An Alternative to Capital Gains Taxes: Donating Stock to CharityBondBeebe
Posting by Billy Thomas
This time of year many individual taxpayers are seeking ways to reduce their 2014 tax bill with April right around the corner. It is no secret tax rates have increased beginning January 1, 2013 leaving some with an uncomfortable reality last April. Plus, many previous beneficial tax provisions have expired on December 31, 2013 and without an extension by Congress*, tax preparers and clients alike are left searching for alternatives to reduce their tax liabilities.
Rest easy, there is one tax planning strategy that can realize the appreciation, increase your itemized deductions and reduce your tax bill all at the same time. Taxpayers are eligible to take a charitable deduction for contributions of long term capital gain property to qualified charities.
Long term capital gain property would include stocks, mutual fund shares, real estate held for investment and a few other similar types of investments held longer than one year. Many people make cash contributions to their favorite charities throughout the year, but instead of cash, you could donate stock at its fair market value and accomplish a similar deduction. This planning tip is effective because it alleviates the need to sell the security in your portfolio and pay capital gains tax on the appreciation above your historical cost basis then to later make a cash contribution to the charity. In other words, you can skip the sale of the security and make the contribution of the security directly to the qualified charity. Many qualified charities are capable of receiving this type of property just as easily as the charity would receive a cash contribution.
Similar to cash contributions, qualified charitable organizations should issue written acknowledgment to taxpayers in order to substantiate the contribution of property. This is a key piece to reporting the deduction, as charitable deductions have been an area of focus for the IRS. Another recent post elaborates on charitable giving tips.
Even if you are ready to part with your appreciated investment, you can postpone the donation to a particular charity, but still receive a tax benefit for the contribution. Donor-advised funds (DAFs) are a vehicle that allow taxpayers to contribute assets to later be designated for a charity to be named in the future. Many DAFs are available for you through your investment company/advisor.
It is important to note there are limitations to donating capital gain property regardless of a direct donation to charity or to DAFs and there are separate considerations for donations of other types of appreciated personal property like artwork, intellectual property, etc. Generally, the limitation exists at 30% of adjusted gross income for capital gain property. It is only long term (>1 year) capital gain property that is eligible for the fair market value donation deduction as short term (< 1 year) capital gain is limited to the taxpayer’s basis in the property. The fair market value for these gifts of stock and mutual fund shares are determined at market quotes on the date of contribution, which are typically, readily available on the exchanges.
Unfortunately, there is another limitation for higher income earners called the Pease Limitation, which came back with a vengeance in tax year 2013. When a taxpayer’s adjusted gross income (AGI) exceeds $300,000 for joint filers and $250,000 for single filers, itemized deductions of charitable contributions, mortgage interest, state and local taxes, and miscellaneous itemized deductions are limited to the lesser of 3% of AGI or 80% of the allowable itemized deductions. A charitable donation of long term capital gain property is often a viable alternative as the gain associated with the property is not included in AGI and does not otherwise factor into this calculation unless your AGI already exceeds the Pease limitation.
Keep in mind, this is just one strategy to help reduce your tax bill in April. At this time, it is unclear whether any of the expired tax provisions will be extended retroactively. All signs are leaning towards an extension as the House* and Senate have recently signed the bill. So, it is important to be mindful of the currently available tax planning strategies and to speak with your investment and tax advisors on a routine basis.