by David John Marotta & Megan Russell | 08-16-2015
In previous years, we have suggested purchasing Virginia Land Preservation Credits or making a donation to a charity that can provide Neighborhood Assistance Program (NAP) Credits to both further your charitable giving and engage in smart tax planning. There are another kind of Virginia income tax credits called Education Improvement Scholarship Tax Credits.
Like NAP Credits, Virginia taxpayers can give generously and offset the cost of those gifts through tax credits and the avoidance of capital gains taxes. For those in the highest tax bracket who give highly appreciated stock, the program can offset all of the costs.
Imagine two married small business owners in the 39.6% federal income tax bracket . They are subject to the maximum 23.8% federal capital gains tax . They decide to give $10,000 of stock with a negligible cost basis to a qualifying Virginia Scholarship Program.
Like Neighborhood Assisstance Program Credits, Virginia taxpayers can give generously and offset the cost of those gifts through tax credits and the avoidance of capital gains taxes.
For their gift of $10,000, the charitable deduction on their federal income taxes could reduce their tax owed by $3,960 and Virginia state tax by $575.
Itemized deduction phase-outs may take some of this benefit if they don't have many itemized deductions already. However, these small business owners already have large mortgage interest deductions over their phase-out level.
Then, because they are gifting appreciated stock, they avoid having to realize the capital gains and thus avoid having to pay up to $2,380 in federal taxes (23.8% capital gains tax) and $575 in Virginia taxes (5.75% Virginia capital gains tax).
Thus, just by gifting appreciated stock, they have reduced their tax burden by $7,490.
Now, if they take advantage of The Education Improvement Scholarship Tax Credits, they will also receive a state tax credit of 65% of their donation or $6,500.
This reduces their state tax bill, but taxes paid to the state of Virginia are deductible from the federal income tax. Not paying Virginia income tax costs the tax avoided times their federal income tax rate.
They have reduced their Virginia income tax by $575 for the deduction, $575 by avoiding capital gains, and $6,500 by receiving state tax credits. Having reduced their Virginia taxes by $7,650, their federal tax deduction will be smaller by that amount. At a 39.6% marginal federal tax rate avoiding state tax will cost them $3,029.40 in federal taxes.
With this factored in, their total savings amounts to $10,960.60 or 9.60% more than their original donation.
There is very little logic to the tax code. Even if you don't agree with the law, you should take advantage of the tax benefits.
For taxpayers in the highest tax bracket, the breakeven point for giving appreciated stock is when the stock has appreciated at least 150%. But even for taxpayers in the 15% capital gains tax bracket with less highly appreciated stock, the cost is still minimal.
For taxpayers in the 25% federal income tax bracket subject to a 15% federal capital gains tax who are gifting stock that has appreciated 50%, they would still save $8,738 on a gift of $10,000. Any gift they give would only cost them 12.6% of the gift.
The process begins when you, as a prospective donor, submit a Preauthorization Form to the Virginia Department of Education to make sure that credits are still available. In order to ensure that your entire gift qualifies for tax credits, you should get preauthorized for slightly more than you will be transferring.
You have up to 180 days after receiving your preauthorization notice to make your donation and complete the paperwork. This should be plenty of time to execute and value the donation.
Identify the appreciated stock you wish to give. You may simply select the stock which has appreciated the most in your taxable brokerage account. An ideal candidate would be stock for which you have lost the original cost basis.
Next, contact the scholarship foundation and let them know that the gift is coming. Send them a copy of your preauthorization notice so that they have it on file when the gift is received. Let them know that you will give them the exact value of the securities after the transfer has taken place.
Ask the scholarship foundation for the account information for where they receive appreciated stock. This will consist of a Depository Trust Company (DTC) number and an account number. Most charities have a stock liquidation account with standing instructions to sell whatever is transferred into it.
The next step is to make the donation. This is done by sending a charitable gift transfer letter of authorization to your custodian directing them where to send the gift and exactly what shares should be gifted. In the case where the security you are gifting has more than one trade lot, your instructions should specify sending the lowest cost trade lot (which is the one with the highest gain).
Most taxpayers fail to value their gift of appreciated stock correctly. The custodian often sends a notice immediately after transfer which is the value of the stock around the moment of transfer. Meanwhile, accounting software sometimes uses the value at the close of the day. Neither of these values are correct.
According to IRS guidelines, gifted securities should be valued by taking the average of the high and low on the day of transfer. These values can only be computed after the market closes that day at 4pm.
After valuing the gifted securities properly, provide that information along with the signed preauthorization notice to the scholarship foundation. The value of the securities on the day of transfer may differ some from your preauthorization, but this is why you preauthorized for slightly more than you planned on transferring.
The scholarship foundation will then provide you with tax credits.
The Virginia Department of Education keeps a list of approved scholarship foundations on their website. If your intention is to help students of a particular private school, you may need to call the school to ask which scholarship foundation they utilize.
We hope to gather together this information for the private schools in the Charlottesville area. If you are a private school administrator, feel free to contact us with your school's scholarship foundation to be included in our list.
Photo used here under Flickr Creative Commons.
Marotta Wealth Mangagement, Inc. of Charlottesville provides fee-only financial planning and asset management. Visit www.emarotta.com for more information. Questions to be answered in the column should be sent to firstname.lastname@example.org or Marotta Wealth Management, Inc., 1000 Ednam Center, Charlottesville, VA 22903-4615.