Employer Stock and Charitable Gifting

A match made in heaven?

Those with charitable inclinations along with substantial employer stock positions have a unique planning opportunity to reduce taxes, risk, and fund future charitable goals. Utilizing a Donor Advised Fund in conjunction with employer stock sales can help accomplish this. But before we get into the mechanics of how this strategy works and some planning items to consider lets first discuss what a Donor advised Fund is and how it works.

A Donor Advised Fund is like a charitable investment account. You fund the account with a contribution of cash, securities, or other assets. You receive an immediate tax deduction in the year of contribution and then can decide when to send gifts to the charities you love, now or at some point in the future). It’s entirely up to you. If not gifted right away, the money can be invested for tax-free growth. The reason you can take an immediate tax deduction upfront is because the donor advised fund itself is set-up as a 501(c)(3) organization.

It’s important to note that grants made to your charities from a donor advised fund must go to an IRS-qualified public charity. If you are unsure whether or not your favorite charity is an IRS qualified public charity, check with the Donor Advised fund (Schwab or Fidelity). Usually they will have a search function to ensure your charity qualifies ahead of funding the account. And even if it isn’t listed in the original search, it doesn’t necessarily mean it doesn’t qualify. Just check with the account sponsor ahead of time to ensure the charities you want to support qualify.

Now that we’ve discussed what a Donor Advised Fund is, let’s dive into how it can help you reduce taxes, risk, and fund your current and future charitable goals!

When you exercise or sell employer stock this creates a taxable event. If in conjunction with that gain, you fund a donor advised fund account (same taxable year), you can create a tax deduction to help offset the income that was created from the employee stock. Let’s start with an example for exercising options:

Let’s assume you have a concentrated employer stock position through Non-Qualified Stock Options (NQSOs) of $750,000 in total value. Over the years, your company has done well and has also been reflected in the stock’s performance. But with that substantial growth over the years it now represents over half of your investable wealth. You realize this is starting to be a big risk in the portfolio and overall retirement plan so you decide it’s time to remove some of the risk and diversify the proceeds. You come to the determination that you would like to remove a third of that risk upfront, or $250,000. If you were just to exercise and sell the options that $250,000 in value will be added to your taxable income this year and taxed at ordinary rates.

Let’s also assume the following tax situation for a married filing joint couple:

• Wages of $150,000

• NQSOs Exercise & Sell $250,000

• Itemize Deductions totaling $25,000:

  • State and Local Taxes - $10,000

  • Mortgage Interest - $5,000

  • Charitable Gifting $10,000

Let us take a look at two scenarios:

Scenario One: to reduce the concentrated employer stock position the couple decides exercise and sell $250,000 NQSOs and pay the taxes. They continue gifting their usual $10,000/year to their beloved charities and don’t fund a donor advised fund. Given their mortgage interest, state and local income taxes, their total itemized deductions are $25,000 each year for the next 10 years.

Scenario Two: while they also reduce the concentrated employer stock position by selling $250,000 of the NQSOs, the couple also decides to fund 10 years of gifting or $100,000 in dollar terms to a donor advised fund with some of the proceeds from the stock sale. In Year 1, their total itemized deductions is $115,000 comprised of $100,000 to the donor advised fund, $5,000 of mortgage interest, and $10,000 of state and local taxes. In year 2 through 10, the couple switches to the standard deduction of $24,000 because they no longer are gifting $10,000/year. The standard deduction of $24,000 is now greater than their itemized deductions of $15,000 (Mortgage Interest of $5,000 plus State and Local Taxes of $10,000) going forward.

Scenario Two equates to a total tax savings of $23,492 over that 10-year period, of which, all the savings being realized in year 1! It’s not like the couple changed their charitable goals in this scenario. They just front-loaded their gifting in year 1 when income spiked due to the exercised stock options. Remember, even though they donated $100,000 to the Donor Advised Fund in one year, they can still gift overtime, giving $10,000 each year to the charities of their choosing just like in Scenario One.

There are a couple items to highlight here that contribute to the overall tax savings by funding the donor advised fund in conjunction with the sale. The first being reducing the couples marginal tax rate. As you can see in scenario one, the couple is exposed to a 32% marginal tax rate in Year 1 when the options value is realized and income spikes. This marginal rate is much higher than what they normally are exposed to in a given tax year.  As you can see the they typically have a top marginal rate of 22%, excluding the options sale. By contributing to a donor advised fund and increasing their itemized deductions in year 1 (Scenario Two) the couple reduces their taxable income to a level that reduces their top marginal rate to 24% versus 32%.

In addition to the reduced marginal rate in year 1, the total tax deductions received over the 10 year time-frame is significantly more in scenario two - $81,000. The reason for this is they are “stacking” deductions in Year 1 and then switching to the standard deduction of $24,000 going forward. By utilizing this strategy, they don’t lose much each year in deductions, even with the reduced $10,000 in charitable contributions going forward.

Other employer stock planning scenarios where you can reduce risk, reduce taxes, and fund charitable goals is donating highly appreciated employer stock to the donor advised fund instead of cash. This provides two benefits. First, by donating the appreciated employer stock you can receive an immediate tax deduction for the fair market value of the stock in the year of donation. Secondly, by contributing the employer stock you can avoid paying taxes on any unrealized gains in the position, which can sometimes be substantial. One thing to keep in mind when donating appreciated stock is the 30% AGI (Adjusted Gross Income) limitation.

There is much to consider when it comes to utilizing a donor advised fund in conjunction with employer stock sales. That is why it is important to work with an advisor that knows taxes to understand any limitations when it comes to donating appreciated assets and the total tax impact. The last thing you want is to implement a stock sale and gifting strategy only to find out that come tax time the tax benefits you originally thought where there have been reduced because of an AGI limitation.   

If you have questions about your concentrated stock position, utilizing a donor advised fund account, or how this all relates to your retirement plan, schedule a phone call to discuss with a Phillip James advisor.

All the information contained herein is for illustrative purposes and should not be relied upon for tax, investment, or legal advice. You should consult with your fiduciary investment advisors to decide what is best for you based on your specific situation. It also helps if your advisor is a tax preparer to understand the tax impact of implementing specific strategies.