Posted on: December 4, 2013 by Martin Curiel, CFA in Tax StrategyEvery year, many families make significant donations to their favorite charities or causes, particularly during the Holiday Season. In our experience, tax incentives are not generally strong drivers behind the reasons to give back. However, as a firm that focuses on maximizing financial efficiency, we strongly advocate that individuals do all that they can to maximize the tax benefits related to their respective contributions. It is almost the end of the year, and in light of the giving season, we wanted to describe a simple technique that can be used maximize the tax efficiency: Donating Appreciated Investments.
Donating money to a charitable organization, such as a 501(c)(3), is usually fully tax deductible. This is considered a “below the line” deduction. That fact has led some people to consider cutting contributions due to the phase-out of deductions. However, the phase-out is based on adjusted gross income, not the level of deductions, so any additional contributions usually reduce taxable income one-for-one.
For example, let’s suppose that a couple has a taxable income of $500,000 per year before making a special contribution, which puts them at the highest marginal tax rate. Let’s assume the rate is 50% for federal and state combined. (They live in California.) The couple decides to give $50,000 to their favorite charity. This will reduce the couple’s taxable income to $450,000, which means that they avoid paying $25,000 in taxes (50% x $50,000). In essence, they provided a generous $50,000 gift to their charity, with only $25,000 out of their pocket.Appreciated Investments
Now let’s suppose that the couple has a mutual fund, ETF, or stock that went from a $10,000 initial investment to $50,000 over a period of one or more years. When the couple decides to sell that stock, they will have to pay the long-term capital gains tax, which is around 35% for high-income earners in California due to the increased federal capital gains tax rates in 2013.
Their “built-in” tax liability on this investment can be calculated as follows:
35% x ($50,000 – $10,000) = $14,000
One viable option that the couple has is instead of donating the $50,000 in cash to their favorite charity, they can donate $50,000 in investments. They can deduct the market value of the donation as long as it has been held for more than one year.
By doing so, they have created an additional benefit – not only will the couple get to write off the full $50,000 against income, but they will also forego having to pay the $14,000 long-term capital gains tax.
The benefit can be calculated as follows:
Gross Value Out = $50,000
LESS Tax Benefit From Charitable Donation = $25,000
LESS Tax Benefit From Avoiding Long-Term Gain = $14,000
Net Value Out = $11,000
From the above, one can clearly see the benefits of donating appreciated stock versus simply donating cash. By donating cash, the couple was out-of-pocket $25,000; by donating their ETF, stock, or other appreciated investment, they are out-of-pocket $11,000. In either case, the charity receives the full $50,000.
In summary, giving back to our communities is something that most Americans do – perhaps more so than other cultures. To maximize the benefits, consider giving your appreciated stock, ETF, mutual fund, or other investment to your favorite charity. This strategy allows you to achieve the rare “Triple Play” of simultaneously reducing ordinary income taxes, reducing capital gains taxes, and furthering a cause dear to your heart.
We wish you Happy Holidays from the MYeCFO Team!
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