With more than half of all Americans now owning stock, it is not surprising that many of them are donating shares of stock to their church. As a result, it is important for church leaders and donors to be familiar with the tax rules that apply to stock donations. Unfamiliarity with these rules can result in additional taxes. This article is the first of a two-part series that will review what donors and church leaders need to know. The second article will appear in the September 2001 edition of this newsletter.
Gifts of stock can provide donors with a double tax benefit. First, they may be able to claim a charitable contribution deduction in the amount of the current market value of the donated stock. That is, they can deduct not only the original cost they paid for the donated shares, but also the value of any increase in the value of those shares. Second, donors avoid paying taxes on the appreciated value of the donated stock.
Example. Bob purchased 100 shares of ABC stock at a cost of $1,000 in 1997, and donates these shares to his church in 2001 when their value is $3,000. Subject to the limitations discussed later in this article, Bob would be able to deduct the full $3,000 market value, and he would not have to pay capital gains tax on the $2,000 “gain” in the value of the stock.
Many church members own stock that has appreciated greatly in value, even taking into account the volatile stock market of the past year. The greater the amount of appreciation, the more capital gains tax the shareholder will face if the stock is sold. But this tax can be avoided if the member donates the stock to his or her church. And remember, the church pays no capital gains tax when it sells the donated stock, so the entire amount of the gift furthers the church’s mission.
Most stock is either publicly traded or privately held by the owners of a business that has not offered its shares for sale to the public. When donors make gifts of privately held stock, there are three special rules that must be understood by both donors and church leaders:
(1) Qualified appraisals
If privately held stock valued at more than $10,000 is donated, then a donor must obtain a qualified appraisal of the donated shares no earlier than sixty days prior to the date of the contribution. The cost of obtaining a qualified appraisal of privately held shares can be costly, and has caused some donors to reconsider making such a gift.
(2) Qualified appraisal summaries (Form 8283)
The donor must complete a qualified appraisal summary (IRS Form 8283) and enclose it with the Form 1040 on which the contribution deduction is claimed. Note that the church must sign this appraisal summary. Unfortunately, some donors have sent this form to their church for signature only to have it discarded or misplaced. The failure of a donor to submit a properly executed appraisal summary will jeopardize the deductibility of the contribution.
(3) If the donor “buys back” the donated shares
It is common for donors who donate privately held stock to a church to “buy back” those shares after the gift. After all, there usually is little if any “market” for shares in privately held companies, and so the church cannot easily sell the shares to anyone else. However, if there is an agreement at the time the shares are donated for the donor to buy back the shares, or for the church to sell them to the donor, then the charitable contribution may be disallowed by the IRS and any gain in the value of the shares may be taxed to the donor.
There are three limitations that apply to a gift of stock that has appreciated in value:
(1) The one-year rule
When contributing “capital gain property” such as stock to a church or other public charity, a donor generally is entitled to claim a deduction in the amount of the fair market value of the donated property on the date of the gift. Property is capital gain property if its sale at fair market value on the date of the contribution would have resulted in long-term capital gain. Capital gain property includes capital assets held more than one year.
Donated stock that was held by the donor for less than one year is not capital gain property. The IRS classifies it as “ordinary income property,” since a sale of the stock would result in ordinary taxable income rather than capital gain on any appreciation in value. The amount a donor can deduct for a contribution of ordinary income property is its fair market value less the amount that would have been ordinary income or short-term capital gain if the donor had sold the property for its fair market value on the date of the gift. Generally, this rule limits the deduction to the donor’s “basis” (cost) in the property.
Example. Barb donates stock that she held for 5 months to her church. The fair market value of the stock on the date of the donation was $1,000, but Barb paid only $800 (her “basis”) for the stock. Because the $200 of appreciation would be short-term capital gain if she had sold the stock on the date of the contribution, her deduction is limited to $800 (fair market value less the appreciation).
(2) The 30% limit
Donors generally can deduct contributions to their church only up to 50% of their adjusted gross income, with any excess being “carried over” to the next year (up to five years in all, with the 50% limit applying to each year). However, gifts of capital gain property (including stock) to a church are deductible only up to 30% of a donor’s adjusted gross income. The 30% limit does not apply to donors who elect to reduce the fair market value of donated property by the amount that would have been long-term capital gain had the property been sold on the date of the gift. In such cases the 50% limit applies.
