There’s a chill in the air (depending on your latitude) and the leaves are turning color. Naturally, your thoughts turn to next April’s taxes. No? Unfortunately, yes, it’s time to start thinking about your 2014 tax bill. Some strategies can be applied next March or April, but many need action before the end of the year to be of any benefit on your 2014 Form 1040.
Our first tip is on charitable donations. If you are charitably minded and have appreciated securities, you can boost your tax savings by donating the stock instead of cash.
How it works
Suppose that some years ago, Jason obtained 1,000 shares of XYZ stock when the trading price of the stock was $2/share. He may have purchased it for $2,000. Maybe his Aunt Matilda left him the stock in her will. Either way, Jason has basis in the stock of $2,000.
The stock is publicly traded, and today it has a trading price of $12/share. Jason thinks the stock has reached its peak value and should be sold. He wants to give the proceeds to the City Rescue Mission, which is a qualified 501(c)(3) charity. Jason can either sell the stock and give the net proceeds to the Mission, or he can give the stock directly to the Mission.
Example 1 – Sell the stock, donate the proceeds
Jason is single and has adjusted gross income (apart from the stock sale) of $150,000. This puts him in the 28% marginal tax bracket for ordinary income.
He has owned the stock shares for over one year, so the sale of stock generates long-term capital gain. The long-term capital gain rate is linked to your highest ordinary income rate:
|
Ordinary Income Rate |
Long-term capital gain rate |
|
10% |
0% |
|
15% |
0% |
|
25% |
15% |
|
28% |
15% |
|
33% |
15% |
|
35% |
15% |
|
39.6% |
20% |
Note: These capital gains rates do not apply to sales of all types of assets. Gain on sales of collectibles, commercial buildings, and certain other assets may be taxed at different rates.
Also note that for some taxpayers, the net investment income tax (NIIT, also called the Medicare surtax) of 3.8% would apply to the gain. So, the maximum rate on the gain is 23.8%. In our example, Jason is not subject to the NIIT and his highest ordinary income rate is 28%, so the federal tax rate on his gain is 15%. His tax on the sale is:
| Proceeds (1,000 shares X $12) |
$12,000 |
| Basis |
$2,000 |
| Gain |
$10,000 |
| Tax rate |
15% |
| Tax paid |
$1,500 |
He then donates the net proceeds to the Mission and gets a deduction on his tax return:
| Proceeds |
$12,000 |
| Tax paid |
$1,500 |
| Net donation to charity |
$10,500 |
| Tax rate |
28% |
| Tax savings |
$2,940 |
His net tax savings is:
| Gross tax savings |
$2,940 |
| Tax paid |
$1,500 |
| Net tax savings |
$1,440 |
Example 2 – Donate the stock directly
In this example, Jason donates the shares of stock directly to the charity. The amount of his deduction is the fair market value of the stock on the date it was contributed to the charity.
Note: The fair market value deduction does not apply to all types of property. For example, donations of tangible property for a use unrelated to the donee’s charitable purpose are limited to your basis in the property.
| Fair market value |
$12,000 |
| Tax rate |
28% |
| Net tax savings |
$3,360 |
Donating the stock directly provides more than double the tax benefit of selling the stock and donating the net proceeds.
Other considerations
The 30% limitation
When you contribute cash to a qualified public charity, you can claim a deduction for the contribution up to 50% of your adjusted gross income (AGI).
However, when you make a contribution of capital gain property, you’re limited to 30% of AGI. If the contribution exceeds 30%, you can carry the excess forward for five years.
Property that has decreased in value
If the fair market value (FMV) of the property is less than your basis, the amount deductible is still the FMV, and no loss is allowed. In this case, it may be better to sell the property for cash and donate the cash to the charitable organization.
Capital loss carryovers
Capital loss carryovers from previous years can be used in full to reduce long-term capital gains. But, if you don’t have capital gains, the loss carryovers can only be used to offset $3,000 of other types of income each year. So, if you have large capital loss carryovers that may never be used, this strategy is less valuable.
Private foundations and other groups
This discussion has focused on contributions to qualified public charities. These rules may not apply for contributions to organizations such as veteran’s organizations, fraternal societies, and certain private foundations. Ask the donee what its tax status is and consult your tax advisor.
Must make the contribution before year end
In order to take the deduction, you must contribute the property by the end of the year. Contributing stock may be a little more complicated than just writing a check, so be sure to allow adequate time.
As always, please consult your tax advisor!
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