When planning a charitable donation, gifting publicly traded securities in-kind is generally more tax efficient than selling the securities first and donating cash. Additional tax efficiency can be achieved by optimizing for the lowest cost base stocks to donate within a separately managed account.
When thinking about charitable donations, a little tax planning can go a long way toward increasing the impact of gifts. An example can help compare the tax advantages over three different donation scenarios.
Consider an investor who invests $1,000,000 on Dec 31, 2020, and is considering a $20,000 charitable donation at the end of 2021. In the first scenario, the investor purchases a S&P/TSX Composite ETF and considers selling some of the ETF to donate cash. In the second scenario, the investor purchases the same ETF and considers donating some shares in-kind. In the third scenario, the investor has a separately managed account ("SMA"), and holds individual stocks at weights similar to the S&P/TSX Composite Index, and chooses particular securities to donate in-kind.
| Scenario 1 | Scenario 2 | Scenario 3 | |
| Sell shares of ETF and donate cash | Donate shares of ETF | Donate appreciated securities from SMA | |
| Value of Donation | $20,000 | $20,000 | $20,000 |
| Adjusted Cost Base | $16,407 | $16,407 | $11,446 |
| Capital Gain | $3,593 | $3,593 | $8,554 |
| Inclusion Rate | 50% | 0% | 0% |
| Taxable Capital Gain | $1,797 | $0 | $0 |
| Tax on Capital Gain (A)1 | ($962) | $0 | $0 |
| Taxes Avoided Forever by Donating Security (B)1,2 | $0 | $962 | $2,289 |
| Donation Tax Credit (C)1 | $8,832 | $8,832 | $8,832 |
| Net Tax Benefit (A+B+C)3 | $7,870 | $9,794 | $11,121 |
The advantages of donating securities instead of raising cash to donate are clear. In all three scenarios the charitable donation tax credit is the same, because in each scenario $20,000 of market value was donated to an eligible charity. However, in scenario 1, there is a realized capital gain involved in selling the ETF. This will lead to an increase in taxes owing at tax filing time. By donating the shares of the ETF in scenario 2, the investor never has to pay taxes on the unrealized gain amount, deferring that lax liability forever.
The investor can amplify this benefit in scenario three. By holding individual securities in an SMA, the investor can find a stock that is highly appreciated. Donating a highly appreciated security will defer its high unrealized gains forever, giving the investor a larger Net Tax Benefit.
Neuberger Berman CDI™ portfolios include detailed reporting and information which helps investors make decisions around which specific securities to gift when they are considering a charitable donation. Positions that are overweight compared to the investor's target investment strategy can be donated rather than sold to avoid a tax hit. Low-cost-basis positions, with high unrealized gains representing a potential future tax impact, can be donated and replaced with high cost-basis positions. Overall tracking to a benchmark may be tightened while potentially improving the potential for tax-loss harvesting.
Considering taxes when looking to donate to a worthy cause can make your gift go further and improve your tax outlook.