Key things to know
Philanthropy that extends beyond traditional gifts of cash can have a greater impact on your preferred charities while potentially delivering important tax advantages for you.
Qualified charitable donations (QCDs), gifts of appreciated stock and donor-advised funds (DAFs) offer immediate tax benefits but require advance planning to best support your targeted charities.
If charitable giving is a priority for you, your intention may be that your gift benefits both the charity and your own bottom line. While traditional “checkbook” philanthropy may be the default approach for many, there are potentially more tax-effective ways to proceed. Planning can make a big difference as you assess ways to support your favorite causes.
These charitable giving strategies beyond traditional cash gifts can have a greater impact on the philanthropic endeavors you want to support, as well as potentially deliver important tax advantages.
IRAs with large balances, particularly those subject to required minimum distribution (RMD) rules are a prime source for charitable gifts. A qualified charitable distribution (QCD) from an IRA is a tax-efficient gifting strategy to consider. Each year, individuals age 70 1/2 or older can choose to make a direct gift totaling up to $105,000 (adjusted annually for inflation) from their IRAs to qualified charities. Rather than the owner receiving a distribution from the IRA, the gift moves directly from the IRA account to the charity.
This has three major benefits for donors.
Be certain that this transaction is handled appropriately. You cannot first take possession of the funds paid out from the IRA to complete a proper QCD. The money must go directly from the IRA custodian to your designated charity.
Note that this strategy works with traditional and inherited IRAs, but not with SEP or SIMPLE IRAs. These gifts must be made within a calendar year to qualify for the QCD provision. Additionally, only certain charities can accept QCDs. Private foundations, supporting organizations and donor advised funds do not qualify for QCDs.
The most common form of non-cash contribution is a gift of publicly traded stock. You may hold stock that has benefited from the generally favorable market conditions of recent years. Highly appreciated securities that would generate a significant capital gain could result in a major tax liability when shares are sold. This includes a top federal capital gains tax rate of 20% plus, in many cases, an additional 3.8% net investment income tax (NIIT).
If you planned to make a $250,000 gift to charity, selling the stock first may require that you liquidate $328,000 of stock. After selling that much stock, and after taxes are accounted for (capital gains and NIIT), your net proceeds would equal approximately $250,000, sufficient to cover the planned gift.
A more effective strategy may be to donate stock valued at $250,000 directly to the charitable organization. This approach also has three major benefits to donors:
Note that any transaction must occur before December 31 of the year in which you hope to claim the tax deduction.
If your portfolio includes assets held for 12 months or less but you’re considering liquidating the positions, donating those assets is an option. If you sell such “short-term” holdings, the applicable tax on any profits are equal to your ordinary income tax rate. That could be as high as 37% under current tax laws. The 3.8% NIIT may also apply, as well as state and local taxes.
There are strategies beyond traditional cash gifts that can preserve more value for charitable giving, deliver important tax advantages and have a greater impact on the targeted charities.
However, unlike donating an asset with a long-term capital gain, one held for 12 months or less has different tax treatment when it’s directed to a qualified charity. You’re only allowed to claim the cost basis of the asset or the current fair market value as a deduction, whichever is less. In other words, if one of your holdings earned significant appreciation in the past few months, you can’t claim the appreciated value as a tax deduction if you donate it. You may be better off waiting until your holding period exceeds one year, at which time you can donate the asset and claim a deduction based on the full market value.
The only advantage to gifting an appreciated short-term asset is that you avoid claiming the short-term capital gain that would result if you liquidated the position.
A DAF allows an individual to transfer assets irrevocably to a charitable fund, be eligible for an immediate tax deduction (in most cases, up to the full market value) and then recommend grant distributions to one or more charitable organizations on their own timetable. Assets eligible for transfer include publicly traded securities, restricted stock, real estate, business interests (see below) and even cryptocurrency and art.
DAFs are easy to establish, simple to manage and a tax efficient way to initiate a large donation. For example, directing appreciated assets to a donor advised fund allows money to be invested and grow tax-free over time, but the donor avoids capital gains taxes. DAFs are an increasingly popular tool for those new to philanthropy, as they require no account administration on the part of the donor. The sponsoring organization oversees charity due diligence, grant processing, recordkeeping and tax filing.
DAFs are also excellent charitable strategies to involve the donor’s family in philanthropy, either immediately or down the road as part of a legacy plan.
When planning to exit a business, you may want to consider incorporating charitable contributions as part of your exit strategy. Gifting all or part of an ownership position in a business can even be effective prior to an initial public offering (IPO), so the charity can take advantage of the opportunity to cash in the stock once it goes public. At the same time, you avoid capital gains tax by limiting the amount of the ownership position that must be sold.
If you sell a business or an ownership position in one year and generate a sudden windfall as a result, establishing a charitable foundation or directing significant dollars into a donor-advised fund can help reduce your tax burden. In both instances, you take a write-off (up to allowable limits) of the amount you designate for that purpose.
Targeted donations to qualified charitable groups can be determined later, over the course of years. Yet establishing such an entity helps you deal with the dramatic tax impact of a one-time windfall from selling the business.
These are a few strategies that can take you beyond “checkbook philanthropy,” but there are others worth exploring. It’s important to incorporate your giving strategy into your overall wealth plan. If you intend to make gifts in order to claim a tax write-off in the current year, be sure to plan well in advance so there’s adequate time to complete the transaction.
Consult with your financial, tax and legal advisors to consider all of the options available to you. Take the time to explore ways that you can leverage your wealth more effectively for your favored charities while also doing so in the most tax-efficient way.
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Charitable giving can play an important role in the sale of a business, helping to establish a legacy and maintain wealth. Here are a few common strategies, each with different tax and legacy-building benefits.
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