December is the time when many people think about giving to charity. Why? One reason is to reduce taxes, and a charitable contribution may accomplish this goal. Perhaps the only other time of the year when people are as philanthropic is in early April, although the donations made in April before you file your prior year tax return won’t help your tax situation until one year later when you file the return for the April donation.
An excellent planning strategy is to give the gift of appreciated securities. Got a stock that has increased in value, but you don’t want to recognize a taxable capital gain? Give it to charity and you can take a tax deduction for the full fair market value of the stock. At the same time, you’ll avoid tax on the stock’s embedded capital gain. The appreciated property must be held by you for more than one year to qualify for favorable tax treatment in this scenario. This charitable gift strategy also works for mutual funds.
Let’s say you own shares in a mutual fund and for some reason, perhaps you realize you are paying too much in annual fees, you’re no longer enamored with the fund. You own $2,000 of shares in the fund, with a cost basis of $900. If you sold the shares outright, you’d have to report a capital gain of $1,100, taxable at 20 percent. However, if you give the shares to your favorite charity, you can claim a charitable deduction of $2,000, and you don’t have to pay any capital gains tax!
Essentially, this is the best of all worlds. You’re getting rid of a stock or fund you don’t like anymore, giving a donation to a charity of your choice (instead of the federal government), and avoiding payment of capital gains tax.
Giving stock or mutual funds with embedded gains to charity reduces your taxes, but only if you’ve owned the stock for more than a year. If you have not held the stock for more than a year, you will not benefit by giving the stock to charity. If you have such short-term capital gain stock, the charitable deduction is limited to your cost basis. For example, six months ago you bought a dot.com stock with a basis of $1,000. The stock is now worth $10,000. If you were to sell the stock, you’d have a short-term capital gain of $9,000, taxable at your ordinary income tax rate. If you were to give the stock to charity, your charitable deduction would be only $1,000, and you still must pay tax on the $9,000 gain.
If instead you held the stock for more than a year, you can give the stock to charity and take a deduction of $10,000, all while avoiding paying tax on the appreciation of the stock.
Cash contributions of up to 50 percent of your adjusted gross income (AGI) can be deducted, and non-cash contributions such as clothing or stock, can be deducted up to 30 percent of your adjusted gross income. Charitable contributions are an itemized deduction and must be shown on Schedule A of your Form 1040. Itemized deductions may be limited if you are a “high income” taxpayer.
But remember this word of advice: when giving gifts to charity, remember not to let the tax tail wag the dog. Give to a charity because you like what they do. A charitable gift is still cash out of your pocket. Although the tax deduction is a nice incentive, your tax savings won’t equal the full amount of the gift, and the deduction may be limited due to the phase out of itemized deductions for high income taxpayers.
Do you spend time volunteering? Unfortunately, you are not able to deduct the value of your volunteer time on your tax return. You are, however, allowed to deduct mileage driven for charitable purposes, at 14 cents a mile (in 2001). Let’s say you visit a cancer patient on a weekly basis in their home, which is 15 miles from where you live. The miles that you drive from your home to the patient’s home for your volunteer work is a deductible charitable contribution. The weekly round-trip deduction is only $4.20, but for the year, that adds up to $218 charitable deduction on your tax return.