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; www.irs.gov/statistics/soi-tax-stats-individual-statistical-tables-by-size-of-adjusted-gross-income
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.
- Charitable Donation Analysis (info sheet)
- Implementing SRI/ESG Values More Tax Efficiently Using Charitable Donations (info sheet)
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