ELITE ADVISOR BEST PRACTICES
Strategies for Tax-Wise Year-End Giving - Part One
Charitable planning during “The Most Wonderful Time of the Year”
By Michael King
- Year-end is an ideal time to discuss your clients’ charitable goals and objectives.
- It may be appropriate to concentrate gifts either immediately before year-end, or after year-end, if a client is likely to be switching tax brackets due to retirement or other circumstances.
- Noncash gifts such as publicly traded stocks, privately held business interests, and real estate will often provide enhanced tax benefits over more traditional gifts of cash.
The last two months of the year are commonly referred to as the Giving Season. According to a Charity Navigator research study, on average, charities receive as much as 40 percent or more of their charitable gifts in the last few weeks of the year, the general time frame of Thanksgiving to New Year’s. This spike in generosity at the end of the year is often attributed to a number of factors, including the altruistic spirit of the holidays, increased appeals from charities as they plan their budgets for the following year, and various tax benefits that encourage charitable giving (and that must be secured by December 31 to be deductible in the current tax year).
Therefore, now is a great time to discuss your clients’ charitable goals and objectives—while they’re contemplating year-end gifts. So, consider these planning strategies to ensure your clients plan their charitable giving in the most tax-efficient and effective manner as the current tax year comes to a close.
Depending on a client’s overall tax circumstances, it may be appropriate to concentrate gifts either immediately before year-end, or after year-end. For example, if a client expects to be in a lower income tax bracket next year, perhaps as a result of a recent retirement, it may be advantageous to accelerate gifts that would otherwise be made next year (or even for several future years) in order to maximize the client’s tax benefit from their charitable deduction. Assume a client plans to give $100,000 next year; he is currently in the 39.6 percent federal income tax bracket, but expects to be in the 25 percent tax bracket next year. By simply accelerating next year’s gift into the current year, he’ll save $14,600 in taxes.
Gifts of Appreciated Publicly Traded Stocks
Although cash gifts are by far the most common and simplest of gifts, a client with appreciated publicly traded stocks may capture essentially double tax benefits by giving stock instead of cash. For example, assume a client plans to make a charitable contribution of $100,000 and was simply planning to write a check for that amount. However, suppose she also owns $100,000 of AT&T stock that she bought many years ago for $25,000. If she gives the stock to charity, she’ll receive the same charitable deduction as a cash gift ($39,600 if she’s in the highest federal tax bracket), but she’ll also avoid a capital gain tax of 20 percent and the Medicare tax on investment income of 3.8 percent, thereby avoiding $17,850 in taxes. As a result, your client saves a total of $57,450 ($39,600 federal tax + $15,000 capital gain tax + $2,850 Medicare tax on NII) on a $100,000 gift. If she wanted to keep her investment in AT&T, she could simply repurchase the stock immediately with the cash she otherwise planned to give, and thereby increase her tax basis to the stock’s current value, $100,000.
Gifts of Non-Liquid Assets
Similar to publicly traded stocks, there may be other assets, such as real estate and privately owned businesses, that provide enhanced tax benefits when gifted to charity. These assets are often illiquid, but may nonetheless be ideal assets for giving.
Anticipate a Sale. If there are plans to sell such an asset in the near future, a charitable gift will provide similar benefits to publicly traded stocks, often allowing your clients to avoid capital gain tax, or at least dramatically reduce their tax liability. It’s not unusual for a privately owned business and investment real estate to have very low tax bases, often significantly lower than the basis clients might have in their liquid investment portfolios. In such cases, a gift of a business interest or real estate may well avoid even more capital gain tax than a gift of publicly traded stock.
In addition, if your client is planning to sell his business or real estate in the near future and make a particularly large charitable gift, he might capture additional tax benefits by making a charitable gift in the year (or years) prior to the sale. If the planned gift is so large that it exceeds the client’s ordinary income, some of the deduction would be applied to offset capital gain income at a significantly lower tax rate—20 percent compared to as much as 39.6 percent. By making a gift in one or more years prior to the year of the expected sale, more of the charitable deduction can be used against ordinary income.
For example, assume a client plans to sell his $5 million business next year, and make a gift of $500,000 from the proceeds of the sale. His adjusted gross income (AGI) for the current year (2014) is expected to be $750,000, consisting of $200,000 of salary and $550,000 of K-1 income from the business. His AGI next year (2015) is expected to be $4,600,000, consisting of $100,000 of salary and $4,500,000 of capital gain income. The $100,000 salary reflects the expectation that the business will be sold halfway through the year, and so he’ll receive half of his annual salary. The $4,500,000 of capital gain income assumes a zero tax basis, and reflects the $500,000 charitable gift of the business that would be made before the sale. If the client makes the gift in the year of the sale (2015), then his $500,000 charitable deduction would offset his ordinary income of $100,000, but the remaining $400,000 of deduction would offset capital gain income on the portion of the business he retains. If instead he gave a $500,000 interest in his business in the year prior to the sale, he could offset $200,000 of ordinary income in the current year, and then carry forward $250,000 of deduction to the next year and apply this deduction to his $100,000 of ordinary income in that year, with his remaining deduction of $175,000 offsetting capital gain income. In light of the differential in tax rates between ordinary income and capital gain, he could save up to $44,100 in taxes by simply making his $500,000 charitable gift in December 2014 as opposed to sometime prior to the sale in 2015.
No Anticipated Sale. Even if there is no anticipated sale in the near future, clients may nonetheless gift an interest in their business or real estate, and still capture valuable charitable deductions. This “give and hold” strategy can be particularly beneficial in helping clients maximize their allowable charitable deductions. Although cash contributions are deductible up to 50 percent of a client’s AGI, gifts of noncash assets such as business interests or real estate are only deductible up to 30 percent of AGI. Particularly for business owners, the value of their business often represents the vast majority of their total wealth. Often, a gift of even a small percentage of a business can produce significant income tax savings.
For example, consider a business-owner client who owns a $5 million enterprise that produces $500,000 in annual taxable income. In order to secure the maximum allowable deduction for a gift of this asset, 30 percent of AGI, your client must make a gift of $150,000. This represents a gift of only 3 percent of the business, but produces tax savings from the charitable deduction of $66,900, assuming a 39.6 percent federal and a 5 percent state tax rate. It is not unusual for successful businesses to appreciate in value at rates higher than what is necessary to give each year in order to maximize the 30 percent of AGI deduction. As a result, your client may be able to make such gifts each and every year without decreasing the value of the business they own directly—over time, they’re simply giving only a portion of the growth and appreciation in the business.
In addition to the business or real estate interest gift, some givers will also give all or a portion of the income tax savings (in the form of cash) generated by the business or real estate gift in an effort to reach the annual maximum 50 percent AGI deduction threshold.
For advisors, this is an ideal time of year to help clients make wise charitable gifts so they can do well for themselves and their families while helping others. In Part Two, we’ll explore accelerating testamentary charitable gifts, charitable IRA rollovers, and other tax-advantaged strategies.