Using the tax system and stock market to donate more: a few basic strategies

BenSchifman

Using the tax system and stock market to donate more: a few basic strategies

Summary

This post describes basic tax planning and investment strategies that you can use to give more to charity. The post first discusses some basic elements of the US tax system and how you can structure your giving to benefit from tax deductions and the tax treatment of capital gains. It then discusses, concretely, how you can easily implement these strategies by opening a brokerage account and donor-advised fund, or using a robo-adviser.

In a simplified example, a couple making $140,000 a year and donating ≥10% of their income to charity could save over $30,000 in taxes over three years and donate that additional money to charity by using these strategies.

Disclaimer

This post is only about the US tax system. This post is also meant to be a starting point for someone who has little or no knowledge of this topic. All the examples are simplified. I am not your accountant or tax lawyer; consider getting advice from a professional.

Strategy 1: Donate more through tax deductions

You can lower the amount of income that is taxed--and thus ultimately the amount you pay in tax--by taking tax deductions.^[1] You can then use these tax savings to donate more to charity.

Tax deductions and the standard deduction

In the US taxation is progressive. That is, the first dollar you earn is likely taxed at a lower rate than the last dollar you earn. For instance, a taxpayer with a taxable income of $50,000 might pay 10% in taxes on the first $10,000 of income, 12% on the next $30,000 and then 22% on the final $10,000.^[2]

A tax deduction lowers your taxable income and thus reduces the amount of taxes you pay--you subtract the amount of the tax deduction from your income, making your taxable income lower. For instance, if your taxable income was $100,000 and you took at $60,000 tax deduction, you would pay taxes on only $40,000 of income. The lower your taxable income, the lower your tax bill.[3] We will not be talking about tax credits in this post, but for clarification a tax credit is different than a deduction; a credit is a dollar-for-dollar reduction in your ultimate tax bill.[4]

There are many potential deductions you may take, including for amounts spent on state and local taxes, medical expenses, retirement savings, or, our topic, donations to a qualified charity.^[5] So in a simplified example if you earn $100,000 and donate $10,000 to GiveWell you would have only $90,000 of “taxable income.” You would thus pay tax only on $90,000 and not the full $100,000.

Most people elect not to take specific deductions, however, because they instead take the “standard deduction.”^[6] The standard deduction is an amount you can deduct from your taxable income regardless of any charitable donations or any other deduction that could take from your taxable income. In 2020, the standard deduction for a single filer is $12,200 and for a married couple it is $24,400.

In the example above, because the standard deduction amount ($12,200) is more than the $10,000 donation to GiveWell, assuming this is your only deduction you would want to take the standard deduction. If, however, you had donated $10,000 to charity, put $10,000 toward retirement savings, and had $10,000 in state taxes then the total you could deduct ($30,000) exceeds the standard deduction. You would then want to claim or “itemize” these deductions, reducing your taxable income to $70,000, and ultimately saving you money.^[7]

Donate more by “bundling:” an example

If you anticipate donating several years in a row and have less than the standard deduction in one year, you should opt to combine (aka “bundle” or “stack”) multiple years of donations into one year.^[8] That may allow you to get the tax advantage of taking more than the “standard” tax deduction. You could then donate the tax savings, increasing the total amount donated. (This approach is often combined with a donor-advised fund discussed in greater depth below so that you can disburse the donated money over time instead of all at once). Consider this simplified example:

The standard deduction for a married couple in 2020 is $24,800.^[9] You and your partner make $140,000 a year, collectively, and wish to give $14,000 to charity each year. Other than the charitable contribution you have an additional $10,000 deduction for state and local taxes and that’s it.

Option 1: donate each year for several years

If you donate $14,000 each year, your itemized deductions will only be $24,000 ($14K for charity + $10K for state and local taxes), which is just under the $24,800 standard deduction for married couples. Thus, you will receive no tax benefit for the charitable contributions or state taxes paid. Your total tax deductions for 3 years will be $74,400 (the $24,800 standard deduction x 3 years).

