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I have a question about an answer that I read on Reddit's r/eli5 (Explain like I'm five) subreddit. The question was "How do rich people use tax donations as write-offs to save money? Wouldn't it be more financially beneficial to just keep the money and have it taxed?" This is something I have wondered about, too. How do you gain if you donate something of value and then only get a fraction of that back in tax savings?

The top rated answer to that question includes this quote:

When I was younger, I was on the young alumni board for the university I went to for undergrad and we used to see this all the time. Someone would donate property/illiquid securities/art/etc with an 'assessed' value of (say) $10M, but when the school went to sell it, they'd only realize (say) $3M in cash. But the guy would still get to keep the $10M tax deduction. To a guy like that, a $10M tax deduction could be worth $4m to $5M easily.

(emphasis mine)

But I don't understand this. How can a $10M deduction be worth $4-5M to a wealthy taxpayer?

  • There doesn't seem to be a question here? Or more accurately, the content of your question answers the question you posed in the title. Could you clarify? – ChrisInEdmonton Mar 7 at 22:13
  • @quid 0.45% of 10 Billion is 45 Million – D Stanley Mar 7 at 22:20
  • Fair enough, I didn't realize whoever wrote this upgraded to billions at the bottom from millions at the top. – quid Mar 7 at 22:22
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Combined federal and state marginal tax rates can easily be 40-50%. The tax owed is reduced by the amount of the deduction times the marginal tax rate.

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To use your numbers, say the rich person is in a 40% bracket, so would pay $4 million in tax on the top $10 million of income. He's likely in the top (20%) capital gains tax bracket, so if he sold the donated property for $3 million, he could owe up to $600K tax on the sale. So the $10 million deduction saves him between $4 and $4.6 million.

  • You make a good point about the tax he pays on the income from selling the property, but he would only be paying tax on the capital gain (how much it increased in value from when he bought it), and he’d be paying tax at the lower capital gain rate. – Ben Miller - Reinstate Monica Mar 9 at 17:05
  • @Ben Miller: My bad. I have, alas, no experience with capital gains at those income levels :-( – jamesqf Mar 10 at 5:38
  • You also have to factor in the phase-out of charitable deductions. Beyond a fairly modest AGI, the value of your charitable deduction starts to be phased out. If you have enough income, the phase-out will reduce your charitable deduction to only 20% of your gift -- or at least that was the case before the new tax law. – ab2 ReinstateMonicaNow Mar 13 at 1:14
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There is an extra feature to donating securities "in kind" as described in the quote (that is, giving the school or charity your appreciated stock) versus selling it and paying tax on it: you don't realize the income, but still gain the deduction at market value. This is similar to the step-up in basis your heirs receive from your estate.

Example from Vanguard Charitable

You own appreciated securities with a market value of $100,000 that you purchased for $10,000 more than one year ago.

Sell securities and donate cash ... After taxes, the gift costs you $81,320.

...

Donate securities in-kind ... After taxes, the gift costs you $63,320-- a savings of $18,000.

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