WEALTH MANAGEMENT – MALCOLM BURROWS
By Malcolm Burrows
Estate planning is an exercise in time travel. It is impossible to predict the future, especially when the time gap between planning and death is often decades. Fast forward 25 years, a charity may not exist when the estate is distributed.
Charity law identified this problem and a solution to it over 500 years ago. The solution is the charitable purpose in a charitable trust. In trust law there are “object trusts” that name people or organizations as beneficiaries. By contrast, a “purpose trust” names the objectives, not charities.
Purpose over charity
The charitable purpose is more important than any single charity. For example, the purpose could be animal welfare, with a particular focus on the rescue and rehabilitation of wild animal in rural Ontario. Several good small charities do this work now, but it is unclear if they will exist in the future — or what new charities will take their place. With a charitable purpose the animals are the focus, not the individual charities that exist to help them. A purpose seeks to address the underlying goal, regardless of the charity doing the work. In most cases, purposes that are in place over many years will likely be carried out by different charities.
A good example of a successful use of charitable purposes is the J.P. Bickell Foundation, a Toronto-based private foundation established in 1953. (Scotiatrust is the sole trustee.) The Foundation has a purpose to make 35 percent of its annual grants to Ontario charities at the discretion of the trustee. About 85 percent of the charities that the J.P. Bickell Foundation currently supports were not in existence 70 years ago. Indeed, many of the needs did not exist in the 1950s, either. Flexible charitable purposes help to ensure ongoing relevance and impact.
Don’t name that charity
In the estate planning process, most people don’t think in terms of charitable purposes. They think in terms of individual charities, just like they do with their lifetime giving. They feel compelled to “name that charity” to complete their will. I am frequently asked “what are good charities that do x, y or z?.” This is often the wrong question. And it mistakes lifetime giving with estate donations, which are usually much higher value. The “name that charity” strategy may make sense if the planned estate donation is modest or a charity is large and well established, but it is less well suited for the donor who has multiple interests or a passion for small charities. Charities close, struggle and change mission. What seems like the right charity today may not be 25 years.
For larger estate donations, the most effective way to support one or more charitable causes is by working with a public foundation to establish a legacy fund to support your charitable purposes. The recipient of the estate donation will be to the foundation that hold your fund, not to an individual small charity. This ensures your gift does not fail, which avoids future legal delays and costs.
Admittedly, creating a fund with a charitable purpose requires a lot of trust in the public foundation that holds your fund. The foundation will be interpreting your wishes in the future and funding charities on your behalf. Not every public foundation has the policies or capacity to manage funds with charitable purposes. The wise donor will ask the foundation how decisions are made, and grant recipients are identified.
A legacy fund with a charitable purpose addresses the time travel conundrum. It bridges the gap between donor intentions today and community impact tomorrow.
Artist inventory and estate donations
In estates, the tax rules governing professional artists and their art are both enabling and complex. On the enabling side of the ledger, art is treated as inventory for tax purposes, which means works can have a NIL value. Sales, however, are fully taxable as income, not capital gains. On the complex side of the ledger, among other issues, artists need to take extra care planning estate donations to charity for tax and legacy reasons.
Canada has financially successful artists who live by selling their works, but most artists — regardless of quality or critical acclaim — have limited sales and significant inventory of works. The fact that an artist can value their art inventory at NIL for tax purposes is helpful to the full spectrum of artists. Simply, there are no tax implications for the artists related to their inventory of works until a work is sold or donated.
In 1998, Canada Revenue Agency published a letter on valuing artist inventory at death. Annually, under subsection 10(6) of the Income Tax Act, the artist needs to elect to value their inventory at NIL for it to be worth NIL at death. This ensures that transfers to heirs can be at NIL, which is the fair market value (FMV) for the deemed disposition at death.
Transfer to beneficiaries
At the artist’s death, the inventory is then treated as a Right or Thing per subsection 72(2) of the Act. If the transfer of inventory to named beneficiaries is within one year of death, the transfer is done at NIL value. That is, there is no tax paid. When the beneficiary disposes of an artwork it is taxable as income.
Estate donation to charity
Art inventory can be donated at death as an ordinary gift to charity, or, for culturally significant works, as a tax-effective cultural property donation. I will focus on ordinary donations, especially to artist foundations held by public foundations.
An artist estate can donate inventory at death to a registered charity at NIL value if the transfer occurs within a year of death. A NIL value transfer means no donation tax receipt is issued. This can be advantageous, as transferring at appraised FMV will likely be a wash for tax purposes. The tax liability will likely be equal to or even greater than the donation tax credit.
Executors may also choose to elect the value of the donation for tax purposes under 118.1(7.1). The election can be any amount greater than the cost (or “advantage” amount) but not greater than the FMV. The elected amount will also be included in income of the estate, but there needs to be a planning reason to trigger the tax.
Charities are, of course, tax exempt. Any sale of art inventory by the charity has no tax implication, but the proceeds must be used exclusively for charitable purposes. Similarly, any grants to other registered charities of art, including public galleries, are tax exempt.
Art inventory in a company
If an artist wants to change the tax treatment of their inventory for donation purposes, she could place art in a company. Rather than donating art as a gift by will, she could donate shares in the art holding company. If the art in the company is valued at FMV, the shares in the company would be reflect that value. An estate donation of the shares would be taxed as capital gains as opposed to income. The donation would therefore produce greater tax savings for the estate than the associated tax liability. The excess tax credit could be used to offset other tax liability on the two final lifetime returns and up to five estate returns.
Admittedly, there are not many charities that could facilitate this plan or support artist foundations. The recipient charity would need to be a public foundation or charitable organization with art charitable purposes. The charity would need experience accepting private company shares and handling art, which would subsequently be transferred from the company to the charity.
Malcolm Burrows is a philanthropic advisor with 30 years of experience. He is head, philanthropic advisory services at Scotia Wealth Management and founder of Aqueduct Foundation.. Views are his own. firstname.lastname@example.org. He writes this column exclusively for each issue of Foundation Magazine.