On January 29th, Finance Minister Bill Morneau moved to have the Liberal government’s Bill C-2[1] of proposed tax changes undergo second reading in the House of Commons. This bill proposes to reduce the second personal income tax rate from 22% to 20.5% and introduce a new top marginal rate of 33% for income over $200,000 (currently, the top rate is 29% for income over $138,586). It also proposes returning the TFSA annual contribution limit to $5,500. The changes proposed in the bill would take effect retroactive to January 1st, 2016.
The new top tax rate of 33%, specifically, is accompanied by several other consequential proposed amendments. This is due to the fact that several existing income tax rules either refer directly to the top rate or use it in formulas. The government is apparently still in the process of reviewing income tax rules to determine whether any others will need adjusting, but several necessary adjustments have already been identified and included in the bill.
One of the areas that will have to be adjusted is the calculation of federal charitable donation tax credits. These tax credits are currently calculated by permitting a 15% credit on the first $200 donated, and then 29% (the current top tax rate) on everything above that, up to a total of 75% of the donor’s net income in the year. The proposed tax amendments will not only change the current tax rates but introduce that new top rate of 33%, which will naturally affect these calculations.
Bill C-2 proposes rectifying this by allowing high-income donors to claim a 33% credit on the portion of their donations that are made from income subject to the new top rate. That is to say, the portion of donations in excess of $200 will still receive the 29% credit, except that they will receive the 33% credit on the lesser of (a) the amount of the donations, and (b) the portion of their income that falls into the top tax bracket, i.e. in excess of $200,000.
As with most tax-related scenarios, this is best explained by an example.
Example A: Where total charitable donations < portion of donor’s income in top tax bracket
Taxable income: $220,000
Portion of income in top bracket: $20,000
Total charitable donations: $10,000
The first $200 of the donations receives a credit rate of 15%. The remaining $9,800 receives the new boosted credit rate of 33%.
Example B: Where total charitable donations > portion of donor’s income in top tax bracket
Taxable income: $220,000
Portion of income in top bracket: $20,000
Total charitable donations: $30,000
The first $200 of the donations receives a credit rate of 15%. The next $20,000 (maxing out the portion of income in the top bracket) receives the new boosted credit rate of 33%. The remaining $10,000 (the amount by which the donation exceeds the portion of income in the top bracket) receives the usual 29% credit rate.
These changes will apply from the 2016 tax year onward. They are obviously meant to recognize and balance out the increased tax burden that the wealthiest Canadians have been asked to shoulder, and to some extent they do that. However, it will also produce a certain increase in necessary verification and documentation, since the nature of the tax credits will be tied to the donor’s income in that particular year, which was not the case before and is something the CRA may need to start checking via increased scrutiny on high earners.