Option 2: Donate several years’ worth of donations at once

If you set aside the amount for several years (say, three) and then donate three years’ worth of donations at once, your itemized deductions would jump to $52,000 ([$14K in charitable donations x 3 years] + $10K for state and local taxes). Your combined deductions over 3 years will equal $101,600 (a $24,800 standard deduction in years 1 and 2, plus $52K in itemized deductions in year 3).

In the bundling example described above, by bundling the donations, you will receive over $27,000 in additional tax deductions ($27,200 = ($100,800 – $73,200) over 3 years) while still donating the same amount. If you wish you can donate the tax savings caused by the $27,200 tax deduction, leading you to donate more to charity overall through bundling.

Strategy 2: Donate more by donating capital assets

If you already have investments such as stocks and bonds, you can likely donate more by donating those investments rather than the equivalent value in cash. Alternately, if you are setting aside several years’ worth of contributions to donate at one time (see strategy 1 above) you may be able to donate more by investing that money over several years and then donating it.

Marginal tax rates on income and capital gains

Unlike other income (say, your salary), a “capital gain” is income you receive for the sale of a capital asset such as a stock, a bond, a piece of land, etc.^[10] A capital gain is considered “long term” if you held the asset (stock, house, etc) for longer than one year before you sold it; otherwise it is a “short term” capital gain. Income from long term capital gains is taxed at a lower rate than other income. Short term capital gains are taxed the same as other income.

Donate more by donating stocks: an example

Suppose you purchased 1,000 shares of Tesla stock five years ago at $5 per share. The stock is now worth $50, so your investment is worth $50,000 total. You wish to donate as much of this as possible to charity.

Option 1: selling the stock and donating the after-tax proceeds

Assume your long term capital gains rate is 15%. If you sold the stock you would have $45,000 in capital gains ($50,000 - your $5,000 initial investment).^[11] You would therefore owe an estimated $6,750 in capital gains taxes ($45,000 x 15% = $6,750).

After paying taxes, your net cash available for charitable giving is $43,250. You can then deduct this amount from your taxable income.

Option 2: donating the stock directly

If instead, if you donated the $50,000 of stock directly to a charity you do not pay capital gains taxes ($6,750) so the charity gets the full $50,000. And what is more, you can claim a tax deduction for the full value of her stock ($50,000) compared to the $43,250 you could deduct from your taxable income in Option 1.

It is easy to implement these strategies and give more to charity: several approaches

There are many ways to implement the strategies discussed above of both bundling your charitable contributions and also donating capital assets rather than cash. I will give a few options starting with the simplest and explain the general pros and cons of each approach.

Betterment

Betterment is a company that allows you to easily invest money in stocks and bonds (which it can intelligently pick for you), and also makes it easy to donate these capital assets to certain charities including the Against Malaria Foundation and GiveWell. To use Betterment to implement the strategies discussed above, you would put open a Betterment account, purchase stocks or bonds and then donate them after at least one year (or several if you are “bundling”).

Pros

Betterment is easy to use. It can be daunting to open a brokerage account and start picking stocks and bonds on your own. (However if you wish to do so, there’s more on that below.) Rather than creating an online brokerage account and making investment decisions yourself, you can answer some basic questions and Betterment’s “robo-adviser” will automatically and intelligently invest your money into baskets of stocks and bonds based upon your risk tolerance.^[12] Betterment or other robo-adviers are often recommended for beginners or people who don’t want to spend much time on investing.^[13]
Crucially for our purposes, Betterment makes the process of donating appreciated stock extremely easy.^[14] Once you have an account simply select “Transfer or roll over” from the menu and choose “Give to charity.” You can then specify how much you would like to donate and which charity you would like your donation to go to. Betterment will even pick the specific shares that have appreciated the most in order to maximize the tax benefit.