Key point. Donors may elect a 50% limit for gifts of capital gain property instead of the 30% limit. Donors who make this election must reduce the fair market value of the donated property by the appreciation in value that would have been long-term capital gain if the property had been sold on the date of the gift. This choice applies to all capital gain property contributed to churches and other public charities during a tax year. Donors make the election on their tax return or on an amended return filed by the due date for filing the original return.
Example. In 2001 Bill has adjusted gross income of $50,000 and makes cash contributions of $5,000 to his church and in addition donates stock to his church that he purchased in 1999 for $20,000 that has a current market value of $25,000. Ordinarily, gifts of “capital gain property” are limited to 30% of the donor’s adjusted gross income, or $15,000 in this case (30% x $50,000), with any excess being carried over to the next five years. In addition, Bill can deduct his cash contributions of $5,000, for a total contribution deduction of $20,000. However, Bill can elect to claim a deduction of up to 50% of his adjusted gross income (i.e., $25,000) if he reduces the market value of the donated stock by the appreciation in value that would have been long-term capital gain had the stock been sold. In such a case, the amount of his charitable contribution would be his basis of $20,000 (what he paid for the stock) plus the $5,000 in cash that he donated to his church, for a total deduction of $25,000 or 50% of his adjusted gross income. Bill would be better off electing the 50% limit since his charitable contribution deduction would be $5,000 greater. Donors are not always better off electing the 50% limit. In general, the more a donor’s shares of stock have appreciated in value, the less advantageous the 50% election will be. On the other hand, if stock has not appreciated greatly in value, then the 50% election may result in a larger charitable contribution deduction.
Donors can “carry over” their contributions that they could not deduct in the current year because they exceed the 30% of adjusted gross income limit. Donors can deduct the excess in each of the next 5 years until it is used up, but not beyond that time. Contributions that are carried over are subject to the same percentage limits in the year to which they are carried. For example, contributions subject to the 30% limit in the year in which they are made are subject to the same limit in the year to which they are carried. Donors deduct carryover contributions only after deducting all allowable contributions in that category for the current year.
(3) Itemized deductions
Donors claim charitable contribution deductions as itemized expenses on Schedule A of Form 1040. Donors who do not itemize their expenses cannot claim a charitable contribution deduction for a gift of stock.
Some donors give their church stock that has declined in value. In general, donors who contribute stock with a fair market value that is less than their “basis” (cost) are entitled to a deduction in the amount of the stock’s fair market value. They cannot claim a deduction for the difference between the stock’s basis and its fair market value (the decrease in value). Persons who have stock that has declined in value generally will pay less taxes if they sell the stock, give the proceeds to charity, and then claim a loss on their income tax return.
Next month. The September 2001 issue of Church Treasurer Alert will contain the second and concluding article addressing gifts of stock. That article will address the following questions: What about selling stock and donating the proceeds? How does a donor value donated stock? What are the mechanics of donating stock? What about gifts of mutual fund shares? How do donors substantiate gifts of stock?
Some donors consider selling their stock and then donating the cash proceeds to their church. Is this a good idea? Not if the stock has increased in value. Let’s illustrate this with an example. Assume that Bill buys stock for $6,000 in 1998 that is worth $10,000 now. Bill sells the stock for $10,000 and donates the proceeds to his church. By selling the stock, Bill realized capital gains on the appreciation, and he will have to pay taxes on this amount. However, if Bill instead had donated the stock to his church, without selling it, he would have avoided capital gains tax on the appreciation and still could have claimed a charitable contribution. This example is summarized in a table.
|Bill’s marginal tax rate||28%||28%|
|tax benefit of gift||$2,800||$2,800|
|tax on gain||0||$1,120 ($4,000 gain x 28%)|
|net benefit of gift (tax savings)||$2,800||$1,680|
By giving the stock directly to the church, Bill avoids paying any tax on the $4,000 gain that he realized on his stock investment, and he gets a charitable contribution deduction for the full value of his shares (unless one of the limitations mentioned previously applies).
Caution. Stock that has been held more than a year and that has declined in value ordinarily should not be given directly to a church or charity. It often is more desirable, from a tax perspective, for the owner to sell the stock and give the proceeds to charity because this will create a “realized loss” that the donor may be able to deduct in computing his or her taxes.
This content originally appeared in Church Treasurer Alert, August 2001.