Tax economic effects to you of your charitable donations

By Jay S. Block, CPA

Assume a donor, Phil Anthropy, wishes to donate to a public charity. Charitable deductions are available to reduce Phil's personal income taxes. Would Phil be economically better off (taking into consideration available charitable tax deductions) by (a) donating property in kind or (b) selling property and subsequently donating the after tax sale proceeds?

As shown in the comparison below, Phil would be better off by $1,830 by donating $7,000 of property in kind, in lieu of selling the property for $7,000 and then donating the after-tax proceeds.

Scenario A: Donating shares of stock in kind to a public charity

Assume that for more than 12 months, Phil has held shares of stock in a publicly held company that is listed on the New York Stock Exchange. Assume the fair-market value (hereafter "FMV') of the shares is $7,000 and that Phil's cost is $1,000. With certain exceptions beyond the scope of this article, Phil may claim the full $7,000 FMV as a charitable itemized deduction on his income tax return. Phil's donation of the shares is not a taxable sale; Phil recognizes no taxable gain whatsoever on the difference between the $7,000 FMV and Phil's $1,000 cost.

Assuming Phil is in a 32.95 percent combined tax bracket (i.e., 25 percent federal, plus 4.75 percent Maryland, plus 3.2 percent Howard County), then Phil's $7,000 in-kind donation of shares to a charity will reduce his income taxes by $2,306 ($7,000 multiplied by 32.95 percent). Phil has thus made a $7,000 charitable donation at a net after-tax cost to Phil of only $4,694 ($7,000 FMV less $2,306 tax savings).

Note that the public charity, a tax-exempt organization, can sell the shares at — 0 — tax and utilize the full $7,000 toward its tax-exempt purposes.

Scenario B: Selling the shares and donating the net after-tax proceeds to a public charity

Phil's sale of the shares triggers a $6,000 long-term capital gain ($7,000 FMV less $1,000 cost). By reason thereof, Phil incurs $1,377 of combined income taxes on the gain ($6,000 gain multiplied by 22.95 percent combined tax rate comprised of special 15 percent federal long-term cap gain rate, plus 4.75 percent Maryland, plus 3.2 percent Howard County). Phil donates the $5,623 net after-tax proceeds ($7,000 less the incremental $1,377 tax). The $5,623 donation reduces Phil's income taxes by $1,853 ($5,623 multiplied by the 32.95 percent combined tax bracket, as set forth in Scenario A above).

In brief, the taxable sale followed by the donation of the net after-tax proceeds to the public charity results in a net $476 reduction in Phil's income taxes ($1,377 increase in taxes by reason of the taxable gain, less $1,853 reduction in taxes by reason of Phil's $5,623 donation).

Note that the public charity has only $5,623 to utilize toward its tax-exempt purposes.

Summary

As shown in Scenario A, if Phil Anthropy donates his shares in kind to a public charity, he reduces income taxes by $2,306 while providing the charity with $7,000 to use toward its tax-exempt purposes. The net cost of the donation to Phil is $4,694 ($7,000 less the $2,306 tax savings).

Alternatively, if Phil sells the shares and subsequently donates the net after-tax proceeds to a public charity, then he reduces income taxes by $476 while providing the public charity with only $5,623 to utilize toward its tax-exempt purposes. The net cost of the donation under Scenario B to Phil is $6,524 ($7,000 less $476 net tax savings).

Bottom line

The above Scenario A tax savings to Phil Anthropy (of donating stock in kind) exceeds the Scenario B tax savings to Phil (of a sale of stock with a subsequent donation of the net sale proceeds) by $1,830. Also, Scenario A yields the charity with $1,377 more to utilize toward its tax-exempt purposes than does Scenario B.

The following assumptions apply for purposes of this article:

Phil Anthropy is married filing a joint income tax return.
Phil's adjusted gross income is less than $145,950; thus Phil is not subject to a special 3 percent itemized deduction limitation rule.
Phil is not subject to the alternative minimum tax (AMT).

Jay S. Block, CPA, is an MACPA member and a tax attorney with more than 20 years of experience in assisting clients with tax and estate planning advice, wills / trusts, probate, tax audit representation, tax return preparation and tax litigation. He has an office in Columbia and hours by appointment in Westminster.

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