1. Look through your taxable investment portfolio before you write a check.
Given the run-up in the stock market over the past several years, many investors are very likely to own shares that have substantial unrealized gains. Gifting appreciated securities to a qualified non-profit organization allows you take advantage of a “double play” of tax benefits. These donations allow you to deduct the market value of the asset at the time of the gift AND escape the capital gains tax.
For example, let’s say you bought a stock for $10,000 several years ago and today it’s worth $20,000. You plan to donate that entire amount to a charitable organization and you're in the 35% federal tax bracket. If you sold the $20,000 stock instead of donating it, it's likely you would pay a 15% capital gains tax. Therefore, the tax savings for donating rather than selling would be $1,500 ($10,000 x 15%). In addition, you can claim a charitable donation deduction on the full market value of the stock. Since you’re in the 35% federal tax bracket, this would generate another $7,000 ($20,000 x 35%) in tax savings. This brings your total tax savings to $8,500. If you are in a higher tax bracket, your total savings would be even more.
Since charitable organizations don’t pay capital gains taxes, they will be just as happy to receive stock versus cash. Keep in mind that this strategy works best for folks whose marginal tax bracket is 15% or higher and who claim itemized deductions. Also, the securities must have been owned for at least one year. Otherwise the charitable deduction will be limited to the stock’s cost basis (what you paid for it and not what it’s worth now). Generally your gift is fully deductible up to 50% of your adjusted gross income (AGI) with any excess carried forward and deducted over as many as five years.
2. Make a Qualified Charitable Distribution (QCD).
Once you are 70 ½ or older, you can make transfers up to $100,000 right from your traditional IRA to eligible charities and have such amounts excluded from your taxable income. The QCD strategy is often more tax-efficient than withdrawing funds from your IRA and then donating the same amount to charity. This is because the charitable gift reduces your taxable income but does not reduce your Adjusted Gross Income (AGI). Since a QCD is not taxable income in the first place, it has no effect on your AGI. This is important because itemized deduction phase-outs, exemption phase-outs, Roth contribution eligibility, the net investment income Medicare surtax, Medicare premium costs, the taxability of Social Security income, and some credit phase-outs all factor off your AGI. Utilizing a QCD also allows you to benefit from charitable giving even if you don’t normally itemize your deductions.
3. Use a donor-advised fund (DAF).
Created several decades ago, these funds are the fastest-growing charitable giving vehicle in the United States. They help eliminate today’s taxable gains and fulfill future philanthropic goals. Here’s how they work: you make an irrevocable contribution of cash or appreciated assets and immediately receive the maximum deduction allowed by the IRS. You name your donor-advised fund account, choose your advisors, successors, or charitable beneficiaries. Your contribution can be invested and grows tax-free. At any time afterward, you can elect grants from your account to qualified charities. Since you are able to separate the timing of the contribution from the donation to the charity, the most common strategy is to “front load” charitable contributions in a high income year. This allows you to maximize the value of the tax deduction, but keep the flexibility to decide which charities the funds will go to and when. These funds are easy to open and operate and are a less expensive alternative to a private foundation.
You should always consult your tax advisor before deciding when to use these three methods in order to make them work best in your particular circumstances.
Charitable giving has so many positive effects. It not only helps others in need, it can bring more meaning and pleasure in life to you. Just make sure to give your money away as intelligently as you’ve made it.
Editor's Note: This article was originally posted in 2017. It has been updated to reflect current regulations and statistics.
