It probably doesn’t come as a surprise to any of you that I spend a lot of time on social media. Given the current events I have found myself even more glued to social media listening to people’s stories and educating myself. While there is a lot to focus on, I have found my attention going to the resources that have been created to give back and support causes that can make a difference. I have also focused on the magnitude of crowd sourcing that has taken place through platforms like GoFundMe and influencers highlighting their cadence of giving and encouraging followers to do the same. The amount of support and giving I have seen take place has been humbling and I view it as a silver lining that has come from the recent current events.
I’ve been grappling with how to help and use my platform for good beyond donating to well deserving causes. I wanted to find a way to use my knowledge of personal finance and investing to further the good that has been happening which has leads me to today’s post, tax efficient ways to give to charity.
There are tax codes that allow for tax deductions or exemptions when contributions are made to a qualified 501(c) (3) charities. The purpose of this post is to point out alternative ways to support charity, beyond giving cash, and demonstrate how donating non-cash securities can potentially have a positive effect on your tax situation.
Types of Contributions
Did you know that contributions to a 501(c)(3) charity can be something other than cash? That’s right, you can also donate securities (stocks, mutual funds, ETFs, etc.) to a charitable organization. As an example, if you have securities sitting in a taxable account you could designate a portion of those as a donation.
If you work for a publicly traded company and participate in in an executive compensation plan, those vested shares can also be used to make a charitable donation. Some examples of these plans are below:
- Vested Restricted Stock Units (RSUs)
- Employer Stock Purchase Plan (ESPP)
- Granted Stock Options
So where is the tax play?
If you are familiar with how a taxable account works, you would know that when a security is sold the account holder must pay tax if there is a capital gain associated with that transaction. The capital gain rate is determined by the length the security was held and the account holder’s marginal income tax rate.
If the time period you’ve held the security is less than one year, it is considered a short-term gain and the tax rate will be your marginal income tax rate. If the security has been held over one year (366 days) it qualifies for long-term capital gains rates which are more favorable (see below):
The longer you’ve owned that security or held onto that vested RSU, the more likely that position has capital gains. There may become a point that selling that positions to fund a purchase or re-invest in a new investment strategy may generate a big tax bill and become cost prohibitive. These types of positions are perfect candidates to donate to a charity of choice. By gifting the highly appreciated security the contribution is not only at a higher amount but you would also avoid paying the potentially high tax bill. Once the security is given to the charity, they can sell the position, without incurring a capital gain as a 501(c)(3) charity and can re-deploy the proceeds towards their efforts.
How cool is that!?
Note that you can only donate positions out of a taxable investment account. If you have a 401(k) or other qualified account, like an IRA, you are unable to charitably give those positions until you hit age 70.5 years old.
I know that the majority of my readers are far from 70.5 years old but I still want to share this next charitable gifting strategy. If it doesn’t apply to you, it might apply to a parent or other family member and spark a healthy discussion around charitable giving.
Qualified Charitable Distributions
The strategy I am talking about is called a qualified charitable distribution or QCD. To provide some much-needed context, before the SECURE Act that went into effect December 2019, qualified accounts, like 401(k)s and IRAs, were required to take distributions, called an RMD, at their age 70.5. Thinking back to the characteristics of a Traditional IRA, distributions are taxed at the account holder’s marginal tax rate.
The QCD strategy allows account holders over age 70.5 that may be required to make distributions (the RMD age was moved to age 72 under the SECURE Act) to instead donate a portion of their RMD to a qualified charity. The beauty of this strategy is that the account holder can support their charity of choice and avoid paying income tax on that part of their distribution.
This is by no means a complete list of strategies to give to charity is a tax efficient manner. The list is long and includes strategies that require working with an estate planning attorney or other professionals to implement. What I wanted to focus on is efficient gifting strategies that the everyday investor could achieve on their own.
Donor Advised Fund
The final charitable gifting strategy I wanted to introduce is a Donor Advised Fund (DAF). This is an account that can be set-up with most of the major investment brokerage firms like Charles Schwab, TD Ameritrade, Vanguard…the list goes on.
With this type of an account, the owner can donate cash or appreciated stocks into the account and submit grants to charities throughout the year and beyond. The unique feature to this account is that the account holder gets the charitable tax deduction in the year the donations are made but can make grants from those charitable funds over several years.
A Donor Advised Fund is a very tax efficient way to plan out charitable giving over several years. Since the tax law changes in 2018, it has become more and more difficult for taxpayers to itemize their tax deductions. One of the few itemized tax deductions that remains is charitable giving which is why Donor Advised Funds have gotten a lot of attention in recent years.
For most taxpayers, to be in a position where itemized tax deductions are larger than the standard deduction, their charitable giving figure is sizeable. The task of deciding where to donate funds and stocks of sizable amount is a big responsibility and can be very overwhelming and can sometimes lead to inaction. The Donor Advised Fund resolves that problem by allowing contributions into the fund to occur in one year and granting to happen over the course of years.
As an example, if you were to contribute $10,000 into the Donor Advised Fund in 2020, you would receive the tax deduction on your 2020 tax return and the flexibility to distribute grants to the charities of your choice over multiple years. To continue with that example, you could donate $2,000 over the next five years or $5,000 over the next two years or somewhere in between. Another benefit to the DAF is that those funds can stay invested and grow with the market and potentially increase your ability to give.
To wrap things up, there are more ways to give to a qualified 501(c)(3) charity beyond cash. Charities can accept individual stock positions, mutual funds, ETFs and can sell those securities tax-free and use those proceeds towards their mission. For those that already have a charitable gifting strategy, consider using appreciated securities or company shares granted to you through an Stock Option, RSU or ESPP program.
Not only are there alternative way to support your favorite charities but there are options around how you give. The traditional method is donating directly to the cause but another option to consider is using a Donor Advised Fund as an intermediary funding tool to control your tax deduction and the cadence of your giving.
I’d love to hear from you if you are looking for new ways to up your charitable giving and do so in a tax efficient manner. You can connect with me through my contact page or reach out at email@example.com