The end of the year typically is a time for making charitable donations. If that’s your practice, consider contributing shares of appreciated stocks or stock funds instead of cash. As long as the shares have been held longer than one year, you’ll get a full tax deduction in 2015 for the appreciated assets, and the charity can easily cash in your gift.
Example 1: Beverly Carson donates $20,000 to her alma mater each year. In 2015, she decides to contribute $20,000 worth of shares of ABC Corp., stock she bought near the 2009 market low. Her basis in the donated shares is $6,000, in this scenario.
Here, Beverly gets the same $20,000 tax deduction she would get from a cash donation. The college, a tax-exempt entity, can sell the shares and keep the entire $20,000. Thus, tax on the $14,000 capital gain is never paid, and Beverly has reduced her stock market exposure by $20,000. The cash she would have donated remains in her checking account, for Beverly to spend or invest elsewhere.
Most investment firms and charitable organizations can help you execute a donation of appreciated assets.
The tactic used by Beverly Carson might be fairly simple to implement, for one $20,000 donation. But what if Beverly’s year-end philanthropy consists of five $4,000 donations? Or 10 $2,000 donations? The paperwork effort involved might outweigh the tax advantages, for many donors.
If you intend to contribute appreciated securities to multiple charities, consider going through a donor advised fund (DAF). Many financial firms and community foundations offer DAFs, which simplify such philanthropy.
Example 2: Dan Evans, who is concerned about a possible stock market collapse, typically makes $25,000 of charitable donations each year, spread among various recipients. Changing tactics a bit, in late 2015 Dan donates $25,000 worth of stocks and stock funds to a DAF. All of the shares are highly appreciated, after long-term holding periods. Dan’s total basis in the donated shares is $10,000.
For this contribution to the DAF, Dan gets a full $25,000 tax deduction for 2015. After the shares have been sold, that $25,000 goes into his account at the DAF, with no reduction for capital gains tax. Then Dan can simply tell the DAF to distribute $4,000 to this charity, $6,000 to that charity, etc. There is no time pressure to make these contributions—and no threat to Dan’s charitable tax deduction for 2015.
Thus, Dan has reduced his exposure to stocks, avoided capital gains tax, and reduced his tax bill.
Give and take
If your philanthropic intentions are significantly greater than Dan’s or Beverly’s, consider a charitable remainder trust (CRT). The principle is the same as it is for the strategies described previously: Donate appreciated securities to get a charitable tax deduction and, if it’s a concern, reduce your exposure to a stock market now trading near record levels. In addition, you (and perhaps another beneficiary such as your spouse) can receive an income stream that might flow as long as an income beneficiary is alive.
CRTs come in two forms: annuity trusts and unitrusts. An annuity trust pays a fixed amount each year, with a minimum of 5% of the original contribution. A unitrust pays a fixed percentage of the trust value each year, with a minimum of 5% of the trust’s value. You’ll also get a partial upfront tax deduction for the fair market value of the remainder interest in the CRT that will eventually pass to the charity.
Example 3: Flo Grant uses $600,000 of highly appreciated securities to fund a charitable remainder unitrust in late 2015. The trust will pay 5% of its value annually to Flo or to her husband Harold, as long as either is alive.
An annuity alternative
Setting up and maintaining a CRT requires some effort and expense, so these trusts generally make sense if you have a substantial amount to contribute. You can get similar benefits with a smaller contribution by acquiring a charitable gift annuity (CGA). Many charities and other nonprofits offer CGAs, often with minimum investments as low as $5,000 or $10,000. Typically, you need to be 50 or older to qualify for a CGA.
As mentioned, the mechanics of a CGA resemble those of a CRT. You donate assets—appreciated assets, such as stocks, are commonly used— to the sponsoring organization. In return, you’ll receive a life-long stream of income; many CGA sponsors base their payouts on tables from the American Council on Gift Annuities (ACGA).
Example 4: Helen and Joe Lawson went to the same university. Now they’re both age 65, and they want to fund a CGA from their alma mater. The ACGA’s suggested maximum rate for such a couple is now 4.2%. The Lawsons contribute $50,000 of highly appreciated stocks to fund a CGA in 2015; they’ll receive $2,100 a year (4.2% of $50,000) as long as either is alive.
Contributors to a CGA also receive an immediate partial tax deduction for the donation. Again, if you fund a CGA with appreciated stocks or stock funds, you’ll reduce your exposure to a possible market crash without owing any income tax.