Everyone has different reasons for donating to charity. Beyond the benefits to the community and the increased happiness of the donor, charitable donations are also an effective way to reduce your tax burden. Often, people tend to get so wrapped up in the why behind charitable giving that they forget about the how.
In this Insight, I explore why donating securities is an important option to consider, and how Donor Advised Funds can help. Below, I’ll walk you through the pros and cons of this option, including an example step-by-step case study.
In short, a Donor Advised Fund (DAF) provides a unique account for giving to charity: tax benefits can be received immediately while grants to charities are paid out over time.
The most common and straightforward way to give to charity is to do it via cash, by writing a check or submitting credit card information. However, donating to charity by transferring securities (if they’ve been held for at least a year and have appreciated in value) is a more tax-efficient strategy. The example below illustrates why.
Jane typically donates $10,000 each year across multiple charities. She is in a combined (federal, state, local) 45% tax bracket for income taxes and 28% for capital gains taxes. She owns 1,000 shares of XYZ stock, which she purchased for $2/share 20 years ago and now is trading at $40/share.
Utilizing a Donor Advised Fund provides numerous benefits to Jane as outlined below. First, it is useful to describe how this type of fund works.
The scenario above highlights some of the central advantages offered by a Donor Advised Fund. I explain each one below.
Like other charitable gifts, DAF donations create an upfront tax deduction.
Jane gets a full deduction of $40,000 when she transfers the stock, thereby reducing her taxes by $18,000 ($40,000 x 45% income tax rate), assuming no limitations or phase-outs.
An upfront deduction is particularly useful for those who may be in a high tax bracket today but expect that to come down soon. In addition, many taxpayers may fall within the standard deduction most years and by bunching their charitable contributions to a single year, thereby itemizing, they reap the benefits that otherwise would have been lost.It is important to use stock held for longer than one year. If the stock was held for less than a year, then she would only receive a deduction on the cost basis. From a cash flow perspective, Jane has kept her cash and received an immediate deduction on the full fair market value of the stock.
Gifting a security rather than cash helps avoid potential capital gains taxes.
In the example scenario, this amounts to a $10,640 tax benefit. If Jane had otherwise wanted to sell and diversify herself out of XYZ stock, she would have owed capital gains tax of $10,640 (($40,000-$2,000) x 28% (capital gains tax rate)). Put another way, Jane is able to grant $10,640 more to charity by using appreciated stock rather than cash.
DAF holders only need to make minimal grants out of the Donor Advised Fund every couple of years, which offers an extended timeline with more flexibility to decide on giving plans over the years.
DAF holders can name a successor to take over at death, so there is minimal time pressure to disburse Donor Advised Funds. We take a deeper look at the value of DAFs for estate planning here.
In the example, Jane no longer needs to track all of her donations for tax records. She can also stop writing checks, filling out envelopes and buying stamps. Grant requests are easy to make online or by phone.
The downsides of a donor-advised fund are straightforward but important to recognize.
While the restrictions on Donor Advised Funds are relatively broad, they are important considerations when considering your own giving strategy.
If you’re looking to sell stock at a profit and benefit from making a charitable donation, you can do both by utilizing a Donor Advised Fund. As we have explored in this Insight, in most cases, charitable giving via transferred securities will be your most tax-efficient option.
Donor Advised Funds are one of many ways to structure giving, each with its own distinct advantages. For further reading, we take a deeper look at charitable trusts and private foundations in this Insight.
Looking for more guidance on charitable giving that is specific to your financial situation? Schedule a complimentary 30-minute consultation with one of our advisors today!