As year-end approaches, many investors are feeling more confident in their investment portfolios compared to last year. However, the charitable sector is still grappling with ongoing inflationary pressures and counting on these critical final months when giving typically surges. How can donors achieve a win-win with their charitable contributions in 2023?
Let’s look at Liz and Carlos, a retired couple in their 70s who recently sold some investment properties. As a result, they’re facing a high tax bill this year. Fortunately, their core capital1 is secure, and they have surplus capital that they can use to fund other goals, such as gifts to their children or charity. While they consider philanthropy a top priority, they also want to ensure that their charitable giving is as tax effective as possible, allowing them to maximize their total gift capacity and impact. What are the best ways to maximize their charitable contributions in 2023 in order to achieve these objectives?
The Magnificent Seven: Contribute Appreciated Stock
As a retired software executive, Carlos still owns a large amount of highly appreciated stock from his former employer—one of the "Magnificent Seven" responsible for most of the US market’s positive momentum this year. Boosted by the frenzy over artificial intelligence (AI), Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla are up 56% year to date through mid-October, while the rest of the market (MSCI US ex. Magnificent Seven) is up just 1.5%.2 When held for one year or longer, these appreciated public stocks can be excellent candidates for charitable contributions in 2023. By gifting the stock, Carlos and his wife can not only receive a charitable income tax deduction but also permanently avoid the capital gains tax they would owe if they sold the stock outright. Should they consider donating appreciated stock, or stick to their usual method of writing a check?
For illustration purposes, let’s assume Liz and Carlos are in the top (37%) federal tax bracket and they make a gift of $100,000 in cash to charity. The gift will reduce their federal income tax liability by $37,000, cutting the effective cost of the gift (the value of the gift minus the tax benefit) to $63,000 (Display 1). For donors paying state and local income tax, the effective cost could drop even lower by further enhancing the tax benefit.
Now let’s assume the couple instead made a gift of $100,000 of their highly appreciated stock, which Carlos acquired for only $10,000. This time, they could also avoid the 23.8% tax on the stock’s $90,000 gain. And the extra tax savings would cut the effective cost of the donation to just $41,580.
This opportunity is not restricted to gifts of public stock. Donors can utilize other appreciated assets—including private business interests, real estate, collectibles, and more. However, their illiquid nature, along with the type of charitable recipient (qualified public charity vs. private non-operating foundation), may impact the value of the upfront income tax deduction.
There are a host of other tax and valuation considerations linked to contributions of nonpublic assets, so it’s important to work with sophisticated tax and legal practitioners when making such gifts. Keep in mind, the contribution timeline for private assets tends to be longer than for cash or public stock for several reasons. The recipient charity must conduct an in-depth due diligence process before accepting such a gift. And donors need time to coordinate with their professional advisors to gauge the feasibility and desirability of contributing such an asset. While the window for illiquid charitable contributions in 2023 is rapidly closing, it’s never too early to plan to optimize tax savings with your 2024 giving.
What About Required Minimum Distributions (RMDs)?
Alongside year-end charitable planning, the couple is also coordinating their 2023 required minimum distributions (RMDs). Individuals over the age of 70½ may make a Qualified Charitable Distribution (QCD), donating up to $100,000 from their IRA directly to a public charity.3 Doing so allows the donor to avoid paying taxes on those funds as they are excluded from AGI, making it an obvious choice for some. However, there are trade-offs to consider when making QCDs versus contributing appreciated securities (Display 2).
While Carlos has built a substantial IRA from his working years, the current appreciation in his single stock portfolio is too great to overlook. The couple decides to take advantage of the elevated value of his tech holdings by contributing appreciated stock from their taxable portfolio. And since the $100,000 QCD limit will be indexed for inflation starting in 2024 (courtesy of the SECURE Act 2.0), they will revisit that strategy next year.
Is a DAF the Right Fit?
Liz and Carlos were eyeing a long-term philanthropic vehicle for their charitable contributions in 2023. Their advisor explained that many donors who contribute from their taxable portfolios leverage donor-advised funds (DAFs). In fact, one in 20 affluent households facilitated their giving through a DAF in 2022.4 DAFs have become increasingly popular in recent years, given their compelling advantages:
- Timing: the ability to strategically time charitable income tax deductions, while retaining flexibility over the grantmaking timeline (especially helpful in years with large liquidity events)
- Administration: the chance to outsource check-writing, record-keeping, etc., at a relative low cost
- Privacy: the option to make grants anonymously
There is also evidence that donors who use DAFs have an advantage during economic downturns. Despite challenging times, DAF grantmaking tends to remain strong in these periods—DAF donors contributed over $45 billion to the nonprofit sector in 2022, for example. And while Americans’ overall charitable giving fell four times since 2011, grants from DAFs rose every year over the same period.5
Why do DAFs tend to be so durable? Because donors pre-fund their charitable capital, they can quickly pivot to making grants during crises, such as during the initial stages of the pandemic in 2020. This provides nonprofits with much-needed stability in tough moments. What’s more, contributions to DAFs that are not distributed right away can produce investment growth, opening a substantial opportunity for future grantmaking.
Given all these benefits, Liz and Carlos decided to make a sizable contribution of their appreciated stock to a DAF. This approach not only helped them avoid paying tax on the large, embedded capital gain, but also allowed them to utilize the charitable income tax deduction to reduce their high taxable income. Once their DAF was established, they were able to quickly disburse grants to the nonprofit organizations they deeply cared about.
Nonprofits are often overwhelmed during the busy months of November and December, just like you. Giving early can ease their burden and yours. Whether or not you choose one of the strategies listed above for your charitable contributions in 2023, the key is to avoid waiting until the last minute. December 31 is the final day of the year to make a charitable contribution that counts for the 2023 tax year. However, since that falls on a Sunday, the deadlines for many asset types will be December 29 this year. By meeting your year-end goals ahead of schedule, you can help the organizations and causes you care about most.
1 Core capital is defined as the amount needed to support their lifestyle spending needs.
2 MSCI, Factset, Bernstein Analysis. Performance quoted is total return.
3 QCDs may not be made to donor-advised funds, private foundations, or supporting organizations.
4 The 2023 Bank of America Study of Philanthropy: Charitable Giving by Affluent Households.
5 Chanda, Jai. “How Donor-Advised Funds Can Provide Crucial Stability for Nonprofits During Economic Uncertainty.” nptrust.org. https://www.nptrust.org/philanthropic-resources/philanthropist/donor-advised-funds-can-provide-crucial-stability-for-nonprofits-during-economic-uncertainty/ (accessed October 20, 2023).