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 of charitable gifts though 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. 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 normally can 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 in most years and bunch all of your deductions into a single year in which you claim a substantial itemized deduction. People might bunch two years of property taxes (paying in January and December of the same year), medical expenses for procedures that are not time sensitive, or combine multiple years of charitable gifts into a single tax year. For the person who has a good number of deductions but still falls 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. Donor Advised Funds were invented by community foundations as a simpler, cheaper, and more tax-efficient alternative. For example, 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 Donor Advised 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 a Fund at your nearby community foundation, you have the benefit of working face-to-face with local non-profit professionals who serve as your personal foundation staff.
Each of these tax planning tools works just fine independent of each other, 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 example, let’s say John and Jane Smith normally donate $20,000 to charity every year 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 at all!
However, the Smiths create the John and Jane Smith Donor Advised Fund at their local community foundation. They bunch the next five years of their charitable giving into this tax year, thereby allowing them to claim a whopping $100,000 itemized deduction in 2021 (5 years x $20,000 in donations per year). The Smiths also very wisely make that charitable gift using $100,000 worth of stock that has appreciated significantly. This enables the Smiths to avoid capital gains taxes while still claiming an itemized deduction of the fair-market value of their $100,000 stock gift this tax year. Then in each of the next four years, the Smiths will claim the standard deduction of $24,800 (adjusted annually, of course). In other words, the Smiths will have both 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 the support they 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 folks bunching multiple years 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.
This column by Bret Bicoy originally appeared in the Peninsula Pulse on November 5, 2021.
Bicoy Philanthropic Advisors 