Americans donate regularly to public charities and other non-profit organizations such as hospitals, schools, disaster relief organizations, and churches. When you donate, you can typically reduce your income taxes by including your donation as an itemized deduction on your tax return. When donating cash, the donor has already paid payroll taxes on the entire donated amount and is responsible for federal and state income tax as well.
In addition to cash donations, many organizations also accept donations of appreciated securities like stocks, mutual funds, and ETFs. Rather than selling these securities that have increased in value and paying long-term capital gains tax of 15-20%, you can donate these securities directly to the charity. According to a recent study, 80% of charitable donors have appreciated assets like stocks and mutual funds, but only 19% have contributed such assets to a charity. When you donate securities, you do not pay capitals gains tax on the donated security and you can reduce your taxes by listing the donated security on the itemized deductions on your tax return. While there are many opportunities to defer taxes (for example, in a 401(k) or IRA), there are few options for totally eliminating taxes.
Let’s compare donating cash versus donating a security.
Scenario #1 – Chip wants to donate $10,000 to charity. After paying taxes (federal income, state income, and FICA/payroll) on $15,785 of salary, he has $10,000 left. He writes a check for $10,000 to the charity. The charity receives $10,000 and Chip paid $5,785 in income and payroll taxes.
Scenario #2 – Mary wants to donate $10,000 to charity. After paying taxes (federal income, state income, and FICA/payroll) on $9,471 of salary, she has $6,000 left. She invests the $6,000 in a stock ETF. After several years, the ETF is worth $10,000. Rather than selling the stock ETF and paying $600 in capital gains tax, she donates the stock ETF to a charity. She pays no taxes on the $4,000 capital gain. The charity receives $10,000 and Mary paid $3,471 in payroll and income taxes.
Assumptions for Scenario #1 – Chip is in the 24% federal tax bracket and his state tax is 5%.
Assumptions for Scenario #2 – Mary is in the 24% federal tax bracket and her state tax is 5%. She is in the 15% tax bracket for long-term capital gains.
You will pay lower taxes by donating appreciated securities than by donating cash. Since many donors already hold such securities, a simple change in what they donate is all that is required to pay fewer taxes. As your investments increase in value, the benefit of donating them continues to grow.
FAQs
What else should I know about donating appreciated securities?
The IRS has established guidelines for donating securities (see IRS Publication 526 for more details and additional guidance):
- You must itemize deductions to use the charitable deduction
- You must hold the appreciated securities for at least one year
- The fair market value for the donation is the average of the high and low selling prices on the donation date
- The IRS has established limits to charitable giving. Donations of appreciated securities held more than one year are generally limited to 30% of your AGI. If you exceed the deduction limit in a given year, you can carryover your deduction to future years for up to 5 years until the deduction is used up.
What if I don’t itemize deductions?
Some people choose to take the standard deduction rather than itemize their deductions because the standard deduction is larger. In that case, you may consider making two years’ worth of charitable contributions in one year if that approach makes your itemized deductions larger than your standard deduction for one year. You could alternate between the standard deduction in one year and itemized deduction the next, which could reduce your overall tax.
When should I donate?
The value of your donation is based on the price of the security on the day you donate. Since the price can fluctuate, you may choose to time your donation when the security has experienced an upswing. If you plan to donate a certain amount in a given year, it may be wise to not wait until the end of the year since security prices can be volatile.
How can this simplify rebalancing?
After donating appreciated securities, you may want to put cash back into your investment account to provide for future donations. Since highly appreciated assets often make the allocation for that asset class too high, donating those securities often helps in rebalancing your portfolio back to your target asset allocation. If the appreciated investment is one you want to keep, you can donate it and then buy more to replace it so you own the security with a higher cost basis that reduces any future capital gains tax if you sell. You may find that you can efficiently couple your charitable donations with periodic rebalancing of your portfolio.
Which organizations can accept tax-deductible donations?
You can make a tax-deductible donation to over 1.54 million tax-exempt organizations including religious organizations (eg, churches), food banks, non-profit educational organizations (eg, public colleges, museums), non-profit hospitals, federal, state and local governments, and other non-profit organizations (eg, American Red Cross, Goodwill Industries, United Way). To check if an organization can receive deductible contributions, search here (you can change Search By to Organization Name to search by name).
How do I donate securities to a charity?
After verifying that the charitable organization is registered with the IRS, you should contact the organization to see if they have a brokerage account you can transfer the security to. Many not only have brokerage accounts, they have accounts at multiple brokerages to make charitable giving even easier. Some smaller charities may not have a brokerage account so you will want to discuss your donation with them directly to see if there are better options for providing financial support. Once you’ve completed the one-time steps above, the typical process you’ll follow each time you donate securities is:
- Determine the security and the amount you want to donate. You’ll want to ensure that the security has appreciated and you’ve held it for longer than one year. If you bought the security more than once (ie, you have multiple tax lots), you need to identify which tax lot you are donating so the correct shares are transferred.
- Request your brokerage make the transfer with either a phone call or written instructions. For written instructions, your brokerage may have an existing form you should use. The form will usually be different if the charity has an account at your brokerage or if the securities are transferring to a different brokerage.
- Notify the charity of your donation including the date of donation, security ticker, and number of shares. For some charities, you may request a specific allocation for your donation. For example, some religious organizations let you request how much of your donation is used for helping the poor, tithing, etc.
- Save the written acknowledgment the charity provides with the details of your donation in your tax file. You must keep the paperwork that the charity provides for proof of your donation.
White Pine Financial LLC is a fee-only Registered Investment Adviser. We recommend you review IRS publications and other reputable sources for more details on this subject. We also recommend you consult with your financial and tax advisor before making any decisions.