A simple question at your next client meeting may be all it takes to uncover valuable tax “gold.”

As a recovering tax accountant, I’ve reviewed far more tax returns during my career than I care to remember. In an effort to add value as a tax advisor, I would frequently mine the tax returns of clients and prospects for tax “gold”—overlooked tax-planning nuggets glittering just below the surface. I learned from experience that one of the most consistent and valuable sources of tax “gold” in the returns I reviewed was individuals with taxable investment accounts donating cash to charity. In fact, this quickly became one of the first things I would check when looking for tax-planning opportunities.

For the charitably inclined, a more tax-efficient alternative to effectively liquidating appreciated securities and donating the after-tax cash proceeds to charity may be to contribute the most highly appreciated securities¹ directly to charity and then replenish the account with cash.

IRS Charitable Giving Statistics

Each year, the Internal Revenue Service (IRS) releases a treasure trove of historical tax return data in its annual Data Book.² In order to more broadly gauge how common such giving strategies are in practice, we decided to pore through this IRS data to see what additional tax “gold” might be uncovered. Since nobody else would willingly subject themselves to this punishment (and may be tempted to use a less generous four-letter word than “gold” to describe anything associated with the IRS), we plugged our noses and took one for the team.

While geeking out on the most recent data released by the IRS, we noticed the large percentage of high-income taxpayers that contribute to charity.

Approximately 75% of taxpayers whose adjusted gross incomes exceeded $1 million in 2018 reported some form of charitable donation on their tax returns, and approximately 74% of them reported cash donations. Average cash donations per return exceeded $100,000 for these taxpayers.

At this same level of income, only about 8% of taxpayers contributed marketable securities³ to charity (which approximates the percentage of Aperio accounts that donate stock to charity in a given year), while nearly 72% of the same high-income group reported net long-term capital gains on their tax returns.

Source: 2018 Form 1040 data.

In other words, if approximately three-quarters of high-income taxpayers are making substantial cash donations to charity while simultaneously realizing large net long-term capital gains, why are the donations of appreciated securities so low at only 8%?⁴

Taxes are complex, and there is certainly a risk of trying to draw too many conclusions from this very high-level, aggregated tax return information. That said, the data supports our suspicion and personal experience that many taxpayers, even those with the highest incomes and presumably the greatest access to sophisticated tax advice, still contribute cash to charity when they could adopt a strategy of donating appreciated securities and replenishing their accounts with cash.

Why Is Adoption So Low?

Despite the fact that many tax and wealth advisors already understand the potential benefits of such an approach, it appears that only a small percentage of taxpayers are taking full advantage of this strategy. Accountants generally have high visibility into a client’s overall tax picture while preparing tax returns; however, they may feel too busy and overwhelmed during tax season or may not have the budget to thoroughly analyze each tax return for forward-looking planning opportunities and communicate the findings to clients. Many wealth advisors have historically ceded tax planning and tax return analysis to accountants who specialize in tax. Finally, it may be more convenient for a client to simply write a check than to coordinate a donation of appreciated securities.

Whatever the reasons, taxpayers may be missing out on billions of dollars in potential tax savings. Employing a “donate and replenish” strategy may allow these taxpayers to avoid paying tax on their unrealized gains, receive a charitable income tax deduction equal to the value of the securities donated, and increase future tax-loss harvesting opportunities. By taking the cash and replenishing whatever securities have been donated, investors can achieve those objectives while maintaining their target asset allocations.

Making charitable contributions in a more tax-efficient manner may reduce the cost of such contributions to clients and allow them to be even more generous and effective with their resources.

In a day and age when advisors are always striving to provide additional value to their clients, a simple question at the next client meeting or quick tax return review may be all that is required to uncover some valuable tax “gold.” For clients who consistently give each year, donating appreciated securities is a strategy that may provide tax benefits for many years to come.

Related resources:

• Charitable Donation Analysis (info sheet)
• Implementing SRI/ESG Values More Tax Efficiently Using Charitable Donations (info sheet)

Send questions or comments to aperio.blog@blackrock.com.

Important notes

Aperio Group, LLC, provides this material for informational purposes only and for the sole use of the recipient. The information contained herein is provided with the understanding that we are not engaged in rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in these areas. The strategies and/or investments referenced may not be suitable for all investors, because the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. None of the examples should be considered advice tailored to the needs of any specific investor or a recommendation to buy or sell any securities. The fees and expenses Aperio charges may be higher than the fees and expenses of other investment advisors and may offset profits. Additional information about the firm, and our fees and expenses, is included in our Form ADV.

Investing involves risk, including possible loss of principal. Asset allocation and diversification may not protect against market risk, loss of principal or volatility of returns. There is no guarantee that any investment strategy discussed herein will work under all market conditions. Many factors affect performance, including changes in market conditions and interest rates, as well as other economic, political, or financial developments.

You should not assume that investment decisions we make in the future will be profitable or will equal the investment performance of the past. With respect to the description of any investment strategies, simulations, or investment recommendations, we cannot provide any assurances that they will perform as expected and as described in our materials. Past performance is not indicative of future results.

Any tax information provided herein is for illustrative purposes only and does not constitute the provision of tax advice by Aperio. Due to the complexity of tax law, not every single taxpayer will face the situations described herein exactly as calculated or stated, i.e., the examples and calculations are intended to be representative of some, but not all, taxpayers. Since each investor’s situation may be different in terms of income tax, estate tax, and asset allocation, there may be situations in which the calculations would not apply. Please discuss any individual situation with tax and investment advisors first before proceeding. For those clients using tax advantaged indexing, taxpayers paying lower tax rates than those assumed, or without taxable income, would earn smaller tax benefits from tax-advantaged indexing (or even none at all) compared to those described.

¹ In general, only securities held for longer than one year should be considered for donation and may include stocks, mutual funds, exchange-traded funds (ETFs), etc.

² 2018 Form 1040 data.

³ Individual tax returns with donations of corporate stock, mutual funds, and other investments as reported on 2018 Form 8283.

⁴ Similar patterns were also generally observed at lower income levels, although the amounts and percentages varied.

MKTGH1123U/S-3230442