The S&P 500 has hit a new all-time high more than 50 times this year. The good news is that there is a way for you to avoid some capital-gains taxes, earn a substantial tax deduction and do a tremendous amount of good for the community you love: Consider using some of your highly appreciated stock to “bunch” several years’ worth of charitable gifts through a Donor Advised Fund at your local community foundation.
Let’s look at these pieces individually before seeing how they can work well together for your tax benefit.
First, when you donate publicly traded stock to a 501(c)(3) public charity, you generally avoid the capital-gains taxes that you would have owed Uncle Sam, and the charity doesn’t pay them either. Almost like magic, those taxes disappear, thereby allowing the entire value of your donated stock to support the charities you love.
Further, as the donor, you can normally claim a charitable tax deduction of the fair market value of the stock. That’s why donating highly appreciated stock is one of the most tax-efficient ways to give. You get the double benefit of avoiding capital-gains taxes and earning a tax deduction.
Second, “bunching” is a tax-planning tool in which you take the standard deduction during most years and bunch all of your deductions into a single year during which you claim a substantial itemized deduction.
People might bunch two years’ worth of property taxes (paying in January and December of the same year), medical expenses for procedures that are not time sensitive, or multiple years’ worth of charitable gifts into a single tax year. For those who have a substantial number of deductions but still fall short of the level that justifies itemizing them on their taxes, bunching deductions into a single tax year can result in enormous tax savings.
Third, a Donor Advised Fund is similar to a private foundation but without the legal, accounting and administrative costs that come with operating a corporate foundation. Community foundations invented Donor Advised Funds as a simpler, cheaper and more tax-efficient alternative.
For example, let’s say you create the John and Jane Smith Charitable Fund at your local community foundation. Donations into your fund are typically tax deductible to you as charitable gifts. Then you use your fund to make distributions to the charities you care about.
There are for-profit financial-services firms that offer Donor Advised Funds, but when you create one at your local community foundation, you have the benefit of working face to face with local nonprofit professionals who serve as your personal foundation staff.
Each of these tax-planning tools works just fine independently, but when you use them all in concert, you dramatically increase both the value of your charitable gift and the tax deductions you can claim.
For instance, let’s imagine that John and Jane Smith normally donate $20,000 to charity annually and have few other tax-deductible expenses. Consequently, they claim the standard deduction of $24,800. In practical terms, this means that the Smiths get absolutely no tax benefit for their $20,000 of charitable giving!
But what if the Smiths create the John and Jane Smith Donor Advised Fund at their local community foundation? They bunch the next five years’ worth of their charitable giving into this tax year, thereby allowing them to claim a whopping $100,000 itemized deduction in 2021 (five years x $20,000 in donations per year).
They also very wisely make that charitable gift using $100,000 worth of stock that has appreciated significantly, which enables them to avoid capital-gains taxes while still claiming an itemized deduction of the fair market value of their $100,000 stock gift during this tax year.
Then, during each of the next four years, the Smiths will claim the standard deduction of $24,800 (adjusted annually, of course). In other words, they will have avoided capital-gains taxes and earned about $75,000 in additional tax deductions over five years using this simple strategy.
Finally, the Smiths will distribute $20,000 every year from their Donor Advised Fund so they can still support the charities they love at the same level they always had.
Goodness knows I’m not an accountant, so you should seek professional counsel to ensure that these tools are right for your particular tax situation. But for many people, bunching multiple years’ worth of charitable gifts by donating highly appreciated stock to a Donor Advised Fund at a local community foundation is an incredibly tax-efficient way to give back.
Contact Bret Bicoy at [email protected]