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Be careful how you donate through your will

We try to make meal-time in our home a lesson in generosity, but it doesn't always work out.

Last weekend, Carolyn made pancakes for the kids. Winston, 6, and Sarah, 5, began to argue over who would get the first pancake. Never one to miss a teachable moment, Carolyn told them: "If the Lord was sitting here with us, He would say 'Let my brother or sister have the first pancake, because I can wait.' "

Winston then turned to his sister and said "Sarah, you be the Lord. I'll be the brother."

Okay, so my kids still haven't got generosity nailed down yet. It'll come. But "generous" is a good way to describe many Canadians, as an increasing number of us are leaving gifts to charity in our wills. But if you're not careful, the tax relief you're counting on from your gift to charity may not materialize as hoped. Let me explain.

The example

Suppose your Uncle Bob dies; you're the executor of his will, and he leaves instructions in his will to donate 10 per cent of the "residue" of his estate to charity. The other 90 per cent of the residue will go to his kids.

Under the terms of his will, the "residue" of his estate will be the amount left over after paying his debts, taxes owing, and giving an amount (to be determined by you) to his grandkids to help them with education costs. Whatever's left makes up the residue of his estate, to be distributed to the charity (10 per cent) and his kids (90 per cent).

Sounds reasonable. Right? Not exactly. You see, Uncle Bob was counting on the donation to charity to provide some much needed tax relief on his final tax return. The problem? He's not going to get a donation tax credit in this case.

The problem

You see, our tax law will normally allow a donation to charity made "by will" to count as a donation on the deceased's final tax return. In Uncle Bob's case, the donation is not considered to have been made "by will." Rather, it will be considered a donation made by his estate, with the tax relief falling into the hands of his estate, and not his hands in his year of death.

In order for a donation to be made "by will," it's necessary that the amount of the donation be clearly spelled out in the will, and not left to the discretion of the executor. How do you spell out the amount? You can stipulate a specific amount, a specific property, or a percentage of the residue of your estate.

While Uncle Bob did stipulate a percentage of the residue to donate to charity, the amount of the residue was at the executor's discretion because the executor was able to decide how much would be given to the grandkids. The amount that goes to charity is then ultimately determined by the executor, and not by Uncle Bob. This is a no-no.

The solution

To ensure you'll get the tax relief you expect after your death, be sure to follow some simple rules when donating to charity in your will.

First, if you're going to leave a percentage of your estate to charity, be sure your will clearly specifies what is to be paid from the estate in determining the "residue," and do not provide your executor discretion to decide this amount.

Second, although it's not absolutely required, name the charities to which you want donations made. This clarifies that a donation is required by you, and ensures the charities will be qualified donees.

Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.

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