Tax reform, the stock market crash and the holiday spirit make this a good time to give charitable contributions.
With top individual tax rates falling next year--to either 28% or 33% from 38.5% this year--many taxpayers can get a bigger deduction for each dollar given in 1987 instead of 1988. Also, the stock crash and subsequent bear market has prompted many investors to consider unloading equities that they might donate instead. And with the holiday spirit, many people give anyway, regardless of the tax benefits.
Accordingly, many charitable, civic, religious, educational, scientific and other nonprofit organizations expect 1987 to be as good a year as ever for giving, despite earlier predictions that tax reform would depress charitable giving. Many gifts will come between now and Dec. 31 as taxpayers rush to include donations in this year's tax calculations.
Unfortunately, many people could do a much better job of planning their giving so their contributions save them more in taxes or cause them fewer headaches with the Internal Revenue Service, financial advisers say.
One of the biggest mistakes is to give cash instead of assets--such as stocks, real estate, jewelry, collectibles--that have appreciated in value. In almost all cases, you will be better off giving appreciated assets instead of cash, if the assets qualify as long-term assets held more than six months (next year the definition of long-term goes to one year). By giving appreciated assets, you avoid capital gains taxes on the appreciation while still writing off the full market value of the assets.
"Cash is one of the most expensive things to give," said Daniel Rice, director of financial planning for World Vision, a hunger-relief charity. "If you have an asset that is worth more today than what you paid for it, and you don't have any sentimental attachment to it, it is better to give it" and keep your cash.
Unfortunately, cash is the preferred way to give, partly because it is the way most charities ask for donations, Rice said. He cited a recent Gallup Poll showing that 71% of high-income donors planned to give cash this year, while only about one in four planned to give appreciated securities or other non-cash property.
Here's how it is better to give appreciated assets:
Suppose you are in the top 38.5% tax bracket and want to give $1,000 to a nonprofit organization. If you give cash, the donation in effect costs you $615. The donation reduces your taxable income by $1,000, and thus you save $385 in taxes. (You save even more when you factor in state taxes.)
However, if you gave $1,000 in stock (held more than six months) that originally cost you $500, your donation would in effect cost only $475. Here's why: The donation also reduces your taxable income by $1,000, saving you the same $385. But you also save $140 in avoided capital gains taxes, assuming you are subject to this year's top 28% capital gains rate.
The worst case, for both you and the charity, would be to sell the stock and donate the proceeds. That way, you must pay the capital gains tax of $140, in effect making only $860 available to give. When you donate that reduced amount, you will only save $331 in taxes (38.5% of $860). So this way of donating $1,000 in effect costs you $669.
What if you want to keep that $1,000 in stock because you like it and think it will go higher? You are still better off giving it and using the $1,000 cash--which you would have given--to replace the stock, said Conrad Teitell, a New York tax lawyer specializing in charitable giving.
By giving the stock and then buying new shares, you can establish a higher cost for the stock for tax purposes, Teitell explains. Then, if the stock does indeed go up, your capital gain taxes will be lower. If the stock goes down, you will have a capital loss for tax purposes, which can be used to offset other capital gains or ordinary income.
There are, however, some exceptions to the rule that giving assets is better than giving cash. One is if the assets have short-term gains (from holding them less than six months). In that case, you can only deduct the price you paid for the assets, not their current market value.
Another exception is if your assets are worth less than you paid for them. Then you are better off selling them to claim capital losses, and then giving the proceeds to charity.
Yet another exception would be if you are subject to the alternative minimum tax. The untaxed value of appreciation in donated property is taxable under the AMT.
Here are some other tips for charitable contributions:
- If you don't itemize, consider bunching deductions. Unfortunately, under tax reform, non-itemizers cannot deduct charitable contributions. But if the tax deductions are important to you, consider bunching gifts planned for two or more years into a single year, in the hope that those and other deductions may pull you over the standard deduction and make itemizing worthwhile.