Charitable deductions warm you twice
One of the best tax deductions is a donation to charity.
There is a saying that heating with wood warms you twice: once when you chop the wood, and once when you burn it. Similarly, a donation to charity makes you feel good for supporting a worthwhile cause, and it puts a little lettuce back in your wallet.
Unfortunately, charitable donations are only deductible if you itemize. If you don’t itemize, I’d still encourage you to contribute, because organizations need your help today more than ever. I believe that the primary consideration in whether to spend money should be whether it makes your life more meaningful — not just what minimizes your taxes.
Nevertheless, if you can take the tax deduction, then let’s discuss how to maximize it.
Let’s say you want to give $500 to support NPR (one of my personal favorites). Let’s look at some options.
You can open your wallet and give them cash (or charge it, or send a check — whatever’s easiest for you), and you will receive a $500 deduction. If you’re in the 28% tax bracket, that puts $140 back in your pocket. Nice.
Instead, let’s say that a few years ago, you invested $100 in Microsoft, and it’s value is now $500. (That would mean you bought it in about 1994, but it’s just an example). You could sell the stock and give the $500 to NPR, but you would owe tax on the $400 capital gains. The long-term capital gains rate is 15%. So that takes $60 away from your $140 savings.
Instead of selling the stock you can donate the stock directly. You get the entire $500 tax deduction and help NPR stay on the air. If you transfer the stock, you don’t pay capital gains (and neither does NPR, since they’re a charitable organization). So you get the full benefit of the $140 back in your wallet.
This scenario assumes that your portfolio has individual stocks. Mutual funds are better for individual investors since they lower your risk through diversification. Can you donate shares of a mutual fund to a charity? Yes, but the tax benefits are significantly reduced. Mutual funds are required to distribute capital gains at the end of the year, and you pay taxes every year that you hold it. So when you sell mutual funds, you typically don’t owe much in tax, since you’re been paying it all along.
Is there some way to stay diversified and yet take advantage of the charitable deductions tax break? Yes. Instead of holding mutual funds, you can buy Exchange-Traded Funds (ETFs). Like mutual funds, ETFs hold a diversified portfolio, but unlike mutual funds they don’t have to distribute capital gains at the end of the year.
Today, of course, most of us aren’t swimming in capital gains. After the stock market plunge, many investments are underwater. If so, it’s better to sell the stock and take the capital loss, and donate the proceeds to the charity. Remember, you can deduct up to $3000 in capital losses. Oddly, the $3000 limit is the same for singles or married couples, so gay couples (who must file federally as two singles) can deduct $6000. Doncha just want to give Uncle Sam a little smackeroo on his whiskery cheek for being so nice to us gay folks?
So why am I bothering to write about capital gains when few of us have anything to worry about? Because now is a great time to take advantage of the low stock market. If you’re holding losses, consider selling some of them to realize the losses. Then reinvest the money in another mutual fund, ETF, or whatever makes sense for your portfolio. You’re selling at a low point, but you’re also buying at a low point. Losses in excess of the $3000 can be carried over to future years.
This simple post can’t cover all of the tax implications and advantages and disadvantages of ETFs vs. mututal funds vs. individual stocks. There are some disadvantages to ETFs, such as they trade like stocks and have transactions fees to buy and sell them. And, of course, your particular situation may be different, so before you take action either do your homework or ask a financial professional.
Finally, donating stock to a charity is not a great option for relatively small contributions. There is a bit of paperwork, and the charity will need to pay the transaction fee to sell the securities, so make sure the donation is sufficiently large that you’re doing them good, too. Or add twenty bucks to your donation — it’s like putting the stamp on the envelope.
IRS Pub 526: Charitable Contributions
Photo credit: stock.xchng
Helen Maynard, founder of Affine Financial Services, enjoys helping people plan their financial futures.
Wow, Helen. A lot of this was over my head, but that’s just because I’m not really investment savvy yet. I didn’t realize that you could donate stocks to a charity. However, I did know that you can donate your car. My partner just donated his old clunker to our local NPR station so he can get the tax write off since the car wasn’t worth much. Anyway, thanks for the information.
Hey Serena,
Kudos to you and your partner for supporting NPR. Donating a used car is indeed a good way to show your support. You can deduct the Fair Market Value. You can use a website like http://www.kbb.com to find the value. Don’t forget to include all the options your old junker had. The air conditioning and alloy wheels may be worth more than the basic car.
Sorry if my post was too technical. What can I do better? Do you have questions about definitions of some of the terms — like “capital gains.” Or perhaps how are mutual funds different than ETF’s? Let me know, and I can answer in a separate post. If I’ve confused you, a) I apologize and b) I’m sure you’re not the only one. Since I’m new to this blogging thing, I’d appreciate your advice.
Thanks.
Helen: I recently learned about the benefits of ETFs vs Mutual Funds:
And now with your post, I understand that “unlike mutual funds they don’t have to distribute capital gains at the end of the year.” Thanks for the lesson!
Hi Helen,
Thanks for your response. I didn’t mean for my comment to be a criticism. I apologize if it was received that way.
One thing that confused me was all of the different types of investments. I think you did a good job of defining things within the post itself. Its just a little mind boggling to make sense of all the options that are available. I sat down with the financial adviser at my credit union 5 times before I made the decision to open my Roth IRA. He had to go over the information several times before I felt like I understood everything. And I’m just a small fry investor. It meant a lot to me that he was willing to take the time for a customer who was only investing a small amount of money.
Maybe I’m the only one who feels this way, but sometimes it feels like information overload when people start talking about different kinds of stocks and mutual funds, etc. Perhaps this could be a reason more people don’t take an active part in managing their 401ks.
Serena,
Thanks for the feedback. Sounds like the information content was ok, just a little dense. If I can make a food analogy: tasty but too heavy. Does that seem right? I can cut down on the portion size — maybe I tried to stuff too many ideas into one post.
Hmmm… I think I shouldn’t blog on an empty stomach.
LOL – nice analogy, Helen. Food is one thing I certainly understand. :^)