The Tax Benefits of Charitable Giving

Charitable giving

As we come to the close of 2013, financial advisors focus our conversations with clients on assessing where they are and what there is to wrap up before year’s end. If we conclude that they’ll owe taxes, we look for ways to reduce what they’ll have to pay, which often leads to a discussion of the tax benefits of charitable giving. For example, if some of a person’s income is the result of required minimum distributions (RMDs) from an IRA because they are over 70 ½, we discuss donating some or all of the distribution (up to $100,000) directly to a charity before the end of the year. This is called a qualified charitable distribution; if they don’t need the income and hate taking the distribution, this can be a favorable strategy because it removes up to $100,000 of income from the tax return and helps a charity.

Of course, donating to charity can be accomplished in more creative ways by giving assets instead of cash. We advise clients to consider donating investment holdings to a charity because there are some added benefits to doing this. Investors who have low basis stock they may have inherited can donate it to a charity and take the deduction for the current market value. This eliminates the capital gains that they would realize if they sold the stock first and then gave the proceeds to charity.

To illustrate, let’s say a person wanted to give $10,000 to charity before the end of the year. He has 100 shares of stock with a current price of $100 per share. If he sells the stock and gives the proceeds to charity, it actually costs him to do it. Assuming the original purchase price of the stock was $10 when the sale takes place, the difference in price (ignoring transaction costs) is $90 per share. The $90 per share represents the gain and since the stock was originally purchased many years ago by the client’s grandmother, the gain is a long-term gain. Because of the client’s income, he is in the highest income tax bracket, making his capital gain tax rate 20%… plus the 3.8% Medicare tax on unearned investment income… plus 5% state income tax. As a result, he would owe just under $2,600 in taxes. If he didn’t want to use additional funds to pay the tax out of pocket, the net donation would be about $7,400, and the resulting charitable deduction would equal about $3,400.

But what happens if he instead donates the 100 shares directly to the charity? The charity receives the donation at full market value and can sell the stock immediately, if it wishes. The donor avoids paying $2,600 in taxes on the appreciated value and gets a deduction for the full $10,000 to reduce his taxable income. That reduction saves him about $4,500 in taxes (federal tax rate at 39.6%, state tax rate at 5%, and Medicare tax at .9%). The net cost of a donation handled in this way is only about $5,500… and the charity receives the full $10,000 for its use.

Giving Through a Donor Advised Fund

There’s another way to donate that simplifies the donation of non-cash assets. In the example above, the stock was given to the charity… but what if the organization isn’t set up to accept stock gifts? The solution is to donate to a Donor Advised Fund (DAF).

A DAF is a charitable plan where a donor makes a gift to a public charity or community foundation (known as the “host charity”), which sets up a sub-account, or fund, in the donor’s name. Then, as determined by an agreement between the donor and the host charity, annual contributions are made from the Donor Advised Fund to one or several predetermined charities (one of which can be the host charity). Once you contribute to a DAF, you get the contribution in the year of the donation for the total amount. In the future, your charitable contributions will be made from your DAF and will not receive an income tax deduction in the year you make the distribution from the DAF. This can be beneficial in years when you know your taxable income is unusually high.

Each of the giving strategies I described requires you to part with some of your wealth, but if you’re charitably inclined, why not use the tax advantages of your generosity? There’s no rule that philanthropy should only benefit the recipient.

Copyright: voronin76 / 123RF Stock Photo

About Barbara Ristow
Barbara Ristow was one of the rare planners who started in the industry right after college. She graduated from Valdosta State University with a degree in Finance. After graduation Barbara enrolled at the College of Financial Planning, where she graduated with Masters in Financial Services. Over the next two decades, she worked in a series of insurance, investment, and planning firms — including one that she founded herself — before coming to Pinnacle to serve as the company’s Director of Financial Planning. Barbara has taken her passion for personal finance beyond the office and into the classroom, serving as an adjunct professor of financial planning at both the College of Charleston and Virginia Commonwealth University.