Why you shouldn't give money to charity
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Thanks to the soaring stock market, a lot of Americans are sitting on substantial capital gains in their (taxable) brokerage accounts. Those Americans should, as a rule, be donating shares to charity this Giving Tuesday instead of giving cash.
Why it matters: It's well known that donations to charity are tax-deductible — which is good news for the 12% of households who itemize their tax returns. What's less well known is that it's possible to save a substantial amount of tax via charitable donations even if you don't itemize your taxes.
The big picture: Normally, it's illegal to sell a stock and then buy it back immediately just for tax purposes — that's considered a "wash sale." But there's no wash-sale rule when securities are donated to charity.
- That allows individuals to replace stock they bought cheaply with stock purchased at the current market price, eradicating their capital gains tax liability.
- Alternatively, a charitable donation can be used to eradicate the tax hit that would normally accompany a regular portfolio rebalancing.
How it works: Let's say that a married couple with two kids normally gives $1,000 per year to charity. They also received $3,400 in the first round of stimulus checks in March 2020, and decided to invest it 50-50 in Vanguard's long-term Treasury bond ETF, and its broad stock-market ETF.
- Today, the stock-market ETF would be worth $2,930, for a gain of $1,230, while the bond ETF would be worth $955, for a loss of $745.
- In order to rebalance that portfolio back to 50-50, the family would have to sell $988 of the stock ETF and use the money to buy the bond ETF. But that sale would trigger a taxable capital gain of $415.
- Alternatively, the family could donate $988 of the stock ETF. Then, instead of giving $988 in cash to charity, they could use it to buy more of the bond ETF.
- The final outcome would look the same — $988 given to charity and a balanced securities portfolio worth $3,885 — but there would be no capital gains tax payable, and the total capital gain in the portfolio would be slashed from $1,230 to $242.
Between the lines: Almost everybody with investments in a taxable brokerage account has some investments that have risen a lot in value. Broadly speaking, whether you itemize your taxes or not, it is always a good idea to donate those investments to a donor-advised fund (DAF) rather than giving cash directly to either the DAF or charity.
- Once the stock arrives at the DAF, it is immediately liquidated and the cash can be divvied up between any number of charities.
- If you simply buy back the stock you donate at the current market price, you eliminate the capital gains liability without changing your portfolio construction at all.
- Naturally, a donor who does itemize her taxes receives a full tax deduction for the current value of the stock on top of losing her capital gains liability. A back-of-the envelope tax-savings calculator can be found here.
The catch: Not all brokerage accounts make it easy to select the tax lots with the lowest cost basis to donate. And the ability able to donate specific shares bought at a low price, while a nice one to have, is not realistically a reason to move your stocks over to a whole new brokerage.
The bottom line: DAFs — tax-advantaged giving vehicles — have generally been pitched at individuals with hundreds of thousands if not millions of dollars they want to give to charity. Now that startups like Daffy are making DAFs available much more broadly, the tax benefits of charitable contributions are available to a much bigger swathe of the population.
Editor's note: This story has been corrected to state that the family would have to sell $988 of the stock ETF, rather than $240, to rebalance the portfolio to 50-50.
