It May Not Be Wise to Dally on Charitable Contributions
Tax reform, the stock market crash and the holiday spirit make this a good time to give charitable contributions.
With top individual tax rates falling next year--to either 28% or 33% from 38.5% this year--many taxpayers can get a bigger deduction for each dollar given in 1987 instead of 1988. Also, the stock crash and subsequent bear market has prompted many investors to consider unloading equities that they might donate instead. And with the holiday spirit, many people give anyway, regardless of the tax benefits.
Accordingly, many charitable, civic, religious, educational, scientific and other nonprofit organizations expect 1987 to be as good a year as ever for giving, despite earlier predictions that tax reform would depress charitable giving. Many gifts will come between now and Dec. 31 as taxpayers rush to include donations in this year’s tax calculations.
Unfortunately, many people could do a much better job of planning their giving so their contributions save them more in taxes or cause them fewer headaches with the Internal Revenue Service, financial advisers say.
One of the biggest mistakes is to give cash instead of assets--such as stocks, real estate, jewelry, collectibles--that have appreciated in value. In almost all cases, you will be better off giving appreciated assets instead of cash, if the assets qualify as long-term assets held more than six months (next year the definition of long-term goes to one year). By giving appreciated assets, you avoid capital gains taxes on the appreciation while still writing off the full market value of the assets.
“Cash is one of the most expensive things to give,” said Daniel Rice, director of financial planning for World Vision, a hunger-relief charity. “If you have an asset that is worth more today than what you paid for it, and you don’t have any sentimental attachment to it, it is better to give it” and keep your cash.
Unfortunately, cash is the preferred way to give, partly because it is the way most charities ask for donations, Rice said. He cited a recent Gallup Poll showing that 71% of high-income donors planned to give cash this year, while only about one in four planned to give appreciated securities or other non-cash property.
Here’s how it is better to give appreciated assets:
Suppose you are in the top 38.5% tax bracket and want to give $1,000 to a nonprofit organization. If you give cash, the donation in effect costs you $615. The donation reduces your taxable income by $1,000, and thus you save $385 in taxes. (You save even more when you factor in state taxes.)
However, if you gave $1,000 in stock (held more than six months) that originally cost you $500, your donation would in effect cost only $475. Here’s why: The donation also reduces your taxable income by $1,000, saving you the same $385. But you also save $140 in avoided capital gains taxes, assuming you are subject to this year’s top 28% capital gains rate.
The worst case, for both you and the charity, would be to sell the stock and donate the proceeds. That way, you must pay the capital gains tax of $140, in effect making only $860 available to give. When you donate that reduced amount, you will only save $331 in taxes (38.5% of $860). So this way of donating $1,000 in effect costs you $669.
What if you want to keep that $1,000 in stock because you like it and think it will go higher? You are still better off giving it and using the $1,000 cash--which you would have given--to replace the stock, said Conrad Teitell, a New York tax lawyer specializing in charitable giving.
By giving the stock and then buying new shares, you can establish a higher cost for the stock for tax purposes, Teitell explains. Then, if the stock does indeed go up, your capital gain taxes will be lower. If the stock goes down, you will have a capital loss for tax purposes, which can be used to offset other capital gains or ordinary income.
There are, however, some exceptions to the rule that giving assets is better than giving cash. One is if the assets have short-term gains (from holding them less than six months). In that case, you can only deduct the price you paid for the assets, not their current market value.
Another exception is if your assets are worth less than you paid for them. Then you are better off selling them to claim capital losses, and then giving the proceeds to charity.
Other Tips
Yet another exception would be if you are subject to the alternative minimum tax. The untaxed value of appreciation in donated property is taxable under the AMT.
Here are some other tips for charitable contributions:
- If you don’t itemize, consider bunching deductions. Unfortunately, under tax reform, non-itemizers cannot deduct charitable contributions. But if the tax deductions are important to you, consider bunching gifts planned for two or more years into a single year, in the hope that those and other deductions may pull you over the standard deduction and make itemizing worthwhile.
- If you are giving cash, use checks so your canceled checks serve as a reminder and proof of the donations.
- If you are donating non-cash items, be sure to obtain the proper paper work and appraisals. Without them, your deductions may be disallowed or you may be subject to a penalty, notes Sidney Kess, partner with the accounting firm of Peat Marwick Main.
If you claim more than $500 of non-cash contributions in a year, you must file Form 8283, “Non-Cash Charitable Contributions,” with your tax return. On that form, you must list a description of the assets and the name and address of the organizations receiving them.
For each item of value over $500, you must also include the date of contribution, date you acquired the item, how you acquired it (by gift, purchase or other means), your cost, its fair market value and how you arrived at it.
Deductions for contributions of non-cash items totaling over $5,000 per year must be accompanied by a statement from a qualified appraiser. Exceptions: marketable securities, which don’t need to be appraised, and stock of privately held companies, which must be appraised if over $10,000 in value. Many nonprofit organizations can give you names of qualified appraisers.
- If you are giving paintings, antiques, coins or other items of personal property (not including financial assets such as stocks and bonds, or real estate) that have gained in value and you have held longer than six months, give them to organizations that can use them as part of their tax-exempt purposes.
For example, donate paintings to art museums, or donate antique books to libraries or historical societies. Only that way can you deduct the current fair market value of the items. Otherwise, if you give those assets to organizations that will just turn around and sell them, you can only deduct the purchase price of the assets.
However, if the items have declined in value since you bought them (used clothing, old blankets, used furniture, etc.), you can only deduct their fair market value anyway, not what you paid for them.
- Consider trusts, pooled income funds, gift annuities and other devices set up by some of the biggest nonprofit organizations.
In a charitable remainder trust, for example, you agree to donate assets such as stocks to charity while you continue to receive income from the assets for a specified period. You get a deduction based on an estimate of the present value of the assets when they eventually go to the charity. You also save on estate taxes and probate costs, and avoid capital gains taxes. Also, the assets can be reinvested by the charity so that you receive a higher income from them.
These trusts, however, are usually tailored for wealthy donors giving as much as $25,000 or more.
For the less affluent, one alternative is a pooled income fund, often called the “poor person’s remainder trust.” It pools donors’ assets like a mutual fund, investing them and paying donors their shares of the income. Minimum gifts are usually $5,000 to $10,000, said Derrell D. Brown, a planned gifts consultant for the Salvation Army.
Another alternative is a gift annuity, which allows you to donate assets and then receive income based on your age and life expectancy, Brown said. The older you are, the bigger the payments. Such annuities are available from the Salvation Army for as little as $1,000, Brown said.
Most major nonprofit organizations have specialists who can advise you of your best alternatives.
