By Justin Vlaanderen
Are you charitably inclined and looking for tax-efficient ways to maximize your charitable impact?
Below, we focus on two strategies:
- Highly Appreciated Securities (referred throughout as DAS)
- Qualified Charitable Distributions (QCDs)
Though both encompass direct donations to a qualifying charity, your optimal charitable gifting strategy depends on various considerations including your age, tax bracket, securities owned, and whether you itemize.
Highly Appreciated Securities
At any age, you can donate cash or highly appreciated securities.
Donate Cash: You can sell your securities, pay taxes on the realized gain, and donate a cash contribution up to 60% of your Adjusted Gross Income (AGI). Any excess deduction will be carried over for five years. Gifting cash, however, is often the least tax-efficient way to charitably gift.
Donate Highly Appreciated Securities: You can donate highly appreciated securities held longer than one year. This results in no taxable gain, but the gifting amount is limited to 30% of AGI. By donating appreciated securities (DAS), there is a double tax benefit - the ability to itemize charitable donations as well as forgo capital gains taxes.
Qualified Charitable Distribution (QCD)
If you are at least age 70½, you can donate directly to a charity with a QCD from your individual retirement account (IRA). The donation amount of the QCD is excluded from your taxable income, up to $100k ($200k if married/joint) per year. QCDs also count towards your current year required minimum distributions (RMDs).
For Estate Planning, QCDs may offer an advantage if you plan to leave an inheritance. By focusing your charitable gifting through your IRA, the appreciated securities held in taxable accounts receive a step-up in basis upon your passing. Consequently, your heirs may receive more favorable tax treatment (capital gains rates vs ordinary income rates) on their post-inheritance appreciation. However, if the inheritance is received through an inherited IRA, no step-up would occur, and the funds would be taxed at ordinary income rates.
Examples & Considerations
The following examples demonstrate each strategy for an individual over age 70½:
When exploring these gifting strategies, an important factor is whether or not you itemize. If you take the standard deduction, QCDs offer an advantage as the gifting amount is subtracted from your AGI. This may also reduce the taxes you pay on Social Security benefits (SSB) depending on your tax bracket. In Example 1, electing a QCD is better than donating highly appreciated securities due to taking the standard deduction. Further, the 0% capital gains tax rate negates the benefit of DAS. If you do itemize, it may be worth donating highly appreciated securities.
In Example 2, there is no clear winner since both strategies produce the same initial immediate tax liability. To determine if DAS makes sense, you must consider cash flow needs, size of position, size of unrealized gain, and desire to hold the position. Moreover, you could use your RMD cash to repurchase the same donated appreciated security, thereby raising the cost basis. This reduces future taxes if that position is sold and allows you to diversify around a large gain.
Other considerations include the cost of Medicare premiums and the Medicare surtax. Because of the many potential nuances, we recommend collaborating with your advisor and CPA to find your optimal charitable strategy.
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