Updated: September 1, 2015
The end of the year is a traditional time for charitable contributions. Why? Many people do some assessment of their income tax status, and charitable contributions are deductible. But what are the benefits of getting a deduction for giving money away? And, is one method of contributing more advantageous for you as a donor than another?
Sensible Financial™ suggests you remember three key points about charitable contributions:
- A gift to a charity increases the charity’s spending power by more than yours is reduced (the government makes up the difference by receiving less in taxes).
- The higher your tax rate, the less spending power your charitable contributions cost you.
- Charitable contributions made with appreciated securities cost even less in terms of spending power.
We’ll illustrate these points with a very simple example¹. Suppose Prudence earns $10,000 per year. She also has $20,000 in Pentangle stock, of which $10,000 is basis, and the remaining $10,000 is long term capital gain. Prudence is in the 15% tax bracket.
Spending power of Prudence’s assets: The capital gains tax rate is 15%. The $10,000 long-term capital gain is worth $8,500 after tax, so the spending power of her assets is $18,500 after tax (her basis will not be taxed).
Spending power from Prudence’s earnings: If she makes no charitable contributions, her income tax is $1,500 (15% of $10,000), and her after tax spending power is $8,500.
Prudence’s total spending power: is $18,500 + $8,500 or $27,000.
Now, suppose Prudence decides to support her favorite charity (the Pensacola Poodle Parade, or PPP) with a $1,000 contribution, drawn from her earned income. Her income tax will be $1,350 (15% of her $10,000 earnings minus the $1,000 contribution), so the spending power of her earnings is $7,650. The total spending power of Prudence and the PPP is $27,150 [$7,650 + $1,000 + $18,500], or $150 greater than Prudence’s spending power before she decided to be so generous. Prudence’s $1,000 gift has cost her only $850 in spending power – the remaining $150 was “contributed” by the government via reduced tax collection.
Finally, suppose that Prudence decides to contribute $1,000 worth of Pentangle stock to the PPP instead of cash. Her income tax is again $1,350 (15% of her $10,000 earnings minus the $1,000 contribution), but now the spending power of her earnings is $8,650 (she contributed stock instead of cash). However, the spending power of her assets is now $17,575 ($9,500 in basis plus $8,075 – the after tax value of the remaining $9,500 capital gain). Now Prudence’s total spending power is $26,225. Her $1,000 contribution has cost her only $775. Again, the $225 difference was contributed by the government. This time, $150 comes from the income tax saved due to the charitable deduction, and $75 from the saved capital gains tax (15% of the $500 gain) on the PPP stock.
This illustrates the general rule – the spending power cost of a charitable contribution equals
- The contribution, minus
- The marginal income tax rate times the contribution, minus
- The capital gains tax rate times the capital gain portion of the contribution.
So, for example, if you are in the 25% bracket, and contribute $1000 of stock in which you have a 30% capital gain, your spending power cost is:
- $1,000, minus
- $250 (25% of $1,000), minus
- $45 (15% of 30% of $1,000), or
- $705 – you can give a dollar at a cost of just over 70¢.
So, it’s less expensive to transfer spending power to a charity than to other causes you might support (say, the New England Patriots), and it’s even less expensive if you have securities with capital gains that you can bear to part with.
If you’d like more information about how to turn your investments into charitable contribution deductions or how to balance your portfolio with charitable giving, please give our office a call. We’d be happy to help you create a strategy that will benefit your favorite cause and you.
