You Can Maximize Tax Benefits by Making Charitable Donations… Here’s How
Should you donate cash or stock to charity? Analyse after-tax benefits for both methods of charitable giving as also a third available option. As the year ends and the holiday season rings in, charity-minded investors decide about causes and organizations closest to their hearts but also about donating in tax-efficient ways. By being more tax-efficient, investors maximize donations to charity while minimizing their tax burden. With many worthy causes available, finding a cause and donating money seems simple. But slightly different approaches to donating yield vastly different results. Let’s compare after-tax benefits of three methods of charitable giving:
As extension of the CARES Act, taxpayers can deduct $300 for individual and a $600 fee for joint filers, in addition to standard deduction for the 2021 tax year. Apart from additional deduction in 2021, charitable donations are only deductible for taxpayers itemizing deductions. Normally, deduction is limited to 60% of adjusted gross income (AGI) for cash donations and 30% of AGI for stock but the CARES Act permits deduction for cash donations for 100% of AGI.
It is easy for donors to write checks and give them to charities as this gift becomes tax-deductible in that tax year. A charitable gift of, say, $50,000 in full cash with the highest tax rate of 37%, reduces the taxpayer’s AGI by $50,000, ensuring a reduced tax bill of $18,500.
Assume the $50,000 gift is securities appreciated by 100%, with initial cost of $25,000. IRS allows investors to include deductions from donated securities if held over one year and the dollar amount gifted is under 30% of investor’s AGI. The investor also avoids tax liability embedded in the investment about $6,000, assuming highest capital gains tax rate of 23.8%. By granting these securities to charities, the investor can avoid this capital gains tax. The charitable organizations is can sell the security tax free, making the gift as good as cash. Similar to the cash gift, the taxpayer also gets a same-year tax deduction of $50,000 reducing their AGI.
Securities donation with cash replenishments
To top the benefits of donating highly valuable securities rather than cash, investors with a tax-managed direct portfolio can realize additional benefits by replenishing their investment portfolio with cash equivalent of value of gifted stocks. We examine a direct indexing $1 million portfolio, with $50,000 in securities to gift with a 100% appreciation level as in the previous example but the portfolio is cash replenished. Most performance increase comes from future tax-loss harvesting, with the incremental tax alpha coming from expected additional tax losses generated from reinvesting added cash. Added benefits include cash replenishment after donating securities in a direct indexing tax-managed portfolio enabling reduced tracking-error risks by picking overweight names for gifting and reinvesting cash under other names, to lower tracking error.
The bottom line
Charity donations are an important part of wealth management strategy. Select the path providing optimum tax benefits, aligning the portfolio with selected investor benchmarks as difficult. Choose an asset manager with expertise, tools, and reporting capabilities to manage the portfolio and make a difference.
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