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: Here’s the charitable-giving strategy that helps the 1% cut their tax bills

As tax season concludes, people across the country are looking for all the ways they can lower their tax bill and increase their refund before the April 18 filing deadline.

This year, that includes rounding up all the charitable donations they made in 2021 in order to take advantage of a pandemic-related tax incentive that’s going away. It’s a write-off that may shave $150 off a married couple’s tax bill, according to one expert.

But for the country’s super-rich — if past years’ tax activity are any clue — tax time likely includes tallying up 2021 charitable stock donations in order to shrink income tax bills to a far greater extent, according to a new report from ProPublica, the investigative news outlet. There’s also no capital gains tax on the donation.

For a tax code that some critics say is tilted towards the rich, the divergent scenarios may be a tale of two tax breaks and the people who use them.

The 400 richest households in America paid an average effective income tax rate of 22% between 2013 and 2018, the ProPublica report said. The capacity to pull together large deductions, including large charitable stock donations that bypass capital gains taxes, is one reason it got this way, the report said. The fact that long-term capital gains are taxed at a lower rates than wages is another reason, the report added.

Tech sector billionaires often donated stock and, as a group, they had a 17% effective income tax rate, ProPublica said. Michael Bloomberg had a 4% average effective federal income tax rate, ProPublica said. The estimated 4% rate for the founder of Bloomberg L.P., the media and financial data company, founder of Bloomberg Philanthropies and former New York City Mayor was among the lowest rates in the select group. The ProPublica report said he took “annual deductions of more than $1 billion, mostly through charitable contributions.”

A Bloomberg spokesman declined to comment. In previous ProPublica coverage, Bloomberg representatives have said he “pays the maximum tax rate on all federal, state, local and international taxable income as prescribed by law.”

In a tally of last year’s top donations and pledges, Bloomberg was responsible for $1.6 billion, according to the Chronicle of Philanthropy.

All together, the top 400 households’ estimated 22% rate is steeper than the 5% and 19% effective income tax rates of households making up to $50,000 and up to $500,000, ProPublica found, after sifting through IRS data on the super-rich that it obtained.

But the estimated 22% effective rate is lower than the 29% rates paid by earners making between $2 million – $5 million and the 27% rate paid by taxpayers making between $12 million and $58 million, according to ProPublica.

The ProPublica report comes as President Joe Biden is pressing for a new tax that would make households worth at least $100 million pay a 20% minimum tax. Under the proposal, the IRS could count up the value of unsold stock when coming up with the tax bill. The top 400 families are paying just over 8% in income taxes when factoring all their income and wealth, including the value of unsold assets, White House economists have estimated.

The latest Biden administration tax idea is a long shot, some observers say. But the debate on what counts as the elite’s “fair share” of taxes will continue regardless of what happens to this proposal.

In tax returns filed last year through mid-July, 9.7 million returns claimed a total $88.2 billion in charitable contribution deductions, according to the IRS. That’s down from the 11 million returns in mid-July 2020 claiming over $96 billion.

The urge to make a difference, not shrink tax liability, is what motivates wealthy donors, some surveys say. Others say philanthropy amounts to reputation washing for elites. Another criticism of charitable stock donations, like Tesla
TSLA,
+3.59%

CEO Elon Musk’s recent donation of more than 5 million Tesla shares, is the potential lack of transparency about where the money ends up.

Either way, charitable contribution deductions are part of the tax landscape for people who itemize their deductions. And itemizing is not what most taxpayers do.
During the pandemic’s early phases, lawmakers were looking for all sorts of ways to incentivize financial help in a time of crisis. The CARES Act, passed in March 2020, created the $300 above-the-line charitable deduction for people who took the standard deduction (which is most taxpayers.)

Lawmakers subsequently extended the write-off into 2021, allowing married couples to deduct a $600 maximum in cash contributions and still take the standard deduction. Though charities have pushed for the deduction to live on and become bigger, that hasn’t happened yet.

Then there are the tax rules surrounding charitable donations of appreciating assets like stocks. First, a household needs it to make financial sense to itemize instead of taking the standard deduction that’s worth $12,500 for individuals and $25,100 for many married couples this year.

Then they need the portfolio ready to go. Last year, 56% of Americans owned stock through individual company share ownership, mutual funds, a self-directed 401(k) or IRA, according to Gallup. The people in that group tended to skew richer; 89% of households making over $100,000 said they owned stock, the poll noted.

When it comes to donating stock and the connected charitable contribution, the deduction is up to 30% of adjusted gross income.

There’s a large tax savings in a direct stock donation instead of selling the stock and donating the proceeds, various analysis show.

A $10,000 cash donation to charity ends with a $3,500 tax savings for a household in the 35% marginal tax bracket, the second highest bracket, according to RBC Wealth Management. Suppose it’s a $10,000 stock donation on securities that gained $8,000 over the years. Selling the shares and donating the cash would mean a 15% capital gains tax hit, and a charitable deduction that would result in a $2,300 tax savings, it said. But a $10,000 direct stock donation ends with a $4,700 tax savings that takes the $3,500 deduction but skips a $1,200 capital gains tax hit.

A Charles Schwab
SCHW,
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analysis starts with a hypothetical couple that’s in the second highest tax bracket, 35%, and subject to the highest capital gains rate, 20%, as well as the 3.8% net investment income tax.

For them, a stock sale for a $100,000 cash donation results in a tax savings of $14,390 after factoring in the capital gains tax and the charitable contribution deduction. Donating the stock to the charity skips the capital gains tax, takes the deduction and results in a net $37,000 tax savings, the Schwab analysis said.

The most important thing is the donation to an organization and cause that fits a donor’s values, while the tax effects “are just icing on the cake,” Schwab wrote.

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