Families who are creating a legacy through charitable giving often question whether they are using the most effective approach to fund their charitable goals. Cash is one of the most common ways to make gifts and often occurs by default when a collection bucket is passed or when a gift is made by credit card through a charity’s website.
While cash is simple to give, it is typically the least tax efficient. When cash is gifted, the primary tax benefit is the itemized deduction that is available for those who have enough itemized deductions to exceed the standard deduction.
As a quick refresher, individuals will only itemize if they have itemized deductions that exceed the standard deduction of $25,900 for 2022. The most common itemized deductions are state and local taxes, mortgage interest, charitable contributions, and, potentially, medical expenses but only to the extent they exceed 7.5% of the taxpayer’s adjusted gross income. See our October 2022 blog post on charitable bunching for additional discussion of itemized deductions.
Key Takeaway:
Cash is NOT a tax efficient asset to gift to charity.
Gifting Appreciated Stock:
For families that are interested in maximizing the tax impact of their charitable giving, gifting appreciated stock is often a valuable strategy. For this strategy to work, the appreciated stock must be long-term (held for more than 1 year) prior to the gift and be held as a taxable asset (i.e., stock held in employer-based retirement accounts or IRAs will not qualify). Closely held business interests can also qualify; so using a portion of the business to fund a significant charitable goal when the business is sold is an attractive choice for charitable small business owners.
When qualifying appreciated stock is gifted to charity, the taxpayer gifting the stock avoids paying any capital gains tax on the appreciation. For anyone who is already charitable, this provides a significant tax benefit. Further the taxpayer is still allowed to use the full fair market value of the gift as an itemized deduction. In effect, the taxpayer receives a double benefit, avoidance of the capital gain as well as an itemized deduction for the full value of the gift.
Focusing specifically on the benefit of using appreciated stock, let’s assume a family chooses to make a $30,000 charitable contribution in 2022 using stock that has doubled in value since they purchased it over one year ago as shown in the following chart.
By gifting the appreciated position, this family is able to avoid capital gains tax on $15,000 of appreciation that otherwise would have been a taxable gain when sold. Assuming they are in the top capital gains tax bracket of 20%, have a state tax rate of 5%, and are subject to the net investment income tax of 3.8%, they would have owed $4,320 in capital gains tax if the position was sold rather than gifted to charity.
As discussed previously, this family would also qualify to utilize this contribution as an itemized deduction. Assuming this family is already itemizing and is in the 37% federal and 5% state tax brackets, they would save an additional $12,600 in taxes from the itemized deduction for total tax savings of $16,920 from this charitable gift.
After all the tax savings, the $30,000 charitable gift will only cost this family $13,080. In other words, they saved 56% of their charitable contribution in taxes which means the cost of the charitable gift to the family was only 44% of the total amount given to charity.
Key Takeaway:
Gifting appreciated assets that have been held long-term can eliminate capital gain taxes and is more tax efficient than gifting cash.
What If I Want to Keep Holding My Appreciated Stock Position:
If the only appreciated stock that a family holds is stock they would like to continue holding, they can still gift the shares and simply backfill their taxable investment account by replacing the $30,000 of gifted stock with the $30,000 of cash they would have otherwise used to make the gift.
Once the cash is contributed to the investment account, they can buy the same stock back. This results in resetting the tax basis to $30,000. With the basis reset, any sale of the repurchased position in the future would result in capital gains being calculated using the new tax basis of $30,000 rather than the original tax basis of $15,000 and would result in tax savings upon the future sale.
Key Takeaway:
Resetting the tax basis in positions you currently hold can reduce the capital gains taxes you pay in the future.
How to Implement This Strategy:
While this strategy is great from a tax perspective, not all charities accept appreciated stock, and even the ones that do often have a cumbersome and difficult process through which to coordinate the transfer of shares.
This challenge can be easily eliminated by using a donor-advised fund. We will have a separate article on donor-advised funds in the future to cover all of their important benefits; however, for purposes of this article the important thing to know is that a donor advised fund is a charitable account which can accept appreciated stock. The donor advised fund will then sell the shares so that there is cash in the account allowing the cash to be distributed to the selected charities.
When a contribution is made to the donor advised fund, it is an irrevocable gift, and the taxpayer is allowed to take the deduction immediately. Going forward, grants can be made from the donor advised fund to specific charities as needed.
Charitable Giving Deduction Limitations:
The IRS has imposed various limits on the amount of charitable contributions that can be deducted by a taxpayer in a given year. The limits vary depending on the type of asset gifted (cash, appreciated stock, etc.) and the type of charity receiving the gift. For purposes of this blog post, the important point to note is that the itemized deduction for appreciated stock gifted to most charities is limited to 30% of the taxpayer’s adjusted gross income.
The 30% limit for appreciated stock can be further reduced if significant cash gifts are also made in the same year. Any charitable contributions that exceed the annual deduction limits can be carried forward for five years.
Conclusion:
Gifting long-term appreciated stock to charity is a tax advantaged way to maximize the benefits of charitable giving for families who have appreciated assets outside of retirement accounts. By maximizing the tax benefits available for charitable gifts, families are able to reduce the personal cost of the gifts they make while allowing them to maximize the impact of their gifts to charity.
If you are interested in working with a Family CFO to ensure you maximize the tax benefits of your charitable giving, we would love to connect to see if what we do is right for you.
