investor cannot repurchase the same security after selling it. Fortunately, there’s no such rule when someone realizes capital gains — which means that after locking in a new adjusted cost base, the investor can immediately repurchase the same security.
Remember that capital losses can be used to offset against capital gains in perpetuity in the future so if you are expecting a big payout in the future, stockpiling some losses now can be of help.
2. Mitigating capital gains tax with an estate freeze
An estate freeze restructures the ownership of a corporation to minimize capital gains tax when assets transfer to the next generation. The current owner holds onto preferred shares that maintain a fixed price and therefore will incur capital gains tax on a predictable amount through a deemed disposition on death. At the same time, the corporation creates common shares for beneficiaries. The common shares appreciate in value but can be held beyond the current owner’s death without a deemed disposition in the hands of his beneficiaries. The result is the deferral of capital gains tax on that growth, and it’s likely going to be sizable.
Now, with the freeze put into place, we need to determine how to create the money that will eventually fund the tax bill or convert the tax into charity.
3. Planning for capital gains liabilities with life insurance
We emphasize to all clients how important it is to make strategic decisions about how to cover the eventual capital gains tax liability on death. In most cases, the choices are to pay the tax with cash set aside for that purpose, with a non-tax-deductible loan at an uncertain future interest rate, with selling assets at what may not be the optimal time or price, or with an adequate amount of life insurance.
For couples, joint-last-to-die (JLTD) life insurance is usually the most cost-effective choice, because it pays out when the second spouse dies (which is when the tax liability occurs) and is easier to acquire as it’s usually based on the younger, healthier spouse’s actuarial projections. JLTD life insurance is a perfect option for estate freezes, can cost 40 percent less than insuring a single life and can work where one spouse may be uninsurable.
Life insurance premiums can be paid using cash flow, by moving taxable assets into a tax-exempt life insurance policy or implementing a financing arrangement (aka IFA – Immediate Financing Arrangement). An IFA can be particularly appealing because when set up properly, it can be cash flow neutral. First, the client uses assets to go towards the first life insurance premium. Then the borrow back the same amount from a financial institution, using the policy’s cash surrender value. The borrowed money goes back into their investments, which makes the interest tax-deductible, in addition to some other deductions available.
Canadian financial institutions love lending against life insurance policies with the cash surrender value as collateral. In fact, they tend to place a higher value on the security of an insurance policy than any other asset, including land, buildings, stocks, bonds, crypto or even precious metals such as gold. As a result, it’s easy to get approved for a loan up to 100 percent of the cash surrender value, and the interest rate is generally very favourable.
4. Reducing capital gains tax with charitable donations
Charitable donations are another powerful way to mitigate capital gains taxes. One approach is to donate either publicly traded securities or (this is less well known) private company shares following an estate freeze. There’s no capital gains tax due on assets like these that are donated in- kind, and the donor receives a charitable receipt for the full market value.
It’s very worthwhile to learn how to donate private company shares but there isn’t enough space in this article to articulate fully. Please reach out to us to obtain our longer article to explain.
Additionally, charitable donations can eliminate 100 percent of estate taxes in the year of death and the prior year. Let’s assume someone anticipates a $5 million estate tax bill. They can acquire a $5 million life insurance policy to cover that tax bill alone for pennies on the dollar. But, if they’re philanthropic-minded and would prefer the tax money to go to their charitable foundation or to a charity rather than to taxes, they can double the policy amount to $10 million. When that $10 million is donated on death to a charitable foundation or charity, it generates a $10 million tax receipt that turns the $5 million estate tax bill into $5 million of charity! We encourage all our clients to incorporate strategic philanthropy using life insurance into their estate planning.
Assemble a professional team to optimize tax savings
With the right professionals in place to advise them, Canadians can implement strategies that help them chart their own best course through tax changes such as the higher capital gains inclusion rate. Your team should include a good accountant, lawyer, investment advisor and philanthropic insurance advisor who collaborate to achieve the best results. Those results may include meeting goals such as preserving wealth, maximizing charity, and creating a legacy that lasts across generations.
Timing IS everything
It’s important to get your planning in place. Reach out to us while the sun is shining for a no-obligation conversation. Introduce us to your situation and allow us to share estate planning, tax minimization and philanthropic strategies that can help you achieve your unique objectives.
For charities and foundations
Your fundraising goals will be more easily achieved if you work with experienced planned legacy giving professionals who will help you navigate the technical aspects of giving with your current supporters and prospective donors. We help charitable organizations and foundations across the country.
MARK HALPERN is a well-known CFP, TEP, MFA-P (Certified Financial Planner, Trust & Estate Practitioner, Master Financial Advisor – Philanthropy). He writes this column exclusively for each issue of Foundation Magazine.
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