Charitable Giving – A Smarter Way
Most taxpayers understand the tax benefits of charitable giving. Subject to limits of as high as 50% of income, charitable contributions are fully deductible as itemized deductions. However, many taxpayers don’t realize there’s even more tax savings to be wrung from charitable contributions. Where possible, contributions should be made of appreciated property – stocks, mutual funds, real estate, etc. – rather than cash. Why? Contributions of appreciated property have a double tax benefit. First, you enjoy the same full tax deduction as cash contributions. The donation is equal to the fair market value (rather than the cost) of the appreciated property. Second, the donated property escapes the income tax that would be imposed if the property were sold. Two tax benefits with the same charitable contribution.
An Example
Here’s an example of how this works. Mr. and Mrs. Smith wish to donate $10,000 to their favorite charity. They review their brokerage account and find they own XYZ Mutual Fund which they purchased three years ago for $6,000. Rather than contributing cash of $10,000 they arrange a transfer of the mutual fund to the charity. This contribution saves them $3,500 of income taxes (assuming a combined federal and state marginal tax rate of 35%). This strategy also avoids $1,000 of capital gains tax (assuming a combined federal and state marginal tax rate of 25% on capital gains) on the $4,000 of appreciation. So, an investment costing $6,000 has generated tax savings of $4,500.
Two More Tweaks to Consider
The above example can have even more tax planning impact. Assuming XYZ Mutual Fund was an investment the Smiths wanted to keep, they can use $10,000 of cash to replace the shares of XYZ they contributed to Ascend. Now, they have the same XYZ holdings as before but the $4,000 capital gain potential has disappeared. Taxpayer wins. Charity wins. Internal Revenue Service loses. Perfect.
A further refinement of this strategy can occur in the last months of the year. That’s when most mutual funds distribute taxable dividends. To avoid the taxable dividend the Smiths make their contribution to Ascend right before XYZ’s distribution date (usually announced in October-December). Once the dividend has been distributed the Smiths replace the XYZ shares (as described above) they contributed to Ascend. This really amounts to a triple tax benefit – deductible charitable contribution, capital gains tax avoided, and taxable dividend avoided.
Your Own Private Foundation – Without All of the Costs
No doubt you’ve heard about the large private foundations of the wealthy. Legal and tax preparation costs and regulation mean private foundations usually make sense only for funding of $500,000 or more. For everyone else there’s a simple, elegant solution – a donor-advised fund. These are large public charities that allow considerable flexibility as to the management of your donated funds and the charitable purposes for which the funds are used. And, of course, you get a charitable contribution deduction.
Continuing the example from above, the Smiths’ annual charitable contributions total $50,000. Again, rather than contribute cash to their various favorite charities they want to contribute $50,000 of appreciated mutual funds and stock. Since they contribute to ten different charities it’s a bit unwieldy to make the securities transfers to each of the ten organizations. And, some of the charities aren’t set up to accommodate this kind of donation. So, the Smiths contact a donor-advised fund and set up the Smith Family Charitable Fund. The $50,000 of appreciated securities is transferred to the donor-advised fund and the Smiths receive a $50,000 charitable contribution deduction. The donor-advised fund immediately sells the securities and invests the proceeds in an investment pool selected by the Smiths. The Smiths then direct the donor-advised fund to make charitable grants to the ten favorite charities. These grants may be made in any year and do not affect the $50,000 charitable contribution deduction the Smiths have already received. The donor-advised fund makes the grants in cash and directly to the charities in the Smiths’ names.
There are many donor-advised funds. Here’s information on the three largest funds:
An Example
Here’s an example of how this works. Mr. and Mrs. Smith wish to donate $10,000 to their favorite charity. They review their brokerage account and find they own XYZ Mutual Fund which they purchased three years ago for $6,000. Rather than contributing cash of $10,000 they arrange a transfer of the mutual fund to the charity. This contribution saves them $3,500 of income taxes (assuming a combined federal and state marginal tax rate of 35%). This strategy also avoids $1,000 of capital gains tax (assuming a combined federal and state marginal tax rate of 25% on capital gains) on the $4,000 of appreciation. So, an investment costing $6,000 has generated tax savings of $4,500.
Two More Tweaks to Consider
The above example can have even more tax planning impact. Assuming XYZ Mutual Fund was an investment the Smiths wanted to keep, they can use $10,000 of cash to replace the shares of XYZ they contributed to Ascend. Now, they have the same XYZ holdings as before but the $4,000 capital gain potential has disappeared. Taxpayer wins. Charity wins. Internal Revenue Service loses. Perfect.
A further refinement of this strategy can occur in the last months of the year. That’s when most mutual funds distribute taxable dividends. To avoid the taxable dividend the Smiths make their contribution to Ascend right before XYZ’s distribution date (usually announced in October-December). Once the dividend has been distributed the Smiths replace the XYZ shares (as described above) they contributed to Ascend. This really amounts to a triple tax benefit – deductible charitable contribution, capital gains tax avoided, and taxable dividend avoided.
Your Own Private Foundation – Without All of the Costs
No doubt you’ve heard about the large private foundations of the wealthy. Legal and tax preparation costs and regulation mean private foundations usually make sense only for funding of $500,000 or more. For everyone else there’s a simple, elegant solution – a donor-advised fund. These are large public charities that allow considerable flexibility as to the management of your donated funds and the charitable purposes for which the funds are used. And, of course, you get a charitable contribution deduction.
Continuing the example from above, the Smiths’ annual charitable contributions total $50,000. Again, rather than contribute cash to their various favorite charities they want to contribute $50,000 of appreciated mutual funds and stock. Since they contribute to ten different charities it’s a bit unwieldy to make the securities transfers to each of the ten organizations. And, some of the charities aren’t set up to accommodate this kind of donation. So, the Smiths contact a donor-advised fund and set up the Smith Family Charitable Fund. The $50,000 of appreciated securities is transferred to the donor-advised fund and the Smiths receive a $50,000 charitable contribution deduction. The donor-advised fund immediately sells the securities and invests the proceeds in an investment pool selected by the Smiths. The Smiths then direct the donor-advised fund to make charitable grants to the ten favorite charities. These grants may be made in any year and do not affect the $50,000 charitable contribution deduction the Smiths have already received. The donor-advised fund makes the grants in cash and directly to the charities in the Smiths’ names.
There are many donor-advised funds. Here’s information on the three largest funds:
posted by Sherman L. Doll, CPA/PFS at
10:26 AM
