The old year came to a close amid an ongoing five-year bull run in equities, which pulled prices from the depths of the economic crisis in 2008 and 2009 to the all-time highs where they ended 2014. To give some perspective, the shareholder of an ETF or mutual fund tracking the S&P 500 would have enjoyed a cumulative return of well over 200% from the lowest point on March 9, 2009, through December 31, 2014.
In addition to potentially allowing client portfolios to more than make up for lost ground, this favorable market environment may yield charitable planning opportunities for your clients.
The Building Blocks of a Charitable Strategy
Clients who had the wherewithal to remain invested in equities during the crisis and recovery likely now own nonqualified positions with low cost basis relative to their current fair market value. For the philanthropic client, these positions can be the building blocks of a successful, tax-efficient charitable strategy that also serves to complement the client’s overall financial plan.
First, let’s consider the client who writes a $500 check to her favorite charity. She may be able to deduct the full amount of the donation from her income, thus reducing the total amount of income on which she will be taxed by the IRS. The tax benefit that accompanies a charitable donation is the federal government’s way of incenting taxpayers to support the various charitable organizations that exist today.
But suppose there’s an even more tax-advantaged way for this taxpayer to fulfill her charitable goals. If she happens to own equity positions in her nonqualified account, there just may be. Let’s assume that this client owns a position in ABC with a fair market value of $500, where that value represents a long-term capital gain of $250 and an income tax basis of $250. Instead of writing a check for $500 to her favorite charity, she could donate her ABC shares directly.
Not only would she receive an income tax deduction equal to the fair market value of the shares, but she would also avoid paying taxes on the long-term capital gain, which she would otherwise have to pay if she sold the shares herself. She also wouldn’t have to worry about the charity footing the bill for the capital gain, since the charity is tax exempt. It’s certainly a win-win from both an income tax and a philanthropic standpoint.
Preserving the Overall Asset Allocation
But what if the shares in ABC were an important piece of this client’s overall asset allocation? Remember, she had a choice to either donate cash or the shares.
Because she donated the shares, she preserved $500 in cash, which she could use to repurchase shares of ABC in her nonqualified account. By repurchasing the shares, she keeps her asset allocation intact and increases her basis in that position—a move that could be advantageous in the future when seeking to minimize capital gains tax or harvest tax losses across the portfolio.
Worried about a wash sale? Don’t be. The wash sale rule prohibits a taxpayer from claiming a loss on the sale of a security if he or she purchases the same or a substantially identical security within 30 days before or after the sale. There are no such issues when donating or selling a position for a gain and then purchasing those same shares.
Enhancing Your Clients’ Charitable Planning Goals
The examples used here are rather simplistic and serve only to provide a foundation from which to build. There are many other factors that can impact what a taxpayer may or may not deduct, including AGI limitations and phaseouts, so be sure to consult with your client’s tax professional before implementing any charitable strategy.
In future posts, I’ll cover more advanced strategies you can use to help enhance your clients’ charitable planning goals.
In the meantime, if you’re not discussing charitable planning opportunities with your clients, why not start today? You may be surprised to find that many have philanthropic intent, but they simply weren’t aware that you could help them pursue their goals. And some clients may become even more charitably inclined when they truly understand the benefits of charitable giving to their financial plan.