Here is some background info on zakah and purification, how Azzad calculates it, and the answers to a few frequently asked questions.
Zakah is a financial obligation that every Muslim must pay if they own certain assets that are worth more than a certain amount, called the nisab, if they have owned those assets for at least a period of 12 lunar months, called the hawl.
Every year, Azzad calculates zakah due on our clients’ accounts with us. Calculations are performed on 23 Sha’ban to give us time to prepare and send individual statements for clients to receive during Ramadan, when many Muslims choose to pay their zakah. We consider the following when calculating zakah:
- Whether the investments held in the account are intended for trade or for generating income.
- Whether the accounts are tax-deferred, taxable, or non-taxable.
- Any taxes or penalties that would become due if the accounts were to be liquidated and the money withdrawn by the account holder. Any tax calculations are based on the account owner’s federal and state tax bracket. Any penalty calculations are based on the account owner’s age.
- Asset that qualify as purification (see next section) are excluded from the zakatable total.
FAQ about zakah and how Azzad calculates it:
How can my zakah calculation be less than 2.5%?
There are two main ways your zakah calculation could be less than 2.5% of the current value of your portfolio.
The first reason relates to the type of account your investments are in. If you have a tax-advantaged account such as an IRA, then you need to consider hypothetical taxes and penalties before you calculate zakah. You own the IRA completely so it is eligible for zakah, but if you were to withdraw money from that account you would pay a penalty if you’re younger than 59.5, and you would pay taxes at whatever bracket withdrawing that money would place you in. Therefore, before calculating zakah on an IRA, you should calculate how much of the IRA money you would have left if you withdrew it all now — subtract the 10% penalty if you’re below age 59.5 and whatever taxes you would have to pay. Then you calculate zakah on the amount remaining.
The second reason has to do with the purpose of your accounts. Many people don’t realize that zakah is calculated differently based on the your intention for your assets. Assets intended for trade are calculated one way, and assets intended for income are calculated another.
An easy way to illustrate this is with real estate. If someone buys a house with the intention of selling it at a profit, then their intention when buying the house is for trade; zakah is owed on the value of the house if the person owns it for more than a year. If someone buys a house with the intention of owning it long-term and renting it out, then the intention when buying the house is for income; zakah would not be owed on the house, but if that person keeps the rent money for more than a year then they would owe zakah on the rent (if their zakatable assets are more than the nisab amount).
This principle is also applied to stocks. There are two basic intentions for purchasing a stock: either for the growth and value appreciation of the stock (trade/growth) or for the income or dividends it can provide (capital/income).
Zakah on growth stocks is 2.5% of the net asset value at the date of hawl, calculated after any hypothetical penalties or taxes.
Zakah on income stocks is more complicated. Zakah is not calculated based on the market value of the shares owned, but on the zakatable assets in the balance sheet allocated to shares owned.
However, it is typically difficult to track this unless that level of company data is available. Therefore, the zakah base of each share of a company can be estimated (khars) by taking the company’s current assets and subtracting the current liabilities and the long term liabilities used to finance the zakatable assets. This amount is then divided by the total number of outstanding shares. The zakah base will be any amount in excess of zero. More accurate khars methods should be used if the data is available.
I opened a new account with Azzad less than a year ago. How do you calculate zakah when it has not completed the hawl (one-year holding period to be eligible for zakah)?
When a client opens an account in the Azzad Ethical Wrap Program, they immediately become eligible to receive zakah calculations from us the next time we calculate (each year, one week before Ramadan begins). Even if they’ve only had the account with us for a short time, we assume that they have owned that money for at least a lunar year, and we calculate their zakah and provide the number to them.
Clients should use their own knowledge of their financial situation to make final judgements about whether zakah is due. For example, let’s say someone recently received the sum of money they invested with Azzad, so they’ve only owned that money for a few months. Those particular assets do not meet one condition for zakah — owning the assets for at least one lunar year — and they would not owe zakah on that money until a lunar year has passed from the time their ownership began.
How is purification different from zakah?
Purification is a process that should be applied to “cleanse” investment returns of any income from companies that may have been generated from unlawful activities according to Shariah-compliant investing principles. Azzad follows strict Shariah-compliant guidelines when investing, but much of the time companies are not required to report income sources that make up less than 5% of the company’s revenue.
In accordance with AAOIFI standards, we advise clients to cleanse any small quantities of impermissible income that may have been earned by a company, such as from interest. Account owners should eliminate such amounts by donating them to charity; they should not benefit directly or indirectly from those donations.
Although the word “zakah” has the root meaning of “purification,” in halal investing zakah and purification have different meanings. Purification amounts should be calculated first, since the purpose is to remove income from impermissible sources and zakah is not due on money that was not gained in a halal manner. Once the purification amount is removed, zakah can be calculated on remaining halal assets.
Who can I give purification money to?
AAOIFI recommends that purification money not be donated to causes for which the donor might otherwise expect ongoing reward for the donations. For example, purification money should not be donated for building a mosque or for printing copies of the Quran. (Of course zakah and other donations can be donated toward causes like those).
Giving away purification money is not considered charitable giving from a religious perspective, since the purpose is to remove income that may have come from impermissible sources, which the investor never intended to benefit from. Account owners should not intend to benefit directly or indirectly from purification donations.