For some of our client families, this time of year means tax planning. For others, we’re focused on how to help them complete the charitable resolutions they set back in January. In today’s blog post we discuss how to achieve both by comparing gifts through Qualified Charitable Distributions, appreciated stock or Donor Advised Funds. For families with a charitable heart and a variety of assets, cash may not be the most tax efficient way to support their charity of choice.
Qualified Charitable Distributions (QCD)
How it Works
Individuals over 70.5 years young can donate up to $100,000/year directly from their IRA to their favorite 501©3(s). These donations will not only make them feel warm and fuzzy, but they will also fulfill their required distribution for the year.
Giving directly from your IRA means that the required distribution isincluded in your taxable income (as it would be if you took the RMD, paid taxes on it and gifted cash). This strategy can of course keep you from moving to a higher marginal tax rate, but it can also help avoid some of the more subtle tax implications associated with an increased AGI. The taxability of your Social Security benefits, the means test that is applied to your Medicare Part B premiums, the 3.8% surtax on investment income and limitations on otherwise available deductions (e.g. medical expenses, misc. itemized deductions and for higher income levels, the phase out of itemized deductions and personal exemptions) are all based on your taxable income.
Mr. and Mrs. Claus want to give $30,000 to The Boys and Girls Club, which happens to be the amount of Saint Nick’s required distribution. If they gift this via a QCD, they will not have to claim $30,000 in additional taxable income. If we compare the tax liability of an outright gift of cash vs. a QCD, Mr. and Mrs. Claus could save about $150 by sending the money directly to the Boys and Girls club. This minimal difference comes from an increase in their misc. itemized deductions due to their slightly lower AGI.
Implementing a QCD is simple. Our clients simply tell us what deserving organization they would like to support and we take care of the rest. We track down donation information, prepare the necessary forms and initiate the transfer. In addition, we send a confirmation note directly to the charity and share this information with our clients CPA.
QCD’s work wonderfully if you have a charitable heart, are over 70.5 and do not need some/all of your required distribution for cash flow. They also work well for clients who are unable to fully take advantage of their charitable deduction (either because some/all falls below the standard deduction or because the contribution is so large is phases out at the 30% - 50% of AGI limits and must be carried forward).
How it Works
After tax brokerage accounts – particularly during market highs like the one we’re experiencing now – can have a large amount of embedded gain. Gifting your most highly appreciated stock or mutual funds has several benefits. The tax liability associated with the position disappears – you permanently avoid the tax liability while at the same time, are able to write off the full market value of the donation.
Rather than using their required distribution, Mr. and Mrs. Claus could instead choose to gift appreciated stock. They have a $30,000 position with Apple that they bought several years ago for $10,000. If they donate their Apple stock, they are eligible for a $30,000 charitable deduction and the tax liability ($3,750) that would have been owed disappears. By gifting their appreciated asset, the $3,750 difference between these two strategies is enjoyed by The Boys and Girls Club, rather than the IRS.
Frequently, growth positions like Santa’s Apple stock not only distort the tax consequences of a diversified portfolio, but also its allocation, making it more risky than intended. Gifting a portion of an overgrown asset can help reduce volatility and rebalance your portfolio.
Donating appreciated stock is great for those with individual stocks or mutual funds that are highly-concentrated and have a low cost basis. Just make sure you’ve held the position for over 12 months. Like most great ideas, it’s best to pencil out a donation of appreciated stock well in advance of December 31st, as it can often take several weeks to complete the transfer.
Donor Advised Funds (DAF)
How it Works
Donor Advised Funds serve essentially as a conduit for nonprofits. They allow donors to gift (and receive a tax deduction) now, and choose their 501©3(s) later. Contributions to a DAF are irrevocable, which is why the IRS views them essentially as a charity and allows an immediate deduction. They can serve as a place to send your cash or appreciated stock donations, but they cannot be funded with a QCD.
DAF’s work well if you have a year of particularly high income, but don’t want to rush the decision of which nonprofits to give to. Because DAF’s have a team of experienced administrators, they are often very useful for clients with non-publicly traded assets (e.g. restricted stock, private company stock, etc.). They have the bonus benefit of making life a little easier for your executor, who is relieved of the burden in finding a buyer for non-public assets. In addition to these perks, we’ve also seen DAF’s serve powerful roles in family giving. (For more on family giving – at all ages and stages – check out our recent blog post.)
What’s Right for You?
Usually when reviewing the options, our clients are asking us to compare one of the above strategies (which take time and pre-planning) with writing a check (which can be done spontaneously and simply). Sometimes the answer is easy. If you don’t itemize your deductions, gifting cash wouldn’t do you much good. But most often for our client families, the answer is more complex. We often find that careful planning, discussion and consultation with their CPA helps to guide us in the right direction. Sometimes, it can be useful to bring an estate planning attorney into the mix to help us imagine an even bigger solution via a charitable remainder or lead trust, or a private foundation. Our role as financial advisors is to have a broad view of our client’s big picture and collaborate with allied professionals to assure everything works in thoughtful harmony.