Leverage Long-Term Appreciated Securities for Charitable Contributions and Tax Savings
Stock markets are at all-time highs after rebounding from the Pandemic lows. The conventional wisdom is that there has to be some type of correction in the near future. If President Biden is successful in increasing the tax rates on long term capital gains, many experts predict that the tax increase will result in a sell-off of securities before the rate increases go into effect which, in itself, would produce a market correction.
As a result of these factors, taxpayers should consider making contributions of appreciated securities in 2021 to take advantage of the current market highs, lock-in the value, and shelter their taxable income.
Give Appreciated Long-Term Securities
The most tax efficient method for making a charitable contribution is to make the contribution using long term appreciated securities. With the strong stock market, 2021 could be a great year to make contributions using appreciated securities.
If the security has been held for more than 12 months, a taxpayer that makes a charitable contribution using appreciated securities receives a tax deduction for the FULL fair market value of the security and does not have to pay income tax on the built in appreciation contained in the security. Keep in mind the deduction for contributions of appreciated securities is limited to 30% of adjusted gross income (AGI), while contributions of cash have higher AGI limits. For donations of appreciated securities made to a private foundation, the donation is limited to 20% of your AGI. If your donation exceeds the AGI limits, the excess charitable deduction can be carried forward for up to five years.
Bunching Charitable Contributions into One Year
Beginning with tax year 2018, the Tax Cuts and Jobs Act (TCJA) roughly doubled the standard deduction for all taxpayers (for joint filers in 2021, the deduction is $25,100). This change, coupled with the $10,000 deduction limit for state and local taxes, means many more taxpayers will find they are no longer itemizing, but rather claiming the standard deduction. It is estimated that for 2020 only 15% of taxpayers will itemize, whereas before TCJA the percentage of itemizers was about 31%.
With the increase in the standard deduction, one strategy to maximize the tax benefits from charitable giving is to pay two, three or even several years’ worth of contributions in one tax year, so that your itemized deductions in that tax year exceed the amount of the standard deduction. In the years that follow, you would not make any charitable contributions but again claim the standard deduction.
Establish a Donor Advised Fund
Many taxpayers may not be comfortable with the above bunching strategy because they do not like the idea of paying more than one year’s worth of contributions to charity at one time. In addition, taxpayers’ philanthropic interests often change from year to year.
If this is the case, to accomplish the bunching strategy, taxpayers should consider setting up and contributing to a donor advised fund (DAF). A DAF is a fund sponsored by a public charity that allows donors to make one (often sizable) contribution to the DAF, receive a current year tax deduction for the contribution, and then recommend grants from the DAF to their favorite charities over time, often many years.
DAFs are an especially efficient tax planning vehicle when there is a year in which you have unexpectedly high earnings and even more so when that income is considered ordinary and taxed in the highest tax brackets
There is a stacking rule built into our current tax code which means that itemized deductions first shelter ordinary income items such as interest income and wages, and then second they offset qualified dividends and long term capital gains. With proper planning, a taxpayer could potentially offset all ordinary income items and just pay tax on their qualified dividends and long term capital gains at the current 0%, 15%, and 20% federal tax rates.
Make A Qualified Charitable Distribution From Your IRA
With the increase in the standard deduction amounts discussed earlier, Qualified Charitable Distributions (QCDs) from IRA accounts have become an even more important tool for qualifying individuals to manage their charitable contributions.
The CARES Act suspension of Required Minimum Distributions (RMDs) only applied for 2020. As a result, taxpayers over age 70 1/2 (in some cases 72) must take their RMD in 2021.
A QCD is an otherwise taxable distribution from an IRA owned by an individual that is over the age of 70 ½ that is instead directed to a qualified charity. The amount directed to the charity is not taxable income to the individual. Taxpayers over 70 ½ can make QCDs of up to $100,000 per tax year. QCDs also reduce the amount of the Required Minimum Distribution (RMD) in a given tax year.
For qualifying individuals, making a qualified distribution allows those who are now taking the standard deduction to still reap a direct tax savings by giving to charity. It should be noted that QCDs cannot be used to make contributions to DAFs.
Using QCD’S to make charitable contributions instead of taking the annual RMD has the impact of reducing a taxpayer’s AGI, and as a result, can help reduce the taxpayer’s exposure to the NET INVESTMENT INCOME TAX.
The value of securities in many IRA accounts is also at an all-time high. Now would be a good time to sell some of those securities, lock- in the gains, and use the funds to make QCD’S
FINAL THOUGHTS CONTRIBUTIONS IN 2021 VS 2022
During President Biden’s first year in office, there has been much discussion about the new Administration’s plan to increase tax rates for those individuals with taxable incomes over $400,000. Many taxpayers may have considered postponing contributions to 2022 in order to shelter income that could be taxed at a higher rate in 2022.
While this strategy could have some merit, it should be noted that tax rates for taxpayers with income over $400,000 are still fairly high, with the top bracket reaching 37%. As a result, taking into account the time value of money, it might still make sense to go ahead and make the contributions in 2021. This is especially the case if the amount and type (ordinary vs qualified rates) of taxable income for 2021 is expected to be higher than 2022.
About the Authors
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.