Gifting appreciated closely-held securities such as stocks directly to a charitable organization can help you diversify your portfolio and avoid the capital gains tax and net investment income tax.
If you’re 70 ½ or older, a qualified charitable distribution from your IRA directly to a charitable organization allows you to avoid claiming income from an IRA distribution.
Just as with other aspects of your financial life, your charitable giving should be built around a strategy. A clear objective for most is to find ways to maximize the impact of your charitable donations. While your primary desire may be to support your favorite charitable organizations, you also want to be sure to fully capitalize on the tax benefits available to you.
The best gifting approach is not to make donations on a whim, but to put more thought into the process. Cash gifts tend to be the default option for many, but they may not be the most efficient use of your charitable generosity. This is true both in the net amount extended to a charity and the tax benefits you can achieve through tax-deductible donations.
Qualified charitable distributions from IRAs and gifts of stocks offer prime opportunities to enhance your giving and achieve greater tax savings.
If you own highly appreciated stock in a taxable account or have built significant sums in a traditional IRA and are at least age 70 1/2, there may be more efficient gifting options available to you. In addition to private foundations or donor-advised funds, you may want to consider these advanced giving strategies as part of your comprehensive wealth plan.
If you own shares of stock that have experienced significant price appreciation, based on current tax laws, as long as that stock is held, it can continue to appreciate in value with no tax consequences. Capital gains taxes are due when the stock is sold, taxed at a rate of up to 20% (on securities held for more than one year) at the federal level. In addition, if your modified adjusted gross income exceeds certain threshold amounts, a 3.8% net investment income tax (NIIT) may also apply.
If you have intentions to sell stock with a low cost basis, one alternative to consider is gifting those securities to charity. This offers important advantages compared to first selling the securities and then making a cash donation.
As an example, let’s say you planned to make a $100,000 gift to charity. If you were going to liquidate a stock position to make that donation, you might have to sell $125,000 worth of stock to cover the long-term capital gains tax impact of the sale. If 3.8% NIIT applies, you would need to sell $131,234 to cover both capital gains and NIIT. State taxes may apply on top of that.
A better strategy may be to donate $100,000 worth of stock directly to a charitable organization. There would be no capital gains tax liability or NIIT impact for you because you gifted the stock instead of selling it. In addition, you could claim a tax deduction (within allowable limits) matching the fair market value of the stock. In this example, making a $100,000 donation only requires you to reduce your holdings by that same amount, not a larger amount to cover taxes, as would be the case with a cash donation made from liquidating securities.
You keep more in your investment portfolio while still meeting your intended gifting target.
What to consider when gifting appreciated closely-held securities
Note that to claim a deduction in the current tax year, the transfer of stock to a qualified charitable organization must occur by December 31. Be sure to plan ahead and start the process early in order to claim the potential tax deduction this year.
If you’re 70 1/2 or older, you have another option to consider for a tax-efficient charitable gift. A qualified charitable distribution (QCD) allows you to efficiently pass on up to $100,000 directly from your IRA to qualified charitable organizations. If you’re subject to required minimum distribution rules (applicable after you reach age 73), a direct transfer from your IRA allows you to avoid claiming income from an IRA distribution in order to make your charitable donation.
A QCD has distinct advantages over making a direct cash donation. For example, if you took a distribution of $100,000 from your traditional IRA, most or all of the distribution would be subject to tax at ordinary federal income tax rates (up to a top rate of 37%). Not counting state and other taxes, those in the highest tax bracket would end up with a net distribution of $63,000. That amount could then be directed to a qualified charity as a cash gift and a deduction claimed for that amount (within applicable limits).
With a QCD, you do not claim any income from a distribution. Instead, the full amount of your donation up to $100,000 in a year goes to the directed charities and you avoid a significant taxable increase to your income. This may allow you to remain in a lower tax bracket and potentially avoid the 3.8% NIIT. It also allows you to maintain a lower level of income to minimize your tax liability on Social Security benefits or keep your income below thresholds that would add expense to Medicare Part B premiums.
What to consider when choosing a QCD
Qualified charitable distributions and gifts of stocks offer prime opportunities to enhance your giving and achieve greater tax savings and should be considered as part of a broader gifting strategy.
It can help to talk to your wealth planning professional about how best to incorporate your giving goals into your larger wealth plan. Be sure to consult with your tax advisor to fully understand the rules and tax ramifications regarding your charitable giving options.
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Careful planning can help you take advantage of tax benefits related to your charitable giving strategy.