From the time it became clear that the Liberals would form a government and would bring in changes to the tax rate structure including a new 33% bracket for high income taxpayers (those with more than $200,000 of taxable income), charities and fundraisers have been concerned about what changes if any would come to the tax credit system.
For many years, after a low 15% credit for the first $200 of donations, all donations got a credit of 29%, equal to the top federal marginal rate.[1] So what happens with a new 33% bracket?
There were three broad options.
- The top rate would remain at 29% and thus the top bracket taxpayers would end up with a tax penalty. This is how some of the provinces including Ontario handled a new, high tax bracket.
- They could extend the tax credit to 33% and apply it to all donations. The problem here is that it would be extremely costly to the government.
- They could develop a system which would protect high income taxpayers by giving them special treatment to try to ensure there was no disincentive for them to give.
When the proposals were made public by Finance Minister Bill Moreau on November 7, it was clear that the government opted for the third approach.
This in effect gives high bracket taxpayers more tax credits for donation than lower bracket taxpayers, the first time this has happened since the system moved from deduction to tax credits a couple of decades ago. But it is a policy decision which, in our view, is not unwarranted.
That having been said, the new regime is mind-bogglingly complicated and a high bracket donor won’t know what credits he or she gets until the tax return is filled out and taxable income is determined.
If you want to read the legislation, here it is.[2]
“(1) The formula in subsection 118.1(3) of the Act is replaced by the following:
A × B + C × D + E × F
(2) The descriptions of C and D in subsection 118.1(3) of the Act are replaced by the following:
C is the highest individual percentage for the year;
D is the lesser of
(a) the amount, if any, by which the individual’s total gifts for the year exceeds $200, and
(b) the amount, if any, by which the individual’s amount taxable for the year for the purposes of subsection 117(2) exceeds the first dollar amount (as adjusted for the year in accordance with section 117.1) referred to in paragraph 117(2)(e);
E is 29%; and
F is the amount, if any, by which the individual’s total gifts for the year exceed the total of $200 and the amount determined for D.
(3) Subsections (1) and (2) apply to gifts made after 2015.
- (1) Subparagraph (b)(i) of the definition “tax otherwise payable under this Part” in subsection 120(4) of the Act is replaced by the following:
(i) the highest individual percentage for the year multiplied by the individual’s split income for the year
(2) Subsection (1) applies to the 2016 and subsequent taxation years.”
If you don’t have an advanced degree in mathematics, the following is a more or less plain English explanation:
Section 118.1 of the Act provides a tax credit to individuals for gifts made to registered charities and certain other qualified donees. The amount of the credit is determined under subsection 118.1(3). Currently, the credit is calculated as 15% of the first $200 of such gifts and 29% (i.e., the highest tax rate for individuals) of gifts above that amount. Subsection 118.1(3) is amended, consequential to the introduction of a new top personal income tax rate of 33% in subsection 117(2). In general terms, a new tax credit rate of 33% will apply to gifts in excess of $200 to the extent that an individual has income that is subject to the new 33% income tax rate.
As a result of this amendment, the credit availabe under subsection 118.1(3) is calculated as the total of
- 15% on the first $200 of total gifts,
- 33% on the lesser of
- the amount, if any, by which the individual’s total gifts for the year exceeds $200, and
- the amount, if any, by which the individual’s taxable income exceeds the dollar threshold for the top personal tax rate (in paragraph 117(2)(e)), and
- 29% on the individual’s total gifts for the year above $200 that are not eligible for the 33% rate above. [3]
The department notes then gives the following example.
“For example, in the case of an individual that has $215,000 of taxable income and makes $20,000 in total gifts in 2016, the individual’s tax credit under subsection 118.1(3) is calculated as the total of:
- $30, being 15% of the first $200 of total gifts;
- $4,950, determined as 33% of $15,000, being the lesser of
- the amount by which the individual’s total gifts exceeded $200 ($19,800), and
- the amount by which the individual’s taxable income exceeded $200,000 ($15,000); and
- $1,392, determined as 29% of $4,800, being the amount by which the individual’s total gifts for the year ($20,000) exceeds the total of $200 and the amount of the individual’s gifts to which the 33% rate applied ($15,000).
In this case, the individual’s 2016 tax credit for gifts would total $6,372 ($30 + $4,950 + $1,392).
This amendment will apply to gifts made after 2015. Gifts made in 2015 and previous years, but claimed in 2016 or a later year, will therefore not be eligible for the new 33% tax credit rate.”
We’d point out a couple of things. First, if the donor in the above example had only $190,000 of taxable income, her or his credits would be $30 on the first $200 and (29% of 19,800) or $5,742 for a total of $5,772. There is a significant difference in tax benefit between two identical gifts. But this of course is intentional to help the high rate taxpayer who makes a charitable donation.
Second, the value of the credit to the high income donor increases substantially as taxable income rises.
Using the same example as did Finance but giving the donor an income of $300,000, we get the following result.
- $30, being 15% of the first $200 of total gifts;
- $6,534 determined as 33% of $19,800, being the lesser of
- the amount by which the individual’s total gifts exceeded $200 ($19,800), and
- the amount by which the individual’s taxable income exceeded $300,000 ($100,000); and
- $0 determined as 29% of $4,800, being the amount by which the individual’s total gifts for the year ($20,000) exceeds the total of $200 and the amount of the individual’s gifts to which the 33% rate applied ($19,800)
Thus the increase in income brought $6,564 in tax credit compared to the earlier example of $6,372.
Put still another way, all of the donation in excess of the first $200 was credited at 33%!
We hasten to add that we see nothing wrong from a policy point of view with this result, which basically treats the high bracket donor in an equivalent manner to lower bracket donors. That having been said, the complexities will mean that donors and those soliciting funds will be hard pressed in many cases to actually assess what the credits will be until a tax return is filed.
And we’d suggest that our readers file away the “plan English” explanation of the credit system. We suspect going to the Income Tax Act won’t be of much help to most non-mathematicians.
[1] Of course, each province has an analogous regime.
[2] http://www.fin.gc.ca/drleg-apl/2015/nwmm-amvm-l-1215-eng.asp
[3] http://www.fin.gc.ca/drleg-apl/2015/nwmm-amvm-1215-n-eng.asp