Cons

But--and this is a big “but”--Betterment only allows donations to a relatively small list of charities.^[15] The list does include GiveWell and the Against Malaria Foundation, so if you are donating there anyway great. Otherwise, it is not as easy and you have to pay an additional fee.^[16] However, Betterment indicates you can request additional charities be added.^[17]
Also, Betterment charges a small fee, .25% of the money you invest. If you pick stocks or ETFs yourself you don’t pay a fee like this. This could be considered a pro when compared to the .6% fee that donor-advised funds charge, see below.
Betterment does not allow regular / automatic donations to charities the way that donor-advised funds do so you would have to remember to manually donate periodically.

Brokerage account and donor-advised fund

An option that is slightly more involved but gives you much greater flexibility is to open a brokerage account and a donor-advised fund. A brokerage account is just an account you can use to buy stocks, bonds, mutual funds and other investments.^[18] A donor-advised fund is an account into which you deposit assets, and then can decide later when and to which charities you donate them to.^[19] (The charity doesn’t get the stock, they get cash). You get a tax deduction when you deposit the money into the donor-advised fund (as opposed to when the money is disbursed to the charities of your choice). This pairs well with the bundling strategy discussed above because when you donate money to a donor-advised fund you take a tax deduction in one tax year but then you have the flexibility to distribute money to charities regularly over time (instead of in one bundle) or even continue to grow the investment while you wait to donate.^[20]

Pros

Flexibility to donate whatever assets you wish
Flexibility to whatever charities you wish.
Flexibility to donate whenver you wish (or wait to donate). Even if you bundle multiple contributions into one year you can still disburse money to charities over time after donating it to the donor-advised fund.

Cons

A bit harder to set up, initially, than betterment.
You have to pick investments (advice below)
While opening most brokerage accounts is free, donor-advised funds charge a ~.6% fee and have minimum amounts you need to invest.

What brokerage and donor-advised fund to use?

Several of the largest and cheapest options are vanguard, Fidelity, and Charles Schwab.^[21] (There are many other brokerage firms I won’t discuss but the same principles apply.)^[22] Fidelity, vanguard and Charles Schwab all allow you to quickly and easily open a free brokerage account and start buying stocks, bonds, or other assets and they also have associated donor-advised funds that are also easy to set up. Each option charges basically the same fees: no fees for opening the brokerage account, and a 0.60% fee for the donor-advised fund.^[23] Once you set up the donor-advised fund it is easy to donate to any charity, and you can also set up recurring donations.^[24]

Minimums and donor-advised funds; an alternative for small donations

Fidelity and Schwab have a $5,000 minimum to open a donor-advised fund account; vanguard has a $25,000 minimum.^[25] If you want to donate smaller amounts, you can do so without opening a donor-advised fund using a service called coatalyst that makes it easy to donate stocks and has no minimums.^[26] Another option is Growfund which lets you open an account with no initial deposit, but it does require a $100 minimum balance and the equivalent of a 0.25% interest fee every month.

But what investments do I buy?

Once you open a brokerage account and put money into it you next have to purchase some capital assets--stocks, bonds, exchange-traded funds (ETF), mutual funds, etc. It is beyond the scope of this post to provide a comprehensive overview of this vast topic but I will offer a few suggestions to point you in the right direction. You likely are not able to “beat the market” by picking particular stocks and so should invest in a broad and low cost “index fund” that tracks the performance of the market as a whole.^[27] A basic option is a three fund portfolio consisting of a domestic stock "total market" index fund, an international stock "total market" index fund and a bond "total market" index fund. If you wish to use this strategy see the Bogleheads article in footnote 27, they have a breakdown of the specific funds for various brokerages so you can just copy that to adopt this approach. For instance, if you were using Fidelity (as I am) you can set up automatic recurring investments (e.g., at each pay period) and purchase a fixed dollar amount of Fidelity ZERO Total Market Index Fund (FZROX), Fidelity ZERO International Index Fund (FZILX), and Fidelity U. S. Bond Index Fund (FXNAX). Fidelity is unique because the ZERO funds charge no fees whatsoever. Vanguard and all other index funds I am aware of charge extremely small fees to manage their comparable index funds.

