How would you feel if I told you that you are probably gifting money to charity the wrong way? There is an “easy way” and an “optimal way” to do most things when it comes to finances. Charitable giving is no exception. This article will contrast two ways to gift money to a charity and introduce a helpful strategy to add flexibility to your giving plans.
For the following example, let’s assume you are part of a couple in the 33% federal tax bracket, with an annual income of $250,000. You have enough overall deductions to itemize on your tax return, and have investments that are held in a non-retirement account.
Let’s say you decide to gift $10,000 to your favorite charity. You write a check, and claim a tax deduction of $10,000 which saves you $3,300 after you itemize the deduction on your next tax return. This is how most charitable contributions work.
Instead of writing a check, what if you contribute $10,000 in appreciated securities (things you own that are worth more than you paid for them like stocks or mutual funds) for which you paid $5,000. You still get the tax deduction of $3,300, but you do not have to pay capital gains taxes on the $5,000 gain. Taxpayers in the 33% federal tax bracket pay 15% on long term capital gains (assets owned for at least 1 year) plus, as high-income earners, the Net Investment Income Tax of 3.8%. By gifting appreciated securities, investment taxes of 18.8% or $940 are avoided on the donation.
What if you really want to hold these assets for the long term, as you expect additional gains or protection from them over time? More good news. Since you did not use your cash to make the charitable donation, you can immediately repurchase the investment you gifted. Plus, you now have higher cost basis in the investment to minimize future tax liability.
Giving appreciated securities away to charity is a straightforward process. Simply contact the charity and ask for instructions on how to gift your shares to them. However, this assumes that you know exactly whom you want to give the securities to and you want to do it immediately. Alternatively, you can setup a donor advised fund (www.fidelitycharitable.org) to receive your appreciated securities.
What is a donor advised fund? A separate account where you can contribute cash or securities. If you have owned the security for at least a year, you can deduct the appreciated value and avoid tax on the gain. You receive the tax deduction in the tax year you make the contribution to your donor advised fund, however, you do not have to distribute the funds to a charity in the same year. The pace of distribution from your giving account is up to you. Donor advised funds are simple to create and allow you to support the same charities you do now in a more tax efficient manner, simplify your charitable recordkeeping, and possibly grow your gifts over time.