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When death and taxes are charitably intertwined

Father's Day is coming up. But I've already received my gift. You see, for Mother's Day I bought my wife, Carolyn, a new Toro lawnmower.

"Honey, you shouldn't have!" she said.

But I knew she'd love it. My wife loves all manner of heavy equipment. Truthfully, the gift was for me, too. Hey, a gift that benefits two people is better than a gift benefiting one.

Now, when I pass away, Carolyn is due to receive the gift of everything I own at that time. Yes, that Toro will one day be hers alone, along with my investments. But since a gift that benefits two is better than a gift benefiting one, I'm going to do something unique with some of the investments I'm leaving to her.

I'm going to help our favourite charities at the same time. Let me explain.

The strategy

At the time of my death, I want to leave a gift that benefits Carolyn, but benefits a specific charity as well. How? I can give to charity in my will, providing me with a donation credit in my year of death, which will save me tax. At the same time, I can provide Carolyn with the income, during her lifetime, from those same investments that I'm leaving to charity.

Here's how. At the time of my death, I'm going to leave a specified amount of investments to a spousal testamentary trust (a trust created in my will at the time of my death). There will be a tax-free transfer of those assets to this trust when I die just as though I had left the assets directly to Carolyn. As my spouse, Carolyn will have a right to all of the income earned in the trust during her lifetime. At the time of her death, the capital of the trust (the investments) will go to the charity of my choice.

Although the charity will not receive the donation until Carolyn dies, subsection 118.1(5) of Canadian tax law will provide me with a donation credit in the year of my death, which will save me tax.

You see, at the time of my death, I will be considered to have given the charity an equitable interest in a trust.

There's a value to that interest, so I'm entitled to claim a donation in my final year for that value. Canada Revenue has said as much in a letter (document 9732295 dated March 20, 1998). Canada Revenue's position is not surprising given a ruling at the Tax Court of Canada in the case of O'Brien Estate v. MNR (1991).

The details

To make this idea work, keep the following things in mind.

Your spouse and others cannot have a right to encroach on the capital of the testamentary trust.

The value of the donation in your year of death will have to be actuarially determined. It'll be something less than the amount placed in the trust since the charity isn't getting the money until your spouse dies.

You'll need to specifically identify in your will the charities to benefit. This decision cannot be left to anyone else.

You'll need to identify the dollar amount or a formula for calculating the amount to be received by the charity. The amount cannot be left to anyone else to determine.

Your executor won't receive a donation receipt in your year of death since the charity won't be getting anything at that time. While a donation receipt is normally mandatory, the O'Brien case established that it's not necessary in this case to claim a donation in your year of death.

Tim Cestnick, FCA, CFP, TEP is author of The Tax Freedom Zone and Winning the Tax Game 2003. He is managing director, National Tax Services, at AIC Ltd.

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