There is something special about the holidays that, for some, elicits deep feelings of philanthropy. So, it is not uncommon that at this time of year we get questions about charitable donations. But, before simply writing a check to a charity, you should consider other ways to gift that may benefit you as well as the charity. Two great strategies to consider are gifting highly appreciated securities and utilizing Qualified Charitable Distributions (QCD’s). We’ll touch on some lesser-implemented strategies as well.
Gifting Highly Appreciated Securities
There are certain types of accounts in which we invest that are subject to capital gains tax. This tax is different from your 401k or your IRA because you only have to pay tax on amounts that you made on the investment. You see, accounts such as individual brokerage accounts, joint tenant accounts, trust accounts, and the like are funded with money that you have already paid tax on. So, the IRS can’t tax you on those dollars again. They do, however, tax you on the amounts that your investments made. This tax is called capital gains tax and occurs once the investment has been sold. At times, the value of these investments grows so much that you don’t want to sell them because they will generate a sizeable tax bill. These are called “highly appreciated.”
When gifting highly appreciated securities, in addition to a tax deduction of up to 30% of your Adjusted Gross Income, you avoid paying capital gains tax on the appreciated assets. You can gift highly appreciated securities either directly to a charity or to a Donor Advised Fund.
In either case, the tax deduction you receive is based on the current fair market value of the securities (i.e. you don’t have to realize a capital gain). However, you must first reach the threshold for itemizing deductions to begin receiving a tax benefit. If you typically itemize your deductions, then you can fully reap the tax savings by gifting highly appreciated assets directly to a qualified charity.
If you don’t typically itemize your deductions, then a Donor Advised Fund is another excellent option since you receive the tax benefit in the year you contribute to it (as opposed to when the charity receives your gift). This allows you to front-load the fund in a single year (maximizing your taxable benefit) while being able to direct your charitable gifts in future years.
Gifting highly appreciated securities is particularly effective because, one; you avoid paying the capital gains tax on the appreciated securities, and two; you receive a tax deduction for the charitable gift.
Qualified Charitable Distributions (QCD’s)
“Qualified Charitable Distributions” is certainly a mouthful, but what you have to know is that for those of you over 70.5, and in particular those of you currently taking Required Minimum Distributions (RMD’s) from your retirement accounts, QCD’s are an excellent option.
QCD’s are a direct cash gift from your traditional IRA account to what they call a “qualified charity,” or to be more technical, a 501(c)(3) charity. They count toward your Required Minimum Distribution total for the year, which typically is taxed as ordinary income. However, in the case of QCD’s you are not taxed on the dollars leaving your pre-tax IRA. In practice, the QCD functions as an above-the-line deduction, meaning you don’t need to itemize your deductions to take full advantage of the tax benefit.
There are a few additional things worth noting regarding QCD’s:
- They are less tax-efficient if you contribute to a pre-tax IRA after age 70.5.
- Inherited IRA’s can be used for QCD’s if you’ve met the age requirement.
- If being used to satisfy an RMD, they lower your Adjusted Gross Income (AGI), which could reduce your taxable social security income and/or Medicare premiums.
- Your annual aggregate QCD’s can’t exceed $100,000.
- Your custodian won’t show your QCD as a non-taxable distribution on your 1099-R tax form, so you need to track it yourself (and inform your tax professional).
The ideal candidate for a QCD is someone who didn’t contribute to their traditional IRA after age 70.5, does not need to take their full RMD to live on, and takes the standard deduction on their taxes (or would be taking the standard deduction if they weren’t making a charitable contribution).
Less Common Strategies
Cash contributions can make sense if you’re trying to maximize your tax deduction in the current year since you can deduct up to 50% of your AGI with them. But, donating physical assets, such as art or a vehicle, might make sense if you’re giving them to a charity that has a practical use for those items. If you have an estate beyond the estate tax exemption limits and want to establish a legacy of philanthropy within your family, a family foundation should be considered. While family foundations offer expanded giving opportunities beyond 501(c)(3) organizations, they also come with a larger administrative burden and ongoing time commitment. Interested parties should speak with an estate planning attorney.
Before writing that check, ask your personal Certified Financial Planner™ professional if one of these strategies may work for you.
Authored by Stephen C. Detweiler CFP® & Lori N. Ong, CFP®