’Tis Better To Give Than To Receive…(In California)
May 3, 2021
If you live in California and own some low basis stock (i.e. stock that cost you next to nothing), you may have the opportunity to make money by being charitable. If the president’s tax proposal included in the American Families Plan (AFP) legislation is enacted and you are selling low basis stock, you would end up with more money in your pocket by giving the stock to charity rather than selling the stock.
President Biden’s American Families Plan proposes increasing the tax rate on long-term capital gains for taxpayers earning more than $1 million. Long-term capital gains for such taxpayers would be taxed at the same rate as ordinary income. The tax rate for these taxpayers would increase from 20% to 39.6%, plus the 3.8% Affordable Care Act tax on investment income. The U.S. income tax on your capital gain could be as high as 43.4% on long-term capital gain income. But if you live in California, there is more. The maximum California income tax rate is 13.3%, which creates a combined Federal and state tax rate of 56.7%.
Let’s say a business that you started with very little capital has grown in value to $10 million. If you sell the business after the AFP is enacted, your combined Federal and California income tax could be as high as $5,670,000, leaving you with $4,330,000 net of tax. If you instead made a charitable contribution of the stock (and your income was high enough), you could save as much as $5,290,000 (39.6% Federal income tax plus 13.3% state income tax on the $10 million) in taxes from the deduction. You end up almost $1 million ($5,290,000-$4,330,000) richer and the charities of your choice get $10 million!
There are annual limits on the percentage of your Adjusted Gross Income (AGI) that you can claim as charitable contribution deductions. Contributions of appreciated long-term capital gain property are limited to 30% of AGI (20% of AGI for contributions to private foundations). Contributions in excess of the limit may be carried forward and deducted in the following five years subject to the same limitation.
Prior to his election as president, Joe Biden had proposed that tax benefit from itemized deductions should be limited to 28%. If this proposal became law, it would erase the benefit of the contribution and result in a small cost. Candidate Biden also proposed to allow the deduction of all state and local income tax. This proposal would benefit taxpayers in high income and property tax states, but it would reduce the benefit of charitable contributions (since the 13.3% state income tax would provide a Federal income tax benefit). Until legislation is passed, there can be no assurance that the idea suggested in this article will be actionable.
By the way, the potential result described here is not without precedent. From the 1930’s to the 1970’s high bracket taxpayers could have saved Federal income tax at rates from 70% to 94% on a charitable contribution when they would only receive 65% to 75% after Federal income tax on the sale of very highly appreciated long-term capital gain property.