For those Canadian investors out there, you will know that if you trade in a non registered account, 50% of the profit is included as income and taxed at your marginal rate. Recently, the Canadian government has eliminated capital gains if you donate stock directly to a registered Canadian charity (it used to be 25% taxable). On top of that, any dollar amount (after the first $200) donated to a registered charity gets a tax return at the highest marginal rate (say 46% for arguments sake). What? No capital gains tax when donating to a charity AND a tax return boot. Are the wheels turning yet?
Tim Cesnick, a renouned tax advisor, has come up with a formula of donating a portion of your profitable shares so that you will pay ZERO capital gains tax to the government on your sale!
Below is an example straight from Tim Cesnick himself:
You may not want to donate 100 per cent of your holdings in a particular security to charity. You’ve decided to sell the security, but you may want to reinvest in something else. In this case, consider liquidating the security, as you’ve planned, but donate enough of those securities to charity to fully eliminate the tax on the rest of the shares you’re selling.
For example, say you own shares of XYZ Co., worth $100,000. You paid $50,000 for the shares. You’ve decided it’s time to sell the shares for whatever reason. If you simply sell XYZ, you’ll trigger a $50,000 capital gain, costing you $11,500 in tax, assuming a marginal tax rate of 46 per cent. You’d be left with $88,500 in your pocket after taxes.
Now, try this idea instead: Donate $20,000 worth of XYZ shares to charity and sell the rest, worth $80,000. The result? The tax on the $80,000 worth of shares sold is $9,200. The tax on the $20,000 worth of shares donated is zero.
The donation tax credit for those donated shares will be $9,200 — exactly enough to offset the tax on shares you kept for yourself and sold to reinvest. You’d be left with $80,000 in your pocket after the donation (and no taxes).
Now, keep this formula handy: The amount you donate to charity should equal the fair market value (FMV) of all the shares ($100,000 in our example) multiplied by the capital gain on the shares ($50,000). Then, divide that answer by the following: Three times the fair market value (3 x $100,000) less the adjusted cost base (ACB) of the shares ($50,000). The answer is $20,000 in our example.
In algebraic terms: Donation = (FMV)(FMV - ACB)/(3FMV - ACB). This formula will allow you to determine the exact value of the securities to donate to eliminate your tax. Call me a math geek, but it works every time, regardless of your tax rate.
Even though we may be Stingy, we are firm believers in giving to charity. This strategy is a double win by giving to those in need AND keeping our profits out of the hands of the government!
Does anyone else have any other tax efficient strategies? Perhaps we can discuss them here in the comments.
[…] Out of the 10 tips, our favorites are number 2 and number 4. Number 2 suggests to donate stock to a charity because of the new tax rules. We think this is a great idea as you don’t have to pay capital gains on the stocks donated AND you get the tax credit. We like it so much that we have written an article on it! Remember though, if you are considering donating stock to charity, you have to do it soon! The donation date is the date that the charity RECEIVES the stock which may take some time depending on the charity. […]
[…] I plan on learning more about tax strategies and how to apply them to our personal situation. There was an article on StingyFinance.com that explained how to donate stock directly to charity to obtain the tax credit which would pay for your capital gains tax. Tax minimization is a key component to building wealth. […]
….In the first scenario (no donation), you are left with $88,500. In the second scenario (donating $20K), you are left with $80,000. How is this better than paying the capital gains wholly on the $50K in scenario 1?
[…] Here is an article on StingyFinance.com, that was originally written by Tim Cestnick, that describes the number of shares that you can consider donating to reduce your capital gains tax payable. […]