The Savvy Philanthropist - You!
If you are new to charitable giving, there is good news. You are about to enter a community that helps people, whether it's local or global, and it will make you happier. I love them win-win’s.
While giving cash to your favorite charity is already a win-win, let’s shoot for a win-win-win by being strategic with your giving. While tax shouldn’t be a primary motivator to give to charity, being a savvy philanthropist can allow you to give more to charity, and potentially provide you with a tax benefit as well.
There are two potential tax benefits with charitable giving, but both have their own quirks.
Giving Stock
There is a tax benefit if you give stock to charity instead of cash. This is because by giving stock directly to a charity, you avoid having to pay capital gains tax on the embedded gains. Federal capital gains tax typically ranges from 15% - 23.8%. Most states have their own tax on capital gains on top, and for high-tax states like California, it can be as high as 13.3%.
This works not just for stocks. It can work for ETFs, mutual funds, bonds, REITs, and more, as long as you’ve held them for at least a year and have long-term gains.
Let’s walk through an example. You purchased $1,000 of an S&P 500 index fund 3 years ago, and it is now worth $2,000. You want to donate $2,000 to charity and are willing to part from this investment.
If you sell the index fund for $2,000, you recognize a gain of $1,000. Since you bought it 3 years ago, they are considered long-term and you will owe long-term capital gains tax on the gain. For simplicity’s sake, let’s say your Federal and state capital gains tax rate is 25%. In this scenario, you will owe $250 ($1,000 x 25%), which will leave you with $1,750.
What you should do instead is donate the stock directly to charity. By transferring your shares to the charity, they will sell the shares for $2,000. Because they are a charitable organization, they do not pay capital gains tax and get to keep the entire $2,000.
Voila - you avoid paying $250 of tax, and the charity gets $250 more in donations!
PRO TIP: Throughout my career, I’ve managed charitable foundations as well as clients that regularly donated stock. Here are some practical tips:
Not all charities are created equal. Make sure the charity is a 501(c)(3) organization. That is a symbol of being recognized as a non-profit by the IRS.
Donate the HIGHEST appreciated securities that are long-term. If you bought the same stock at different times, make sure you specify the lot by noting the date of acquisition and purchase price.
Charities understand the benefit of donating stock, and will typically have instructions for donating stock to their account. Make sure to reach out to the charity to give them a heads up that a donation is coming. It’s not always clear to the charities when the donation comes in and from whom.
The custodian that you hold your stocks typically has a form for transferring or gifting stock. Look under “forms” or reach out to a representative to make sure you get the correct form.
Tax Deduction
Another possible tax benefit of giving to charity is a deduction.
Quick primer - the IRS does not tax EVERY DOLLAR you make. The first few thousands of dollars are tax-free by the way of a deduction. Most people take the standard deduction, which is roughly $12,000 for a single filer, and $24,000 for a couple filing jointly. You may qualify to take an itemized deduction instead, typically if you have enough state and local tax (SALT), mortgage interest, and charitable donations. You do not get to take both deductions, and you take the higher of either the standard deduction or itemized deduction in any given year.
The Tax Cuts and Jobs Act of 2018 has made it much more likely that you will take the standard deduction, and therefore miss out on the tax benefit from charitable giving through a deduction.
One way to work around the new tax law is to create a donor advised fund and “bunching” several years of donations into one year. This can be a good strategy if you give consistently year after year.
A donor advised fund is a tax advantaged charitable account where contributions are eligible to be an itemized deduction, the account can be invested and the growth is tax-free, and you have complete control of when donations are made, who it is made to, and how much to donate.
Let's look at an example. A couple donates $5,000 annually and they plan to do this for the next five years. Their state and local tax is $30,000 but by law it is capped at $10,000 for tax purposes, and their mortgage interest that's deductible is $10,000. Their itemized deduction in 2021 will be $25,000, but the standard deduction in 2021 is $25,100, so they're going to instead take the standard deduction. really happened right because they got the standard deduction.
What they should do is take advantage of a donor advised fund. Instead of giving $5,000, every year, they can bunch $25,000 to their Donor Advised fund all in 2021. From their donor advised fund, they can give $5,00 over the next 5 years.
Looking at their itemized deductions again, the $10,000 in state and local tax and the $10,000 mortgage interest stays the same, but now they have a $25,000 donation to their donor advised fund. Their itemized deductions for 2021 is now $45,000, and now they get to take advantage of itemizing their deductions and getting a tax benefit out of their charitable gift.
How much does itemizing their donation through a donor advised fund save them in taxes? In giving cash, their total deduction looking over the next five years will be $125,500 (the standard deduction will adjust every year, but for simplicity's sake, we're just going to say that it stays at $25,100). In the DAF example, their total deduction over five years will be $145,500.
The additional $20,000 deduction, assuming a 35% marginal tax bracket, could mean tax savings of $7,000. That is more than enough to cover another year’s donation, with some change to donate to another charity!
PRO TIP: Donations to DAFs do not have to be in cash. In fact, you can leverage both tax benefits discussed here by donating appreciated securities to your DAF.
Any transfer to your DAF is irrevocable, meaning you cannot get it back. Make sure whatever you are donating won’t impact your own goals. Giving is good, but you also want to give sustainably.
A good time to fund a DAF is when you have a year with extraordinarily high income, such as a big commission year where you don’t expect it to continue, or say, your company’s IPO and you have RSU’s that vest all at the same time.
There is no minimal amount you have to give from your DAF, but if you plan to not give for several years, it could make sense to fund your DAF later. For example, let’s say you have $10,000 of shares you plan to transfer to your DAF this year, but don’t plan to give from your DAF for another 5 years. You invest in the same share in your DAF, and it grows to $20,000 in 5 years. In that case, it would have been better for you to hold onto your shares for 5 years, and give $20,000 to your DAF at that time for a greater tax deduction.
Whether you’re giving $100 or $10,000 to charity, donate like the millionaires and take advantage of the tax benefits available. The savvy philanthropist is… YOU!
If you found this article to be helpful and would like to work with me to develop and execute a financial strategy for you, schedule a call with me.
