It's standard year-end advice. When making charitable gifts, consider donating appreciated securities instead of cash. But this year, investors should pay special heed to this tax-saving maneuver.
See Also: Year-End Tax Moves for 2013
Among the reasons for investors to consider such gift giving before the year ends: Because stocks have posted strong returns this year, many older investors may be looking to trim these holdings anyway—and they may not have many losing investments that they can sell to offset the taxable gains. What's more, upper-income investors this year are facing higher income and capital-gains tax rates as well as an additional surtax on unearned income.
This year's higher tax rates make charitable gifts of appreciated securities "more valuable from a tax perspective," says William Zatorski, partner at PricewaterhouseCoopers. By donating appreciated securities instead of cash, you not only get the income-tax deduction that you would receive when writing a check to charity, but you also avoid paying tax on your capital gains. But recent tax-law changes have added new wrinkles for investors looking to slash their tax bill and support charity—including a limit on itemized deductions for higher-income taxpayers.
To get the biggest tax bang for your charitable buck, you will need to pay attention to income thresholds that trigger higher taxes. Single filers with taxable income of more than $400,000 ($450,000 for joint filers) will pay a top income tax rate of 39.6%, up from 35% in 2012, and a higher long-term capital-gains rate of 20%, compared with 15% last year. Singles with adjusted gross income over $250,000 ($300,000 for joint filers) face a new limitation on itemized deductions. And singles with AGI over $200,000 ($250,000 for joint filers) are subject to a new 3.8% surtax on net investment income.
Look for Winners in Your Portfolio
When sifting through your taxable accounts for potential gifts, focus on winning investments that you've held for more than one year. If you donate stock held one year or less, you can only deduct your "cost basis" (the original cost), not the current value. And rather than donating losing holdings, you're better off selling those investments, donating the proceeds and using the capital loss to offset gains elsewhere in your portfolio.
As you review your winners, look for asset classes where you're overweighted and need to trim back anyway. Also, if you've bought those holdings in bits and pieces over the years, "identify the lot that has the lowest basis," says Tracy Green, financial-planning specialist at Wells Fargo Advisors. Donating those shares can save you the greatest amount of capital-gains tax.
Higher-income taxpayers shouldn't let the new limitation on itemized deductions discourage them from donating appreciated securities. The provision reduces total allowable itemized deductions by 3% of the amount by which a couple's AGI exceeds the $300,000 threshold. But even for taxpayers above that threshold, "in a lot of cases it will have very little impact to no impact" on the value of charitable deductions, says Alisa Shin, senior wealth planner at Vanguard.
Consider this example from Vanguard: A married couple has AGI of $400,000 in 2013, and they want to claim $50,000 worth of state and local taxes as itemized deductions. Their allowable itemized deductions are reduced by 3% of $100,000, or $3,000, so they can only claim $47,000 rather than the full $50,000. If they decide to make a year-end charitable contribution of $10,000, the limit on itemized deductions doesn't come into play. The $3,000 reduction has already been absorbed by the non-charitable deductions, so the couple gets the full value of their charitable deduction.
Say, instead, that the couple's only itemized deduction was a $50,000 charitable gift. Because of the new limitations, they would be allowed to write off only $47,000 for the donation.
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