After three years of strong markets, many investors who had deferred gains received an unwelcome surprise this April: a tax bill for the rally they enjoyed. Now, to get ahead of the curve, they're considering two popular giving strategies: donating appreciated stock and bunching gifts to charity.
Turn Gains into Gifts That Keep Giving
The S&P 500 has recorded double-digit returns in five out of the last six years, with a healthy annualized return of 17.4%. And while the market may be down so far this year, many portfolios still hold significant pent-up gains—making investors hesitant to sell due to the steep tax liability. To complicate matters, tax deductions are harder to come by, given the limits on mortgage interest and state and local taxes (a.k.a. “SALT”, which is capped at $10,000).
But investors with a charitable mindset may find additional room to maneuver by giving shares of appreciated stock directly to charity. Why go direct? When you donate shares to a charitable organization, you may receive a tax deduction based on the fair market value of the stock you’ve gifted.i And in doing so, you enjoy the added benefit of diversifying or trimming holdings while avoiding embedded gains—all while helping cherished causes that could likely use your support.
It May Cost Less than You Think
To illustrate, we calculated the effective cost of making a $10,000 gift of securities with an unrealized gain of $5,000, net of the tax deduction benefit and gain avoidance (Display).
First, by giving $10,000 of appreciated stock to charity, the donor receives a $10,000 tax deduction. We assumed this deduction will offset income that would have been subject to a top tax rate of 37%—essentially pocketing $3,700. Because the gift helps the donor avoid the embedded $5,000 gain, she accrues an additional $1,190. Taken together, the total savings of $4,890 means a $10,000 gift effectively costs only $5,110.
Of note, making a $10,000 gift does not automatically result a tax deduction due to the need to itemize. For most families, itemized deductions are limited to mortgage interest, state and local taxes, and charitable gifts.ii Even then, you’ll only itemize if these add up to more than the standard deduction, which currently sits at $12,950 for single filers and $25,900 for married couples.
Bunch Together or Spread Out?
For most taxpayers, the standard deduction tends to exceed their itemized deductions. That’s why some turn to another common giving strategy—“bunching.” Bunching may help push your itemized deductions above the standard deduction threshold and thereby head off another tax-season surprise.
Here is how it works: Instead of making charitable gifts each year, a donor aggregates two or potentially several years’ worth of gifts into a single tax year. Importantly, the donor must have sufficient taxable income to fully deduct several years of charitable contributions with a single stroke in order to avoid bumping up against deduction limits.iii In the year an individual or couple bunches donations, they will itemize deductions on their tax returns. Then, in the years that follow, they’ll claim the standard deduction if they do not make sufficient charitable gifts or lack other deductions.
Consider the following hypothetical example (Display) of a married couple with no mortgage interest to deduct, but who are giving $20,000 per year to charity.
- Continue $20,000 Annual Charitable Giving: Here, their total deductions—including mortgage interest and state and local taxes—exceed the standard deduction by $4,100 per year. This allows the donors to recognize an annual tax savings of $1,517, or $6,068 over four years.
- Bunch Charitable Giving in Alternate Years: In this alternate scenario, the donors bunch two years’ worth of charitable gifts, or $40,000, in 2022 and again in 2024. When combined with other deductions, this surpasses the standard deduction by a higher amount ($24,100). Now the donors recognize a total tax savings of $17,834 over the four-year period—$11,766 more than our base case.
While a “bunching” strategy can create significant tax savings over time, it can be lumpy. In other words, the donor needs to budget for larger gifts during the “bunching” years. Some donors may also balk at giving a larger amount to a charity all at once. In this case, a Donor-Advised Fund (DAF) might help. By making a “bunched” gift to a DAF first, the donor can then make grants to a qualified charity at any time and disburse their donations in a more measured way.
- Andrew Bishop, CFA
- Director—Wealth Strategies Group
i For stock that is owned for more than one year, your deduction is based on the fair market value on the date of the gift. For stock that is owned for less than a year, your deduction will be based on the lesser of the fair market value or your cost basis.
ii Itemized deductions can also include for those who qualify, medical expenses (deduction limited to medical expenses in excess of 7.5% of AGI), and student loan interest (deduction limited to $2,500 if Modified AGI is less than $70,000 for a single filer, and $145,000 for a joint filer. Once your Modified AGI reaches $85,000 for single filer or $175,000 for a joint filer, your deduction is completely phased out).
iii Charitable deductions for gifts to public charities are limited to 60% of adjusted gross income (AGI) for cash gifts and 30% of AGI for a gift of an appreciated asset.