This is not tax advice. My relevant training is in reading, writing, and arithmetic.
Reading this post is much more likely to be fun than useful, but if you donate more than you can deduct from your US taxes, it might save you a few hundred dollars.
If you own appreciated stocks and want to donate to a charity, you have a choice between the following options:
- Donate the stocks directly to a charity
- Sell the stocks and donate the cash
These two options have different tax implications. There are several posts that discuss tax optimization for large donors in the United States. These posts are helpful and good and recommend donating the stocks directly. This is usually correct because
- Selling the stocks will cause you to owe tax on the realized gains
- Avoiding capital gains will allow you to deduct up to $3k of capital losses from your taxable income
However, there is a quirk of the tax system such that you can sometimes end up owing less tax by realizing more long-term capital gains.
The amount of your charitable contributions that you can deduct from your federal taxes is limited to a certain percentage of your AGI. The highest limit is 60% of AGI for cash donations. If you've already donated cash in excess of the 60% limit, then a marginal dollar of AGI increases your charitable deduction by 60 cents. Long-term capital gains are included in AGI but taxed at a lower rate than ordinary income. So realizing capital gains has two counteracting effects:
- Creating a tax liability on the capital gains themselves
- Decreasing your income tax liability by increasing your deductions
If the latter outweighs the former, then you effectively face a negative marginal tax on long-term capital gains. If you donate cash in excess of the 60% limit and don't have capital losses, this can happen in real life.
Federal-Only Examples
Suppose you're a single filer and your 2024 ordinary income was $750k and you donated $600k of that to a public charity and do not have any capital losses. You can deduct $450k, 60% of your AGI, which puts your taxable income at $300k. This is in the 35% income tax bracket and the 15% capital gains tax bracket. Additionally, because your AGI exceeds $200k, your marginal capital gains are subject to the 3.8% net investment income tax. You are not subject to the alternative minimum tax because the alternative minimum tax calculation still allows subtracting charitable donations. A marginal dollar of AGI lets you deduct an additional 60 cents from your taxable income. Putting all of this together gives you an effective marginal long-term capital gains tax rate of 0.15+0.038−0.35×0.60=−0.022. That is, realizing $1000 of long-term capital gains would reduce the amount of tax you owe by $22. If you're in the 32% federal income tax bracket, this still works out slightly favorable: 0.15+0.038−0.32×0.60=−0.004. Putting some test numbers into FreeTaxUSA's filing software gives outputs consistent with the above calculations. If you live in a state that doesn't tax wages or capital gains, then that's all there is to it.
Illinois Examples
Illinois imposes a 4.95% flat tax on wages and capital gains and does not allow deductions for charitable donations. This only works out to a negative combined rate if you're in the 0% capital gains bracket. Suppose you're a single filer with $85k of ordinary income and $60k of cash donations. This puts your taxable income in the 12% income tax bracket and the 0% capital gains tax bracket. You are not subject to the net investment income tax. A marginal dollar of AGI lets you deduct an additional 60 cents for your donations and increases your Illinois tax liability by 4.95 cents. The additional state tax is deductible from your federal taxable income. So your effective marginal rate on the capital gains is 0+0.0495−0.12×(0.60+0.0495)=−0.02844.
I have not checked the state-level results against the output of tax preparation software or state tax authorities' worksheets, so these calculations are much more likely to be wrong than the federal-only ones.
California Examples
California has a progressive income tax system and taxes capital gains as ordinary income. Suppose you're a single filer with $135k of ordinary income and $95k of cash donations. This puts your federal taxable income in the 22% income tax bracket and 15% capital gains tax bracket. And your California taxable income in the 9.3% bracket. Charitable donations are deductible from your California taxes, but California limits the deduction to 50% of your federal AGI. This means your effective marginal California tax on capital gains is 0.093×(1−0.50)=0.0465, which happens to be close to the Illinois tax rate. This gives a combined rate of 0.15+0.0465−0.22×(0.60+0.0465)=0.05427, so in this case, you're better of donating the stocks directly. If you're, instead, in the 32% federal tax bracket, you can't use that same formula because of the $10k limit on deductions for state and local income tax; Someone with a high enough income to be in the 32% federal bracket would owe more than $10k of California tax and be unable to deduct marginal state taxes and also be subject to the 3.8% net investment income tax. So you end up with 0.15+0.0465+0.038−0.32×0.60=0.0425, which still favors donating directly. So, as with Illinois, realizing the capital gains only works out to being favorable if you're in the 0% capital gains bracket. If you're in the 0% federal capital gains bracket and the 6% California bracket, your effective marginal capital gains tax rate would look like 0+0.06×(1−0.50)−0.12×(0.60+0.06×(1−0.50))=−0.0456.
