When we contribute to our favorite charities, most of us go the easiest, most familiar way--simply writing checks or using credit cards. We get a tax deduction; the charitable organization receives the money.
But donors who want to make major gifts and also lose less to the Internal Revenue Service should familiarize themselves with other, often overlooked ways to fund philanthropies. One option that allows the charitably inclined to realize significant tax benefits is to donate appreciated properties they have owned for more than 12 months and that will be taxed as long-term capital gains when sold. Some common examples are shares of individual stocks, shares of exchange-traded funds and mutual funds, bonds and real estate.
The "give 'em away" gambit permits contributors of appreciated assets to deduct their full market value when donated. Savvy benefactors also avoid all of the federal and state taxes assessed on profits realized from sales of investments, effectively decreasing the cost of donations. But if the investors sell their holdings first and then donate the cash proceeds, the IRS will pocket a chunk of the profits.
For 2008, the top rate for long-term capital gains is 15% for individuals in income-tax brackets of 25% or higher (taxable income above $65,100 for joint filers and $32,550 for single filers). The levy drops from 5% for 2007 to 0% for 2008 for individuals in the two lowest income-tax brackets of 15% and 10% (taxable income below $65,100 for joint filers and $32,550 for single filers). Beyond 2008, the top rate of 15%--as well as the 0% rate--apply through 2010. Add to Uncle Sam's take whatever his nephews and nieces exact for taxes at state and local levels.
On Nov. 22, 1991, the Wall Street Journal noted that "This tax-saving strategy is immortalized in the 1959 film "The Young Philadelphians," starring the late Paul Newman as an ambitious attorney involved with the elite of the Main Line, the affluent suburbs lining the Pennsylvania Railroad west of Philadelphia.
The Newman character's "suggestion of giving appreciated stocks to the local Society for the Prevention ofCruelty to Animals helps him win the business of Mrs. J. Arthur Allen, an eccentric millionaire," played by Billie Burke (better known for her role as Glinda the Good Witch of the North, in "The Wizard of Oz").
But donations of appreciated assets are not only an appropriate technique for Mrs. Allen and her well-heeled acquaintances. They also benefit people of far more modest means.
The numbers look like this: Let's say Joan Barthel intends to fulfill a $10,000 pledge to Roosevelt University. Her long-term holdings include some shares of stocks that she acquired for $4,000 and is now about to unload for $10,000. To reap a perfectly legal double benefit, Joan should contribute stock worth $10,000--not the same amount of cash.
Going the stock route makes no difference to Roosevelt University, a tax-exempt entity that incurs no taxes when it sells the shares and ends up with close to the same amount of money. But it does make a decided difference in the size of Joan's tax tab. A charitable gift deduction of $10,000 cuts taxes by $3,000, assuming Joan falls into a combined federal and state bracket of 30%. In addition, she sidesteps forever the taxes that are due on the $6,000 gain if she sells the stock--a federal levy of as much as $900 and whatever her state exacts.
A common situation finds Joan is at "sixes and sevens" about whether to relinquish her position in some appreciated stock. Moreover, do her asset allocations need a makeover? The standard recommendation is that Joan should donate the stock to Roosevelt anyhow, and use the money that she would have donated to buy back the shares for their current market price. That way, she preserves a contribution deduction of $10,000 and dodges tax on the $6,000 that appreciated since she acquired shares.
Even better, Joan reaps a benefit other than the deduction and diversification of her holdings. Brokerage commissions aside, a repurchase of the stock makes it possible for her to measure any gain or loss on a subsequent sale against the new, higher cost basis of $10,000, not the original one of $4,000--a tactic sanctioned by the IRS.
There are other concerns and complications to mull over. For starters, the additional tax break is available only for donors who hold their shares in taxable accounts, not traditional IRAs or other kinds of tax-deferred retirement plans.
Nor does the IRS look kindheartedly on donations of assets owned less than 12 months. The tax collectors place a ceiling on Joan's charitable write-off. The cap is what she paid for them or their current market value, whichever is less. They are uncompromising even though the shares are worth more when she gives them away. With shares that have gone up a lot--and swiftly--that stings. Unsurprisingly, the Feds set other snares for Joan as she navigates this limitation.
Suppose she purchased some of those shares two years ago and purchased additional shares last month or--in the case of mutual fund shares--acquired them through automatic reinvestment of distributions of capital gains and income less than 12 months ago. The IRS allows the current value deduction only for her two-year-old shares and limits the deduction for her newer shares to their purchase price.
Other IRS guidelines spell out how Joan should determine the actual value of the shares she transfers. For shares of publicly traded companies, she should use the average of a stock's high and low prices on the date of delivery. For mutual fund shares, she should use the fund's closing price on the date of delivery. As for shares of non-listed companies, the value is the amount she would receive from a third party in an arm's-length transaction, a determination that may require her to obtain a written opinion from a qualified appraiser.
In any case, it's a good idea for Joan to check with a tax expert before she makes sizable contributions, especially if she plans to donate appreciated property. If she claims a deduction of more than $5,000 for any gift of property (more than $10,000 in the case of stock in a closely held company), the IRS wants a written appraisal. But it does not ask for an appraisal of shares in publicly traded companies since stock markets determine their value daily.
Julian Block, an attorney based in Larchmont, N.Y., conducts continuing education courses for financial planners and other professionals. Information about his books is available at www.julianblocktaxexpert.com.