A note about leverage

Another topic beyond the scope of this post is to what degree you should seek to use leverage, that is borrowing money to invest. If this interests you see these links.^[28]

Putting it all together: example of applying these strategies

Here’s a simplified example that illustrates how you can donate more to charity by using the strategies discussed here. (Spreadsheet illustrating each scenario here).[29] Assume you and your spouse make $140,000 a year and want to donate at least 10% of your income (≥ $14,000) a year. You also contribute $10,000 to a retirement account, for which you also get a tax deduction.

Option 1: Donate yearly in cash

Each year you donate 14,000 in cash to charity and put 10,000 into a retirement account. Your total tax deductions are 24,000 which is lower than the standard deduction. After the standard deduction your taxable income is 115,200 and you pay 44,185 a year in taxes for a total of 132,555 over three years.

Option 2: Bundle 3 years of donations

Each year you set aside 14,000 in cash for charity into a savings account and put 10,000 into a retirement account. On the third year you donate the 42,000 (14k x 3) in cash. You take the standard deduction in years one and two which lowers your taxable income 115,200 and you pay 44,185 for the first two years. In year three, you donate the accumulated 42,000 in money set aside to charity. In year three you itemize your deductions and have a taxable income of 88,000 and pay taxes of 16,985 for a total of 105,355 over three years.

Option 3: Bundle 3 years of donations, donate stock

Each year you put 14,000 into a brokerage account and purchase an index fund that tracks the stock market. You also put 10,000 into a retirement account. On the third year your initial investments have increased by 7% (the historical average)[30] to 44,940 and you donate this amount into your donor-advised fund. You take the standard deduction in years one and two which lowers your taxable income 115,200 and you pay 44,185 for the first two years. In year three you itemize your deductions and have a taxable income of 85,060 and pay taxes of 14,045 for a total of 102,415 over three years.

Thus, the third option allows you donate an additional $30,140 to charity compared to the first option.

Conclusion

Hopefully this post gave you some concrete steps you can implement to structure your charitable donations in the most tax efficient manner and thus donate more overall. Of course, your specific situation is likely different than the simplified examples here so consider consulting a professional. And if you have any questions please ask away in the comments!

Possible project: EA robo-adviser

While adopting these strategies isn’t exactly rocket science, it is a bit involved and none of the options are perfect. A possible future EA-aligned project could be to either make a new EA robo-adviser or get existing brokerages or robo-advisers to offer a product that make this process easier or even automated. For instance, I would love a robo-adviser that would automatically and intelligently invest my money but also automatically and intelligently donate stocks to an associated donor-advised fund subject to certain rules (such as until the amount I wish to donate had been reached). That is, the robo-advier could offer different default automated donation options such as a rule that whenever a stock had been held for one year and appreciated, it would be donated to the donor-advised fund and a replacement stock would be purchased. (This is similar to tax-loss harvesting which Betterment does to some extent.)^[31]

If anyone works at or has connections to Betterment or any of the other robo-advisers or wants to take on this project go for it!

Effective Altruism Forum
EA Forum

Using the tax system and stock market to donate more: a few basic strategies

24

Using the tax system and stock market to donate more: a few basic strategies

Strategy 1: Donate more through tax deductions

Tax deductions and the standard deduction

Donate more by “bundling:” an example

Strategy 2: Donate more by donating capital assets

Donate more by donating stocks: an example

It is easy to implement these strategies and give more to charity: several approaches

Betterment

Brokerage account and donor-advised fund

What brokerage and donor-advised fund to use?

But what investments do I buy?

Putting it all together: example of applying these strategies

Conclusion

Possible project: EA robo-adviser

Further reading

24

Reactions

More posts like this