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A Charitable Way to Keep a Lid on Taxes

October 27, 1995

While tax uncertainties loom in Washington, one thing is clear: It’s a great time for charitable givers to donate appreciated mutual-fund shares.

Lots of people give to their favorite causes in the last few months of any year. This year, many of the same folks are sitting with stock funds that have risen 30 percent or more. Alas, if they sell the funds now, the tax man will pocket a chunk of the profits _ and even if they don’t, there will be tax on the fat distributions many stock funds make between now and year end.

But savvy holders of mutual-fund shares can reap big tax savings from the ``give-’em-away″ gambit.

When you donate appreciated securities to fulfill charitable commitments, you completely escape tax on the capital gain. That’s better than eventually paying tax at some reduced capital-gains rate Congress may devise.

Most investors never think of using their mutual-fund holdings for charitable giving. But the tactic ``makes a lot of sense _ especially this year, when the market has risen so nicely,″ says Steven Garrett, a financial-planning manager with securities firm A.G. Edwards & Sons in St. Louis.

Consider a hypothetical couple with $5,000 pledged to a college and a five-year-old holding of shares in T. Rowe Price New Horizons Fund. That small-company fund has zoomed 44 percent this year alone. Its net asset value of $21.23 earlier this week is more than double the $9.49 paid.

If the donors were to sell $5,000 in fund shares and donate the resulting cash, they’d owe $774 in capital-gains tax at the current maximum 28 percent rate. (They would owe hundreds in taxes even at a reduced capital-gains rate.) If the fund shares were simply handed over to the college, though, the tax bill would disappear.

People who donate appreciated securities get ``a double dip″ of tax savings, says New York attorney Sanford Schlesinger. ``You get the charitable deduction that you would get for giving cash, plus you are avoiding the capital-gains tax.″

Using mutual-fund shares to fulfill charitable pledges can make lots of sense in conjunction with a periodic review of your portfolio. If you aim to keep a certain percentage of your assets in stocks, for instance, this year’s surging stock prices have probably thrown that allocation out of whack. Some investors may want to lighten up on the funds that have risen most strongly.

Even if you don’t want to trim your stake in a fund, giving some fund shares to charity may still make sense. In the above example, for instance, the couple could simply invest another $5,000 in New Horizons after making the gift. Because that mutual fund is sold without a ``load″ or sales commission, there are no transaction costs involved in buying a replacement stake.

The couple would end up with the same number of fund shares _ but at a higher ``cost basis,″ which will reduce the taxable capital gain when the fund holding is ultimately sold.

Giving away mutual-fund shares is easy. If you have an account with a no-load fund company, simply call and ask for a form to transfer ownership. If you have invested through a brokerage firm, ask that the shares be transferred to an existing or new account in the charity’s name. ``We just simply move the position from the customer’s account to the charitable association’s account,″ says a spokesman at Charles Schwab & Co., San Francisco.

There are a few caveats and complications to consider _ which is to be expected given the intricacies of both tax law and mutual-fund accounting. For starters, you get the favorable tax treatment when gifts are made to ordinary or so-called public charities, but not to private foundations such as those set up by some wealthy families. (Private foundations used to qualify and might do so again once Congress completes its current tax tinkering.)

More important, you must give away assets held for more than a year. If you’ve held the shares for a shorter time, you can deduct only your cost _ not today’s higher market value.

If you donate only a portion of your holding in a fund, there may be an issue of which shares you are giving away. If you have made periodic purchases of fund shares, or reinvested fund distributions, you’ll naturally own shares purchased at various prices. You will get the biggest tax savings by giving the shares purchased at the lowest prices.

Tax law generally presumes that a sale or transfer involves the oldest holdings, which are likely to be low in cost. You can also specify the particular shares involved, either in a letter to the broker or fund company or on a transfer-of-ownership form. But if you have previously sold shares in a particular fund and figured your gains or losses by using an average-cost method, tax law generally requires you to stick with that approach.

A final thought: If you are interested in donating fund shares, check when the fund will be making its year-end distribution of realized capital gains. Those distributions reduce a fund’s net asset value and force holders to pay tax on part of the fund’s gains.

For maximum tax advantage, ``you’d be better off making the gift before″ that payout, says Steven Banks, a vice president and tax specialist with T. Rowe Price Associates in Baltimore.

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