What goes around
In the mid 1990s, America experienced a similar economic revival. At the time, the stock market was showing signs of renewed growth as the economy recovered from the recession that clouded the early 1990s. In a landmark moment, the Dow Jones Industrial Average closed above 5,000 for the first time in November 1995, and the Dow was predicted to reach 10,000 by the year 2000.
A growing number of investors felt jubilant about the surge in stock prices. But that optimism was tempered by lingering doubts about whether those levels could be maintained. Many felt that a stock market correction was not merely a possibility on the distant horizon but a certainty for the near future.
Onward and upward?
Despite a number of overvalued stocks, the stock market continued to march upward in the 1990s. Exceeding most experts’ predictions, the Dow first closed above the 10,000 mark on March 29, 1999, and reached its highest point of 11,722 on January 14, 2000.
The market upswing of the second half of the 1990s resulted in a positive effect on charitable giving. When the Dow was at its highest, gifts of appreciated securities, in particular, became increasingly popular for a broad group of donors. As a consequence, many development officers took it upon themselves to become more familiar with a variety of gift planning strategies that feature special benefits when funded with appreciated, low-yielding securities.
But things soon changed. After reaching its peak, the Dow experienced a significant correction, eventually falling below 7,300 in October 2002.
After the stock market retreated from its high point, the number of gifts of securities from living donors dropped off dramatically. However, gifts of appreciated securities from estates remained strong and helped to fuel record levels of charitable bequests as reported on federal estate tax returns. Some have speculated that this occurred because older persons may not have been as heavily invested in high growth stocks that suffered the greatest losses during the market correction.
As the economy began its current recovery in 2003, many charitable organizations saw renewed interest from living donors in gifts funded with appreciated securities. Unfortunately, some fund-raising executives, particularly those new to the field, were by that time either “rusty” or completely unfamiliar with both basic and more advanced planning strategies utilizing securities.
Why donors appreciate gifts of securities
Donors are attracted to gifts of appreciated securities by the combined tax savings of the charitable deduction and avoidance of capital gains tax. The most popular gifts are those funded with publicly held stocks and bonds that have been held over a year (long-term).
Some have speculated that the lower income and capital gains tax rates brought about by recent tax law changes might reduce the attractiveness of gifts of appreciated assets. While it is true that donors will not receive the same level of savings that were available under the previous law, consider the situation of taxpayers planning gifts under the current rules. For them the additional capital gains saved by “giving a paper profit” that has never been taxed continues to hold great appeal. In fact, some major donors may be surprised to discover that they may be able to give more today at a lower after-tax cost!
A case in point
Consider a donor that gave a $10,000 check to charity in the past when he or she was subject to the highest ordinary income tax rate of 39.6%. The after-tax cost of making the gift was $6,040 ($10,000 – $3,960), assuming it could all be deducted in the year of the gift. This year, under the highest marginal tax bracket of 35%, the after-tax cost of the cash gift has increased by $460 to $6,500 ($10,000 – $3,500).
Suppose that the donor identifies a highly appreciated stock that had been purchased for $1,000 and is currently valued at $11,000. The after-tax cost of the gift is determined by subtracting the tax savings from the charitable deduction and the capital gains tax that is avoided. Here’s how the numbers work:
$11,000 Gift of appreciated stock
-3,850 ($11,000 x .35) Income tax savings
-1,500 ($10,000 x .15) Capital gains tax avoidance
$5,650 After-tax cost of gift.
From an accounting standpoint, the cost of this $11,000 gift is lower than the previous $10,000 cash gift! Obviously, the exact savings must depend on the donor’s tax bracket, basis in the security, and other factors. Still, this example serves as an illustration of the attractiveness of gifts of appropriate appreciated assets as compared to cash. Our current environment may thus cause an even broader group of donors to consider gifts of appreciated assets.
Beyond outright gifts
In addition to their appeal for funding outright gifts, appreciated securities have also gained in attractiveness for a variety of split interest gifts such as gift annuities and charitable remainder trusts. Distributions from these arrangements that are categorized as long-term capital gain or qualified dividends are likely to be taxed at 15% rather than at a rate as high as 35%.
Some planned giving donors that previously had established a bequest or other simple remainder gift may wish to consider a life income gift in addition to or in place of the original charitable bequest. As the estate tax issue goes away for most individuals, current tax and income planning may be increasingly important. For example, donors that had previously included a charity in their wills for $25,000 may find that a charitable gift annuity funded with appreciated securities can provide attractive payments for life and create current income tax savings.
A number of other specific strategies exist to meet personal and philanthropic goals with gifts of appreciated assets, but charities must inform the donor and advisors about them or this opportunity may be lost. Sharpe provides a number of publications designed to help nonprofits communicate giving opportunities to their constituents. Contact a Sharpe representative to learn more about how Sharpe’s booklets “Better Estate Planning,” “A Guide to Giving in 2004,” and “Giving Securities” (see page 6) can help. Those who wish to polish their skills in using appreciated assets to fund charitable gifts may also find the popular Sharpe Group seminars described on page 3 to be of interest.