Many Americans who can comfortably do so include regular charitable giving in their financial planning strategy. If your goals include helping charities that support causes you care about, it’s important to understand that how you give can have just as much impact as how much you give. Carefully planning your charitable gifts could allow you to give more away while also keeping more for yourself.
This becomes possible when you properly structure the donation of appreciated assets, such as your company stock. If you own pre-IPO stock, donating it to charity can be a great way to diversify out of your concentrated position while saving money on taxes and possibly even creating an income stream for yourself. In this article, we’ll explore the benefits of donating stock and how to make sure your donation provides the best possible benefit to your charitable beneficiaries while reducing your tax obligation.
Why donate stock?
If your values include charitable giving, making donations of stock can be much more cost effective than donating cash. When you sell stock, profits from the sale are typically subject to capital gains tax. If, on the other hand, you donate shares directly to charity, you avoid taxation on the sale. You could then use cash that you would otherwise have donated to purchase whatever investments you like, essentially creating a tax-free way to shift assets out of a concentrated position in equity compensation.
Additionally, if you itemize deductions, you can still take a charitable donation deduction of up to 30% of your adjusted gross income for donations of stock. If your donation exceeds this amount, you can carry forward the remainder on your tax returns for up to five years. Donating stock to charity leaves more money in your pocket at tax time, allowing you to give more while enjoying the lifestyle you desire.
How can I donate my company stock to charity?
To donate your stock to charity, you first have to hold it for more than one year. Stocks with significant capital gains are great candidates, since the greater the appreciation, the more tax you can avoid with the donation. Only a small fraction of U.S. charities accept donations of stock, but donor advised funds and charitable trusts allow you to turn your stock into donations to any 501(c)(3) charity.
In a donor-advised fund, a third-party administrator manages charitable donations of funds contributed by multiple donors. Often, they’re administered by financial institutions. Because funds are pooled, donor-advised funds can be ideal ways to contribute a few thousand dollars in appreciated assets to help build long-term support for important causes. Although very rare, the fund administrator does get the final say on which charities receive what funds and when, so if you want more control over your donation, you might choose to set up a charitable trust instead.
Charitable lead trusts (CLTs) and charitable remainder trusts (CRTs) are two ways donors can structure donations of equities. Both allow for a substantial tax deduction in the year the trust is funded and provide income for both charitable and non-charitable beneficiaries. The initial donation is used to generate an income stream during the life of the trust with the remainder distributed at the end of its term.
Charitable Lead Trusts
A grantor CLT provides a stream of income to a charity for a specified period. At the end of this term, the funds that remain are returned to the person who made the initial contribution (the grantor). The grantor gets a tax deduction in the year they set up the trust, which is calculated to estimate the amount the charity will receive during the life of the trust based on the initial contribution, the term of the trust, and expected rate of return based on IRS tables. If your donation ends up being less than estimated using this method, you still retain the full value of the deduction.
The catch when using a CLT is that the grantor must pay taxes on the trust’s income, including interest, dividends, and capital gains, even though they aren’t receiving any money from the trust during its term. However, capital losses incurred within the trust are also reportable by the grantor, allowing them to offset other gains. If you decide to establish a CLT, it’s important to budget for the associated annual tax obligation.
Charitable Remainder Trusts
Like a CLT, a CRT allows you to claim a charitable deduction when you set it up. With a CRT, however, the income stream goes to the grantor or other designated non-charitable beneficiary (often a spouse) for either their lifetime or a defined period (up to 20 years). When the trust expires, the remainder is passed to the charity. The grantor’s tax deduction is calculated using the same IRS tables as with a CLT to estimate the present value of the eventual charitable donation.
When you transfer stock to a CRT, the trustee is free to sell some or all of the stock. The trust is not subject to income tax on asset sales or on dividends or interest generated by its holdings. Instead, the grantor or other beneficiary who receives the income stream pays tax on these payments as they receive them. The deferred realized capital gain from the stock ends up being distributed to the beneficiaries over time, instead of in one fell swoop. As with a CLT, your tax deduction for a CRT donation is set at the time the trust is established and will not be adjusted based on actual performance.
When is the right time to donate my stock?
For charities, the best time to make a donation is on a regular schedule. By setting a goal for your charitable donations, such as a set amount per year or a percentage of your income, you can help ensure your beloved causes have the support they need on an ongoing basis, regardless of market fluctuations. For investors, it is often beneficial to make a large donation at year’s end when you’re facing an unusual spike in income. This allows you to take the deduction in the current year to reduce your tax obligation. By contributing to a donor-advised fund or charitable trust, you can make this donation go farther—for you and for the charities you care about.
What else should I know about donating stock to charity?
Charitable trusts are complex financial instruments that require expertise to structure correctly. The trusts are required to file annual tax returns, like any other taxpayer. The tax code is full of pitfalls, and donating stock without professional guidance could create unpleasant surprises at tax time. If you are interested in donating equity compensation to charity, it’s critical to work with investment and tax professionals who have experience with charitable trusts and can help you identify the most advantageous way to make your gift.
The investment and financial planning experts at WRP specialize in helping pre-IPO executives and employees make the most of the opportunities that equity compensation can offer. For more IPO planning tips, subscribe to our blog or visit our free resource library.