First, a little background on tax benefits before we get to the benefits of donating appreciated stock. When you donate to a charity, you are eligible for a deduction on your federal and state taxes, as long as you itemize your deductions on your taxes. So, assuming your combined Federal and State marginal tax rates add up to about 40% (family income of $150k or greater), when you donate $10,000 to your local public school you will save at least $4,000 on your taxes.
This is great -- however, it would be even better if you donate appreciated stock because you get additional tax savings.
Say you own shares of a stock or mutual fund that you bought in 2008, which are now worth twice what you paid. If you were to sell $10,000 worth of those shares, you would owe capital gains taxes on the $5,000 increase in value. In California, where capital gains are treated like ordinary income, you might owe 15% or 20% federal capital gains tax plus, say 9.3% CA state tax (if your family makes more than $100K/yr). Estimating a 25% total tax rate, you would pay approx $1,250 in taxes on the sale of the stock. The taxes would of course be even higher if the stock had appreciated more - say you bought Apple stock at the same time, for example, the tax bill might be closer to double that - $2,500 on the $10,000 stock sale since most of the value would be taxable gain.
Say you own shares of a stock or mutual fund that you bought in 2008, which are now worth twice what you paid. If you were to sell $10,000 worth of those shares, you would owe capital gains taxes on the $5,000 increase in value. In California, where capital gains are treated like ordinary income, you might owe 15% or 20% federal capital gains tax plus, say 9.3% CA state tax (if your family makes more than $100K/yr). Estimating a 25% total tax rate, you would pay approx $1,250 in taxes on the sale of the stock. The taxes would of course be even higher if the stock had appreciated more - say you bought Apple stock at the same time, for example, the tax bill might be closer to double that - $2,500 on the $10,000 stock sale since most of the value would be taxable gain.
What the government allows you to do is to make a charitable donation of your appreciated stock directly, instead of cash and without ever selling the stock. By doing this, you get the full $10,000 tax deduction, and never have to pay taxes on the gain in stock value. So by donating appreciated stock in this example, you can give $10,000 to your school and the government will effectively pay you back $5,250 of your donation!
To maximize the value of this, our family keeps a few of our most highly appreciated stocks in our portfolio just for our charitable donations. If you have something that has increased in value many-fold over the years, that is the perfect candidate for a stock donation.
Most charities, including of course our local Burlingame Community for Education (BCE), will accept stock donations, which typically requires instructing your financial institution to transfer a given number of shares to a specific account for your charity. For BCE stock donation information, see http://www.bcefoundation.org/donate/#stock or email stockdonation@bcefoundation.org for details. Given that you may have purchased different lots of your shares at different times, you should also make sure that your financial institution specifically transfers the shares that have the lowest cost basis.
This is great, and not too difficult for your larger donations. However, our family also makes a number of smaller donations, to colleges we attended, charities and non-profits we support and the occasional one-off donations when a friend or family member is fundraising. In the case of one-off donations of $50, $100, etc., it may not be worth the effort to make those donations with appreciated stock. This is one way that "donor-advised funds" can come in handy and a perfect segue to that topic.
Donor-Advised Funds
Briefly, the way donor-advised funds work is that you make a donation to the fund (in our case, we use Fidelity Charitable, http://www.fidelitycharitable.org/) who will then set up an account for you to hold your donation(s). This is basically like having your own family foundation, though it can be done with much smaller amounts of money (Fidelity Charitable's minimum to set up an account is $5,000 - and after that initial donation, there is no minimum balance required). You get the tax deduction at the time you donate to your fund account and cannot ever get the money back for your own personal use thereafter, so you should only do this with funds you know you will eventually want to donate.
Once your account is funded, you can select from various investment choices, much like a 401K, and the account may grow in value, depending on how you invest it. Then, over time, you direct the fund to make donations from your account to your preferred charities, with the timing and amounts that you select. When a donation is made to your selected charity from your account, you do *not* get a tax deduction, since you got the deduction already, when you made the initial donation to the donor-advised fund.
Once your account is funded, you can select from various investment choices, much like a 401K, and the account may grow in value, depending on how you invest it. Then, over time, you direct the fund to make donations from your account to your preferred charities, with the timing and amounts that you select. When a donation is made to your selected charity from your account, you do *not* get a tax deduction, since you got the deduction already, when you made the initial donation to the donor-advised fund.
There are several benefits to donor-advised fund accounts:
* You can very easily donate appreciated stock. In our case, we use Fidelity to manage many of our securities and it is literally a 2 min task to select the stock that has the greatest appreciation and transfer some shares of it to our donor-advised fund account.
* You can very easily make small donations from the account - Fidelity has a super simple interface to find a charity (say, American Red Cross) and make a donation of any amount. It's also very easy to set up annual donations, which we do for all our colleges, etc so the money goes to the charity every year without us needing to do anything.
* Very interestingly, you can now control the tax year of your donations much more flexibly. For example, if you have one particularly high income year, you can fund your donor-advised fund account with several years worth of charitable donations. This maximizes the tax deduction value of those donations. Or, if you have some years when you itemize deductions and some when you do not, you can group all your donations into the tax year when you are itemizing. The same approach can apply if you have some years when you are subject to the AMT (which has a lower deductible rate for charitable donations) and some when you are not. You get the idea...
* You can have the fund donate in your name, or anonymously, and with or without your address. This can decrease the mail you get when non-profits sell or rent their donor lists to other charities.
There are of course potential disadvantages which you should be aware of:
* Once you give the money to the donor-advised fund, you cannot get it back. You (or your heirs) can choose when and who to give it to, but you can't undo your donation. So if you are making several years' worth of donations at once, make sure you will not change your mind.
* Your fund account can grow in value, which is great since you will have more money to donate to your favorite non-profits. However, if you instead kept the stock in your personal account and let it grow there, and then donated it to the fund later, your deduction would be even larger. So there is a tradeoff between controlling the tax year for your donation and "just in time donating", which may maximize your deduction, assuming the market always goes steadily up...
* There are some fees associated with donor-advised fund accounts. For example, Fidelity charges $100/yr or .6% (whichever is greater) from your giving account balance. For us, this is dwarfed by the tax savings of making small donations with appreciated stock, but it is something to be aware of.
And critically, if your employer matches your charitable donations, this donor-advised fund strategy may not be right for you because your company might not match your donation to your own donor-advised fund account and they certainly won't match the donation from the account to your selected charity. If you take advantage of corporate matching, I would suggest: (a) checking with your company to see if they will match donations to donor-advised funds and, if not, (b) donating appreciated stock directly to your charity to get your maximum company match and then using a donor-advised fund for additional giving or for any donations for which you will not get the company match.
Finally, I should say that I am not a lawyer, nor an accountant, nor have any official connection to Fidelity (other than as a customer). I'm sure other large investment banks offer donor-advised funds. So you should investigate these options for yourself and see what is right for your family. But, any time you are making a charitable donation with cash, check or credit card and not getting your employer to match your donation, you should be thinking about making the donation instead with appreciated stock, either directly or via a donor-advised fund.
For those of you who give to BCE, now that you understand how the government will effectively reimburse you for 50% or more of your donation, hopefully you will adopt this strategy and then double your BCE donation next year. :-)
