This tip is specifically written to comply with US tax law. I’m not a tax attorney, or qualified tax professional, so seek competent, professional advice before actually implementing this suggestion.
Giving to Charity — the Normal Deduction
When you give to a charitable organization, the IRS allows you to deduct that contribution from your taxable income. For instance, if I had $60,000 of taxable income and donated $6,000 to a qualified charitable organization, my taxable income would be $54,000 ($60,000-$6,000).
What are the tax savings from this? It depends on my marginal tax rate. For the sake of this example, let’s say it’s 20%.
Without the charitable contribution, my taxes would be $12,000 ($60,000 * .20).
With the charitable contribution, my taxes would be $10,800 ($54,000 * .20).
Total tax savings as a result of the contribution: $1,200.
(The quick way to calculate the savings associated with any deduction is to multiply the deduction by your marginal tax rate. In this case, we would do: $6,000 * .2 and get $1,200.)
But this isn’t the Savings Tip.
Giving to Charity — the Souped-Up Deduction
Let’s suppose that instead of giving $6,000 in cash to a charitable organization, you gave $6,000 of an appreciated asset. For our example, let’s pretend you bought into XYZ stock at $1,000 and it has now appreciated to be worth $6,000. Let’s also assume that you had held the XYZ stock for three years.
First, let’s do an example without the charitable contribution.
You decide to sell the stock, in order to donate the $6,000 to a charity. Because you’ve sold a capital asset, you’re subject to the capital gains tax (remember, governments tax us buying, earning, growing, and dying). In this instance, your capital gain is $5,000 ($6,000 – $1,000). The capital gains tax is either 15% or 5% depending on your situation. For this example, let’s assume it’s 15%. The tax due on this sale of XYZ stock would be $750 ($5,000 * 15%). (Special Note: If the XYZ stock had been held less than a year, it would be classified as a short-term capital gain and would be taxed at our example person’s ordinary tax rate of 20%, so the tax on the realized gain from the sale would be $1,000, not $750).
BUT, you can completely avoid the capital gains tax if you simply donate the stock to the charity. The charity can then sell the stock and have the $6,000 in cash (less a tiny selling fee probably). So, you avoid a $750 capital gains tax because your basis increased from $1,000 to $6,000, but you get the full deduction available to you of the current value of the stock at $6,000.
This is the scary thing about taxes. You can do something one legal way and pay more. Or you can do it another legal way, and pay less.
This is also why you should get great advice. TurboTax is fine and everything, but it would never tell you what you should have done, only what the tax ramifications are from what you have done. I’m actually working with an extremely knowledgeable tax person about putting together some fantastic ways to save on taxes. We’re still in the concept stage, but I’m pretty excited about it.
If you’re going to be selling some stock, and you give to charities, considering giving the appreciated stock (or a portion of it) to the charity to avoid the capital gains tax.