Among all the reasons people give to charity, reducing their taxes is often far down the list. According to a survey by the Charities Aid Foundation in the U.K., more important reasons people give are:
- 96%: personal values including a sense of morality and ethics
- 75%: belief in a specific cause
- 71%: faith and religion
- 61%: personal experiences
- 13%: tax savings
In other words, personal passion drives giving much more than an intellectual understanding of our tax system.
That being said, reducing tax while donating, as a happy side effect, enables donors to give more than they planned or give the same amount at a lower cost, and one of the most tax-effective ways to donate is through a corporation. Let’s explore the whys and hows of this strategy.
Get a deduction instead of a tax credit
When people make personal donations, they get a charitable tax receipt, which is a non-refundable tax credit they can use to mitigate up to 75% of their net taxable income. There’s also the option to carry forward the tax credit (or unused portions of it) for up to five years.
Donating cash through a corporation offers even better tax advantages. The donor receives a full deduction (rather than a tax credit) against net taxable corporate income. Any or all of an unused deduction can be carried forward for use within the next five years.
Build a tax-free pipeline from the corporation
Some corporations may consider using appreciated securities to donate to charity.
Here’s an example of a gift in question. Let’s say a corporation bought $500,000 worth of various securities: public stock, exchange-traded funds, mutual funds, and segregated funds, and they’re now worth $1 million.
Corporations must resist the urge to sell the securities, and donate the proceeds. If they did, they would have to pay capital gains tax of $135,000 (27% of the $500,000 gain). The final cash donation ends up being $865,000.
Instead, consider the magic that happens when a corporation donates appreciated securities as an in-kind gift to a charity. Although doing so also offers good benefits to an individual who makes such a donation, there are even better advantages for corporations.
With either personal or corporate donations, you don’t have to pay tax on the capital gain, and the charitable donation receipt can be used to reduce net taxable income now, or at any time during the next five years.
What’s different is that donating corporately means the amount of the capital gain is credited to the corporation’s capital dividend account (CDA) and can now be withdrawn from the corporation tax-free!
In this example, the donation results in a $500,000 credit to the corporation’s CDA, and there’s no tax on future withdrawals against that credit. That saves a further 47% tax that you would have paid had you withdrawn the $500,000 directly from the corporation.
Effectively, depending on provincial corporate tax rates, this roughly doubles the total tax savings and creates a tax-free pipeline that converts corporate dollars into personal dollars.
Amplify gifts with corporate-owned life insurance using the “Give & Get Strategy”
Life insurance can be used strategically in many ways to amplify personal gifts to charity — but there are ways that it, too, can be even more powerful when purchased through a corporation.
When corporate dollars are used to pay life insurance premiums, the death benefit is credited to the CDA, allowing that money to flow through to assigned beneficiaries tax-free, effectively turning corporate money into personal dollars. And, beyond tax-effective estate planning, corporate-owned life insurance has the power to amplify philanthropic gifts, when the beneficiary is a charity.
Here’s a quick case study.
Imagine a couple, both age 65 and very successful entrepreneurs. Their net worth is $60 million held in personal registered and non-registered accounts, along with significant corporate assets shared with other partners. Their estimated tax liability when the second spouse dies is $12.5 million. They’re concerned about that, and they’re also passionate about leaving a substantial legacy to their favourite charitable causes.
They have four basic options to cover the anticipated eventual $12.5 million tax bill:
- keep cash available for that purpose,
- instruct that the estate borrow to cover the cost,
- instruct that the estate sell assets (such as a cottage, business or real estate investments) to cover the after-tax cost, or,
- buy life insurance. Generally, the last option is the most attractive – and corporately owned life insurance is often the best approach.
At their age, the couple can likely buy a corporately-owned joint last-to-die policy that will be worth $12.5 million when the second spouse dies. The policy requires premium payments of about $160,000 annually over 20 years, or $320,000 annually over 10 years. Either way, the premiums will cost the corporation approximately $3.2 million of corporate money to cover their personal tax bill.
But we’ve established this couple also wants to leave a charitable legacy. They know that the charitable tax receipt on a very large gift will result in a 50 percent tax deduction. So instead, this couple buys a $25 million dollar policy at a cost of about $6.4 million, and makes the beneficiary their charity. The $25 million tax receipt is then used to reduce their final tax liability to zero. As a bonus, their substantial donation has created an enduring family legacy.
Leveraged charitable arrangements
By giving through a corporation, there is another way to use life insurance to give generously that doesn’t cost anything. A business owner can take a sum of money, say $500,000, from his investment portfolio, and through his business, buy a permanent policy that offers an initial death benefit of $10 million, which grows over his lifetime.
The business owner pays $500,000 annual premiums for 10 years, and these premiums are considered “cash value” that can be used as collateral in getting loans. In the first year, he takes out a business loan worth 100 percent of his cash value, and reinvests the borrowed funds in his stock portfolio, which makes the interest he pays on the loan a tax-deductible business expense.
He increases his loan by $500,000 every year, generating a loan of $5 million. By the time of his death, his policy is worth $15 million, and he’s left instructions for his estate to repay his loan from his death benefit, and to donate the balance to his favourite charity ($10 million). The $10 million charitable tax receipt covers his estate’s entire tax liability of $5 million.
Recognition can be inspirational
Today, many charities fully understand the value of legacy gifts and are happy to recognize future donors while they are alive, if they so desire. This recognition reinforces the donor’s role as a community and corporate leader during their lifetime and enhances a business’s reputation as a caring contributor to its community. It often also inspires children and grandchildren to follow in the older generation’s philanthropic footsteps.
Help donors do even more good
Charitably-minded people already want to do good. Corporate philanthropy can help them do even more good — but are advised to seek expert advice to make the most of the opportunity.
Mark Halpern, CEO at WEALTHinsurance.com is a well-known CFP, TEP, MFA-P (Certified Financial Planner, Trust & Estate Practitioner, Master Financial Advisor—Philanthropy).
Mark@WEALTHinsurance.com He writes this column exclusively for each issue of Foundation Magazine.
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