Donating Stock Gives You the Full Value of Deduction

Stocks have risen so high so fast that many investors face a pleasant problem: what to do with their gains. One good idea--particularly appropriate at this time of year--is to give them to charity.

Thanks to a innovation by Fidelity Investments, you can even use stocks or mutual funds to start your own little foundation. But in making donations, be very careful; tax laws are tricky, and lots of money is at stake.

Consider the man who recently approached me at a cocktail party. He had inherited $4,000 in General Electric Co. stock and dutifully reinvested the dividends in more shares, so that today it’s worth $120,000.

If he sells the stock, he’ll have to pay federal taxes of 28% (plus state taxes) on a capital gain of $116,000. My interlocutor wasn’t pressed for cash, but didn’t like the prospect.

Why not donate the stock to charity?

Notice I said the stock. Because of what Robert Carlson, editor of the newsletter Tax-Wise Money, calls “a perverse twist in the tax code,” you’re far better off giving away stock (or bonds or mutual funds or real property) directly than selling it and donating the cash. But you must own the stock for at least a year, and have a profit in it.

Let’s go back to that $120,000 worth of GE. If my cocktail friend--let’s call him Fred--sells the shares, he’ll have only $80,000 after taxes to give to charity--and only $80,000 in deductions against his income. But if Fred gives the stock itself, the charity gets $120,000 in value--and can sell the shares itself with no tax--and he gets $120,000 in deductions.

If you want to make a gift of financial assets before the end of this year, you better move immediately. The paperwork could take time. Also, check with an accountant, lawyer or other tax specialist, because there are limits on yearly deductions.

Ready to go a step further? Instead of donating your appreciated stock directly to charity, you can now create what amounts to your own private foundation, with an initial contribution of $10,000 in financial assets.

You get an immediate tax break, the same as you would if you made a donation to the American Cancer Society or your alma mater. But the money stays in your foundation. Then, you dole out the proceeds to worthy institutions over as many years as you want.

Here’s how it works: The first major provider of such a service, Fidelity Investments (800) 258-5759, takes your assets, evaluates them and uses their worth in dollars to open an account in your name--call it the Fred Foundation. The account becomes part of the Fidelity Charity Gift Fund.

Let’s say that Fred wants to use his GE stock to set up his account. He could also use bonds or mutual funds (they don’t have to be Fidelity funds). Cash is accepted, too, but that misses the point.

When Fred contributes his stock to the Fidelity Charity Gift Fund, he gets an immediate tax deduction of $120,000, but the $120,000 remains under his control, as the Fred Foundation account. The account will almost certainly grow over time.

Fred, or his appointed successor when he dies, can use the account only as the source of donations or “grants” to organizations qualified as charitable and tax-exempt by the Internal Revenue Service. That includes most schools, universities, churches and disease-fighting and welfare-promoting groups. (The tax deduction is earned only when Fred contributes his $120,000 to the Gift Fund.)

Fred explicitly instructs Fidelity to whom to make the grants; Fidelity does the bookkeeping and sends the money. In deciding where to allocate his $120,000 account, Fred can choose among four “pools,” each composed of Fidelity stock or bond mutual funds or money market funds.

Launched four years ago, the Gift Fund has been a runaway success. Investors (or junior philanthropists) already have directed Fidelity to give away $250 million to a total of 20,000 charities.

Participants in the Gift Fund can start making grants as soon as they set up their accounts, or wait for years. Meanwhile, assets can accumulate without being depleted by taxes.

With his Gift Fund account, Fred has another advantage over a “real” foundation. The Internal Revenue Service does not require him to make grants in a minimum amount every year to keep his tax-exempt status. He can choose to invest his $120,000 in a pool for decades, allowing it to become an enormous sum before giving it away.

But if that were Fred’s aim, he might be better off letting his GE stock sit in his brokerage account. He’d have to pay taxes on the dividends, but if the shares grow in the next 27 years as they did in the past, he’ll have $3.6 million worth of stock.

Now that would make a nice gift to charity--and a nice tax deduction.