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In this series Empirical advisors answer common questions about financial planning and investing as an individual. If you have a question for our advisors, please leave your name and question in the comment section at the bottom of this article.

I want to donate to charity, is there a particular method I should use?

With all of the uncertainty around the “fiscal cliff” and taxation in the future, how do we spend the last few days of 2012 making the best charitable giving decisions?  We know the current tax law, but we do not know what changes will take place for next year.  No one has the foresight to predict exactly how much tax rates will increase by, so it makes the most sense to work with the information we have.  If we assume that taxes will increase (by any amount), it would be logical to defer any giving this year to next year, when the tax benefit of charitable giving is more valuable.  Some may wonder what would happen if tax code changes ultimately eliminate the deduction available from charitable giving, but we believe that speculating about the specifics of the tax code is just as detrimental and ineffective as speculating about the stock market.  We recommend developing a long-term charitable giving strategy that works under any tax code.

Donor-advised funds, available at brokerage firms such as Charles Schwab, allow you to maximize your tax benefit from charitable giving.  If you have not heard of a donor-advised fund, it is a 501(c)(3) (charitable organization) that allows you to make unlimited gifts at any time, and make grants (gifts) to a 501(c)(3) charity of your choice  at a future time.  The account can be invested to grow over time.  This type of account is similar to a private foundation, but can be opened with as little as $5,000.   These investment vehicles are especially useful when gifting long-term appreciated investments, thus avoiding the capital gains tax that would occur if you sold the securities and made a cash donation instead. Use of a donor-advised fund generates two tax benefits:

1.  It allows you to avoid the current 15% capital gains rate
2.  It qualifies as a deduction against income (as much as 35% depending on your Federal income tax bracket)

Donor-advised funds are also a great tool when you are in a higher tax bracket relative to what you expect in future years.  These tax bracket movements could result from a sale of property, a business, or just from additional ordinary income.  For example, if your income in a given year pushes you to a 35% tax bracket when you are normally in a 25% bracket, you can give twice as much to a donor advised fund in the high-bracket year to save 35% on every dollar given instead of the 25% you would normally save.  You can then grant to charities during years when you are back in a lower tax bracket.

As always, charitable giving should be done for its positive impact on the recipient, and not solely for tax purposes.  However, if you are going to give, it makes sense to try to maximize the gift from a tax perspective, and a charitable donor-advised account can help you to achieve this.

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About Shan Zubair

As a financial advisor, Shan works closely with his clients to help define and commit to their retirement and investment objectives. Shan is a Certified Financial Planner™ and Chartered Mutual Fund Counselor (CMFC®).

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