Optimizing Your Charitable Donations
While last year presented unprecedented challenges, charitable giving reached a record high, according to Giving USA. Individuals, foundations, and corporations gave an estimated $471.4 billion to U.S. charities in 2020. The global pandemic, the ensuing economic crisis, and efforts to advance racial justice created the widespread need and significantly increased the demands on nonprofit organizations. Generous giving coupled with the stock market turnaround in the year’s final months helped to buoy contributions.
Despite the ongoing challenges and uncertainty, the economic environment remains favorable for charitable giving in 2021. Close to 30% of giving occurs in December of each year, according to Network for Good. So now is the time to execute your end-of-year charitable giving strategy. Charitable donations are a great way to benefit those in need and have the added benefit of a tax deduction. But what is the best way to give? Appreciated non-cash assets or cash?
Give appreciated non-cash assets instead of cash
For those who itemize deductions, appreciated non-cash assets such as stock held for more than one year may offer an additional tax benefit in comparison to cash donations. A stock held for greater than a year that is donated to a qualified charitable organization removes the capital gains tax liability. It allows you to deduct the fair market value of the donation from your adjusted gross income (AGI) on schedule A of your federal income tax return. Choose shares with the lowest cost basis. Keep in mind, however, that the deduction for a donation of appreciated stock to qualified charities is limited to 30% of your AGI. Any amount over the 30% threshold would be a carryover for up to 5 years. As show in the example below, more can go to charity by donating appreciated stock, and less can go to taxes.
Note that highly appreciated stock in a portfolio may become a capital gains tax issue once the investor is ready to sell that position. The capital gains tax can be as high as 23.8% when the Medicare surtax applies. As you see from the example, donating stock can increase the size of your gift. Since you avoid paying capital gains tax incurred when selling the shares that have appreciated for more than 12 months, this portion can go directly to the charitable organization.
While appreciated non-cash assets often are the best way to maximize charitable gifts, not all charities have the capabilities to accept these types of gifts. Another opportunity to donate and avoid capital gains would be to set up a donor-advised fund. If you have a donor-advised fund account, simply transfer the appreciated stock to the account, and you may qualify for a fair market value tax deduction if you itemize on the date of transfer. It also allows the investor to then decide over time how to donate assets in the fund to deserving charitable organizations. When compared to setting up a private foundation, donor-advised funds have no upfront costs, no annual payout requirements, and are housed under entities such as Community Foundations who handle most of the administration. This is a smart option for investors who are looking for efficient and knowledgeable grant making strategies, while receiving tax advantages. Simply put, you pay no capital gains tax when the assets are liquidated, the cash proceeds can then be invested, and you can recommend grants to your favorite charities immediately or over time at your convenience.
Use Cash to Replenish Your Portfolio
If you want to maintain the shares in your portfolio, choose low basis shares to donate and buy back the same number of shares using cash. Then, you still have the same value in your portfolio, but you have essentially given yourself a “step-up” in basis, without having to recognize again. This sets up the investor to have a higher cost basis than the gifted shares. Over time, this higher-basis investment increases the potential for eventual tax-loss harvesting, which should help reduce future tax payments.
In conclusion, charitably-minded investors should consider donating non-cash assets like stock. Donating stock means you may end up donating a higher dollar amount to a deserving charity and manage your capital gains tax in the process. However, please consult with your advisor to determine the best option for you when considering donating appreciated stock or cash.
Most importantly, your donation remains a powerful way to help the charitable organizations of your choosing.