Equity compensation in the world of big tech is complicated enough as is.
- How do you prepare for the tax and investment implications of restricted stock compensation?
- Is your employee stock purchase plan even worth considering?
- When is the best time to exercise your incentive stock options?
The questions and strategies are seemingly endless!
As an employee of a fast-paced technology company with equity compensation considerations, you may not have thought about how your charitable contributions and employee stock options could cross paths. Believe it or not, there are opportunities to reduce your tax burden via your stock compensation.
Let's review some savvy ways to save on taxes while giving to your favorite charitable organizations.
Donate Your Equity Compensation for a Tax-Advantaged Gift
The good news is, there may be an opportunity to reduce some of this headache. Once your company shares vest and you are eligible to sell the stock, you can donate those shares to a charitable organization and avoid a significant tax liability.
- Your restricted stock vested 6 months ago at $50 per share. At the time, you owned 600 shares (total value = $30,000).
- Today, you still own those 600 shares, but the stock price is now $85 per share (total value = $51,000).
- If you were to liquidate those holdings today, you would owe ordinary income tax on the $21,000 gain.
- In years past, you might donate cash to your charitable organization of choice. Now, you can donate your shares. In this scenario, you don’t pay taxes on the $21,000 gain (and neither does the charity). Not only do you avoid the tax liability, but you also give more to the charity than you would have if you sold the stock and withheld money for taxes before the donation.
When you’re making the “donate vs. hold” decision, you have already recognized $30,000 of ordinary income when the shares are vested, and you will have an additional $21,000 if you liquidate the shares.
By donating the shares, you get an itemized deduction on the entire $51,000 FMV provided it doesn’t exceed the AGI cap for the year. Any unused deductions can be carried forward for five years. More details on the AGI cap are below.
Assuming you were planning to donate $51,000 regardless of the strategy, there are no reasons not to grant the shares. If you’re adamant about holding the stock, you can simply repurchase it with the cash that you saved (and effectively step up your cost basis).
Donate Investments With Large Unrealized Gains
As you may have gathered from the above example, this charitable donation strategy can be applied to other investments (not just employee stock compensation). If you own other publicly traded assets with significant unrealized capital gains, this strategy can save you a ton in taxes.
Common Situations Where This Strategy Applies
- Legacy holdings that you’ve held for an extended period (i.e., individual stocks your parents bought you when you were a child).
- Inherited investments you forgot about (or never knew) you had.
- Investments held at the back end of a long bull market (i.e., 2009 to 2021).
Consider Donor-Advised Funds
In addition to gifting highly appreciated investments, another strategy is commonly used to make tax-efficient donations: Donor-advised funds.
These funds (or investments) allow you to make a charitable contribution to the account, take an immediate tax deduction, and control how the funds are distributed (now and in the future).
In addition to these benefits, you can invest the donated funds (and potentially grow the assets long term). You have the option to donate cash and non-cash (i.e., stock) assets.
- Cash Donations: If you itemize your tax deductions, you can deduct cash donations up to 60% of your adjusted gross income. For contributions in excess of 60% of your AGI, you can carry forward the deductions for up to 5 tax years.
- Non-Cash Donations: For these donations, you can deduct up to 30% of your AGI with the same 5-year carry forward rules. If you gift appreciated securities, you will also avoid the tax burden on any sale (as we previously discussed).
Donor-advised funds are an excellent way to realize tax benefits in the short term while implementing a charitable donation strategy for the long term. Unlike a direct donation, DAFs do not require you to give to a charity in the current year. In many cases, the assets within a DAF will grow in a low-cost and tax-efficient manner (thus increasing the benefits to your favorite charitable organizations).
Consider Donation Bunching
If the Donor-advised fund feels too “formal” or complex for your liking, a more straightforward approach that can have a similar effect on your taxes is donation bunching. Due to the high standard deduction ($12,550 - Single; $25,100 - Married Filing Jointly for 2021), you might get a limited benefit (or no benefit at all) on your tax return for your charitable giving.
Donation bunching is a strategy where you donate 2x your typical annual contribution every other year. In the donation year, you itemize your deductions, and during the non-giving year, you take the standard deduction.
You and your spouse typically donate $10,000/year to your favorite charity. You have $10,000 in eligible mortgage interest, and you can claim $10,000 per year in state and local taxes (SALT). Your total itemized deductions = $30,000. If you chose the standard deduction, you would get $25,100, so the $10,000 donation only provides an additional $4,900 in deductions ($30,000 - $25,100).
By “bunching” your donations, you give $20,000 every other year. This results in an itemized deduction of $40,000 ($20k charity + $10k mortgage interest + $10k SALT). In the non-giving year, you get the $25,100 standard deduction.
Over the two years, the donation bunching strategy yields $65,100 in total deductions while the strategy of $10,000 in annual donations results in $60,000, and the charity gets the same $20k either way.
Donate With Purpose
Donating to charity is an admirable thing to do. With that said, the more you can save in the form of taxes, the more the charities stand to benefit. If you want to integrate your investment, tax, and charitable gifting strategies into a clearly established plan, schedule a call today and see how we can help.