We hear the following questions from our clients on a regular basis:
- How do I minimize my taxes?
- What is the most efficient way for me to give to my favorite charities?
For those clients with high ordinary income from cash and non-cash compensation on a yearly basis, the answers might coincide with one another. Meeting both goals at once is appealing!
We have many clients that are charitably inclined. We also have many that would like to be but have either not made it a priority or don’t fully grasp the best way to give. For those that do give regularly, the ongoing commitment to donate a portion of their hard-earned resources is there, but often we see that the method used to make such donations is not the most efficient.
Whether you are a Senior Leader at a public company with stock options or a private company with higher cash compensation, the problem remains the same. Every year you have a high ordinary income with few ways to combat or minimize it. You can max out your 401k and Health Savings Accounts, but that only goes so far. Occasionally, tax loss harvesting can be accomplished in a professionally managed portfolio, but this is better seen as an investment decision rather than purely a tax play. The remaining route to take is charitable contributions.
Optimal and non-optimal methods of giving:
Life moves fast, and before you know it, the date is late December. Either you have a set-in-stone amount you give each year, or you pick a number that is similar to past contributions. The checkbook is dusted off, and checks are written directly to various institutions. We call this checkbook philanthropy. Did you receive a deduction for this donation? Yes. Is it the most tax-efficient and cash-flow-efficient way to do so? No.
Ditch the checkbook:
Instead of writing a check, we recommend that our clients open a donor-advised fund (DAF). The caveat to this is that you also need a brokerage account with appreciated securities that have long-term gains. Instead of writing a check with after-tax resources, which also has an impact on cash flow, we prefer utilizing appreciated securities. A stock with a substantial gain in a taxable account is generally not going to be liquidated because of the additional income tax that liquidation would generate. If the accountant has recommended a specific amount to go towards giving to offset income, we then go to the portfolio and look at positions that have substantial gains. Imagine a few corn stalks sticking above the rest of the pack – those are the golden candidates. Instead of selling these, we would donate the desired number of shares directly to the DAF, and the deduction would be based on the Fair Market Value at the time of the donation.
For example: if you bought a stock for $10k and it is now worth $50k, the deduction is based on the $50k value. Once the shares land in the DAF, they are sold immediately. There is no time requirement to then make donations out of the DAF.
A brief review of the WHY behind a DAF:
- Give: Donors make a tax-deductible donation and minimize capital gains tax by contributing long-term appreciated securities. A single donation can support multiple causes, all while simplifying recordkeeping. There is no longer a cash draw from checking if you are used to writing a check.
- Grow: There is potential for the assets in the DAF to grow tax-free post-donation which can maximize the account values to support additional charitable causes.
- Grant: Support charities all through an easy-to-use online platform. There are ways we enjoy showing clients how to involve other family members and adult children in the process of giving via the DAF. Anonymity is possible if desired. Some even incorporate the DAF into their Estate Planning by making a bequest in the will.
What if the market is down?
Even in a down market, a portfolio like our Core Dividend sleeve has over 35 positions currently. There will be positions up and down in nearly every market year. In a seasoned taxable account, some positions have such significant appreciation that even a correction in the price for one year does not remove the ability to utilize appreciated positions for giving. In 2022, the S&P 500 has been down over 20% for most of the year. The Bahnsen Group has multiple positions in our Dividend Growth strategy that are up over 50% on the year. Often our semi-annual and/or annual reviews with clients lead to picking a few DAF candidates.
The thought of magnifying your gifting without increasing the check size at year-end might sound too good to be true. When a DAF is just getting started, it is common to make a contribution and then give it to a charity right away. Over time, there will be years where a higher amount is needed as a DAF contribution (think of a year in which a large number of stock options are exercised). A few years go by, and all of a sudden, you have 6 digits in the DAF. Once the account value reaches $250k or more, investment managers such as The Bahnsen Group can invest in the account instead of using the mutual funds offered by the DAF Sponsor. There will be years when we have substantial returns, and perhaps this is when you decide to grant a larger amount out of the DAF. In years where the market is down, some clients decide to elect all dividends (typically a 4%+ yield) go to cash, and this accrued cash balance is what ends up granted throughout the year.
In our business, one of the most gratifying things we see is the generosity of our Senior Leader clients. To be able to assist in generous giving through the management of donor-advised funds is a blessing. With donor-advised funds, we help our clients make strategic tax deduction decisions and provide greater intentionality, planning, and confidence around giving. Generosity flourishes when there is the freedom to give.
Stoddard Barnhill, CFP®
Sarah Leitzke, CFP®
Phillip Barnhill, CLU®