Americans have always been known for their generosity and devotion when it comes to giving. But many people with charitable intentions tend to be reactive with donations, giving by cash or check, and often are unaware that donating certain tax-advantaged assets instead of cash may enable them to have a greater impact. So it may be helpful to think more strategically when putting together your personal giving plan.
Typically, cash and appreciated publicly traded securities—such as stocks, bonds, and mutual funds—are the two types of assets used in individual charitable giving, but donating certain complex assets may be a better option in some cases. For many, charitable contributions of illiquid assets—such as private C- and S-corporation stock, restricted stock, limited partnership or LLC interests, and other privately held assets—may be an effective and tax-efficient method of giving. These types of interests often have a relatively low cost basis for the donor—and for entrepreneurs who have founded companies, the cost basis may effectively be zero. The benefits of the strategy of donating low-cost-basis complex assets are even more pronounced when considering that these assets when sold may trigger significant capital gains and can therefore come with a hefty tax liability.
"We are seeing a significant increase in donors—including those investors going through mergers and acquisitions—leveraging a broader spectrum of their assets, such as restricted stock and privately held securities, for charitable purposes. This is a sign of more strategic charitable planning on the part of those who are charitably inclined," said Karla Valas, managing director of the complex assets group of Fidelity Charitable, an IRS-qualified 501(c)(3) public charity with a donor-advised fund program.
Valas believes this is an exciting trend, because these types of assets can have powerful tax advantages, and donating them to a donor-advised fund makes the process easy for the receiving charities.
Options for donating complex assets
When such an asset is donated to a public charity in this manner, not only can it minimize any potential capital gains exposure for the donor, but it also is generally entitled to an income tax deduction in the amount of the full current market value,1 not just the cost basis. This tax treatment offers significant benefits at the federal level and frequently at the state level as well.
After outlining their charitable goals with their advisers, investors and their advisers typically devise a detailed plan for their privately held assets that outlines immediate and long-term charitable goals, and then decide upon the best method for donating the assets.
Investors often quickly find that their options are limited. Many nonprofit organizations are not well equipped to handle complex assets, and therefore might require that a donor first sell the assets and contribute the proceeds. A donor in this situation may have taxable income, and thus would not, in most cases, choose to donate the entire amount of the proceeds. Rather, the donor might deduct his or her “cost” to liquidate (including both the selling costs and the incurred tax) and then donate the net proceeds—thereby reducing the total amount of the charitable contribution. In this situation, the donor would be able to take a deduction only for the amount of the resulting cash contribution rather than for the fair market value of the contributed asset prior to liquidation.
Donors who look into creating a private foundation often find the setup fraught with complexities and higher costs—similarly reducing the amount of money that eventually reaches the donor’s chosen charities. Moreover, contributions of most illiquid assets to a private foundation are generally limited to the cost basis for deduction purposes rather than the current (or fair) market value. Donating these types of assets to private foundations is further complicated by IRS rules and regulations related to “self-dealing,” “jeopardizing investments,” and “excess business holdings.” However, private foundations do have a certain advantages, such as not being limited to mere “advisory” privileges, and the ability to have family members sit on boards and receive compensation.
In many cases, an optimal method for donating complex assets to charity—measured by cost, flexibility, simplicity, and tax benefits to the donor, as well as by the degree to which it maximizes the net proceeds ultimately made available to charitable organizations—may be to make the contribution to a charity with a donor-advised fund program. Even donors with private foundations may wish to consider establishing a complementary donor-advised fund (DAF) specifically to receive complex asset donations. Once established, the private foundation founders can recommend grants to public charities from the DAF in accordance with the mission of the private foundation.
Many of the larger donor-advised fund programs in the United States, including Fidelity Charitable, have the requisite expertise and dedicated professional resources to work directly with donors and their advisers to maximize the giving power of these assets.
How a donor-advised fund works
For those who may not be familiar with the DAF concept, with charities that have donor-advised fund programs, donors make irrevocable contributions to the charity, and the charity then establishes a DAF account from which the donor is able to recommend grants to other eligible charities—generally speaking, IRS-qualified 501(c)(3) public charities—from the balance in their DAF account.
The benefits of a DAF are numerous. First, donors are able to make a charitable contribution and are eligible for a tax deduction on that contribution in a specific year, but are able to distribute their grants over a period of years. Donors are permitted, of course, to make further contributions at any time, but having the balance in place in their DAF means that they can engage in longer-term charitable giving, allowing them to maintain a certain level of giving regardless of changing financial circumstances—a critical point during challenging economic times, both for donors and for their recommended charities.
Second, individuals who create a donor-advised fund are typically also able to recommend how those funds should be invested. Many DAFs offer a variety of investment pools that allow donors to recommend the investment style that fits best with their time horizon for recommending charitable grants—growth, fixed income, money market, or blended investments. The funds that have been contributed to the DAF have the opportunity thereafter to grow tax free.2 In addition, DAF programs provide consolidated tax reporting for the year’s contributions, eliminating paperwork for the donor, and simplifying and improving the process for compliance with IRS requirements.
Donor-advised funds are more flexible and cost-effective than many other charitable giving options. They help donors achieve strategic, thoughtful giving for themselves and, in many cases, for their entire family. Often, in fact, donor-advised funds are established in the name of a donor’s family; by planning for charitable contributions and grants over a period of time—one year, five years, 10 years, or more—families can make a continuing difference.
Donating complex assets via a donor-advised fund
In the specific case of donating complex assets, the sponsoring charity of the DAF accepts responsibility for liquidating the assets in compliance with IRS rules and regulations—including handling all legal review of documents and IRS reporting. This enables the grant-receiving charitable organizations to focus on what they do best—fulfilling the organization’s charitable mission—rather than overseeing an often-complicated financial process and being responsible for getting the transactions right for both the donor and themselves.
As mentioned, the donation of these complex assets to a public charity means that donors themselves realize no capital gain, and thus pay no capital gains tax. This helps ensure that the highest possible percentage of the funds from the sale of the asset or assets actually goes to the chosen charitable organization.
Perhaps best of all, by donating complex assets to establish a DAF, these donors are able to diversify their giving with one asset in that they are able to recommend multiple grants to many different charities, as opposed to donating the asset (or assets) to one nonprofit organization—or going through a transfer agent to break up the asset to facilitate multiple gifts. The experienced charitable giving professionals at the DAF program are able to do this work for the donor.
- Learn more about donor-advised funds.
- Call a Charitable Planning Specialist at 800-262-6039 for more information.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917