Your adult child is just starting out on their own and you want to give them $10,000. Also, your church has just started a building fund and you want to donate $10,000 to it as well. You have $10,000 in cash and 10,000 worth of stock that you paid $5,000 for years ago. Should you give the cash to your child and the stock to the church? Cash to the church and stock to your child? Does it make any difference?
From a financial standpoint, there is a right and wrong way to make a gift. Make it the right way and, aside from the cost of the gift, you could save a significant amount of money. Make it the wrong way, and well…
A Rule of Thumb
You probably know that giving money to another person doesn’t qualify as a tax deduction while giving it to a charity does.
What many people fail to think about is that with a gift to charity, future taxes may be avoided as well.
How is that possible? Gift appreciated assets to charity! I’m using stock in the examples below, but this may also applies to other appreciated assets such as collectibles (coins, stamps) and real estate.
There’s an old rule of thumb that financial advisors use,
“Give cash to people and appreciated assets to charities.”
As with many rules, it is valid in many cases but there can be some variation depending on the situation.
Gifts to Charity
You could certainly give the church cash. In that case you would have a $10,000 tax deduction, saving you anywhere from $1,000 to $3,960 (10% to 39.6%) depending on your tax bracket.
You may also save on state taxes depending on your state of residence. In Virginia (5.75% tax rate) the savings would be another $575.
Alternatively, if you gave the church the stock, you would still get the full $10,000 tax deduction and you might also be removing taxes on a future $5,000 capital gain. How much tax? Since the capital gains tax rates are different than the income tax rates, it’s a little more involved.
If you’re in the 10% or 15% tax bracket, the stock gift may not save you any future tax. If, on the other hand, you’re in the top bracket, you would be avoiding up to $1,190 in future federal income taxes. In Virginia, you’d also be saving an additional $287.50 in state taxes.
Gifts to Individuals
Should you always give cash to an individual? Are there any exceptions to the rule of thumb? What happens if you gift an appreciated asset to a person?
When you give an asset to another person, you are also giving them the gain in the asset. This is true for the charity as well but since they don’t pay tax, the gain is irrelevant. Obviously you won’t have to pay capital gains tax on the stock when it’s sold, but the new owner will at whatever capital gains tax bracket they are in. In the example, if your child is in a lower tax bracket, you could give them enough extra money to pay the tax and still come out ahead.
We’ve covered a couple of scenarios about when it makes sense to gift cash and when appreciated securities may be the better choice. Although I’ve covered the more common aspects, each situation is unique. Always check with your tax professional to understand your individual circumstances before making a gift.