Tesla CEO Elon Musk liquidated Tesla shares, starting in November 2021, that totaled more than US$16 billion. So far, he hasn’t declared plans to donate the proceeds from selling those shares to charity.
Instead, Musk donated $5.7 billion in Tesla shares to one or more charities in late 2021, according to paperwork filed with the Securities and Exchange Commission. He has not disclosed which charities they were. But based on what’s known about the year’s biggest donors, he is now among the nation’s most significant philanthropists.
As an accounting scholar, I’m not surprised that he went in this direction. It’s much better – from a tax perspective – to just donate stock directly to a cause a taxpayer supports. That is simpler to do than, say, selling Tesla shares and then donating the proceeds. Donating stock also more sharply reduced the taxes he owes.
The mechanics of the charitable deduction
Billionaire taxpayers are among the roughly 5%-10% of Americans who can significantly trim their tax bills when they give money to charity. This is because they can deduct the value of their donations from their taxable income when they file their taxes – reducing what they owe Uncle Sam.
Before the tax reforms enacted during the Trump administration, a much bigger share of Americans could take advantage of this arrangement, known as the charitable deduction. But because of those tax changes, many of those people now take the standard deduction instead.
There are usually limits on how big the charitable deduction can be, however. Since 2018, the maximum amount of cash contributions that can be deducted has been 60% of total adjusted gross income. Often called AGI, this is all of the income someone generates minus specific adjustments allowed by the tax code.
The government suspended this restriction in 2020 and 2021 because of the COVID-19 pandemic to encourage support for charities.
Similarly, the government let all taxpayers who didn’t itemize their returns to take a $300 charitable deduction, or $600 for couples who file jointly in 2021, as it did in 2020. However, both of these changes are currently scheduled to expire in 2022.
Cash, stock, art and real estate
Wealthy people usually donate cash, just like those of us who don’t have billions of dollars, or even millions, to spare.
But there are other ways affluent Americans can use their assets to support the causes of their choice. The law lets them donate any kind of property, as long as it’s with “disinterested generosity.” Generally speaking, this means that donors may not obtain any substantial benefits in return for their charitable gifts. Donations may go to nonprofits or, in some cases, domestic or global government agencies.
The most common way to donate without giving money is by giving away stocks and other securities that have appreciated – that is, grown in value. The benefit of giving away the stocks directly is that if they were to sell those appreciated investments instead, they would have to pay capital gains taxes on their profits before distributing any remaining cash to the charity.
The tax consequences depend on whether or not taxpayers have owned the stock for at least a year.
A hypothetical example
Consider the following example:
Imaginary taxpayer Johnny Dollar owns 10 shares of the hypothetical company Veridian Inc. that he purchased for $10,000. This stock’s current market value is $100,000 and he wants to use it to make a donation to his favorite charity.
If Johnny sold the stock he would be taxed on a $90,000 gain. Assuming that he would have to pay a 15% tax rate for the gain, he would owe $13,500 in capital gains tax, leaving only $86,500 left to give away.
If Johnny were to instead give that stock directly to the charity, he wouldn’t have to include any capital gain in his taxable income, and the charity would get a bigger boost. Plus, Johnny could deduct the $100,000 from his income at tax time.
This is how it would work if Johnny has owned the stock for longer than one year, which is what the government considers to be a long-term investment. However, the IRS limits deductions tied to donations of stock and other forms of property to 30% of AGI.
Things would work differently for Johnny if he were to give to charity assets he’s owned for less than a year. The authorities see the value of such property – which, if sold, would be subject to a higher tax rate – to be the asset’s purchase price. In this example, that would be $10,000 – even if the asset’s value has soared. The maximum deduction anyone can take for a gift of such assets is 50% of their adjusted gross income.
If instead the value of Johnny’s stock has declined, he would typically be better off if he were to sell first and donate the proceeds. That’s because he could deduct that loss against any other gains he might have from selling property, reducing his overall taxable income. He could then give away the money obtained by selling those shares – getting a tax deduction that also reduces his taxable income.
There are, of course, other kinds of property that Americans can donate, including artwork, vehicles, real estate and even cryptocurrency. While there are some unique considerations for each of those, the general rules discussed in the example above still apply.
In short, whenever high-income people give away property that is worth more than when they got it, they avoid paying taxes on the gain and they get an income tax deduction for the contribution.
But when they hang on for longer than a year to property they purchased for a relatively low amount and that increased substantially in value, they will reap the biggest tax benefits.
Should the gift be so large that it exceeds this maximum deductible amount in a given year, it’s possible to spread out this tax break for up to five more years.
Taking advantage of big donations
Timing tends to play a role in terms of how big a tax break donors can get from their charitable gifts. Because the government limits how much income-related tax liability the taxpayers can reduce through their use of the charitable deduction, wealthy donors benefit most in terms of tax reduction when they make large donations in years with especially high incomes.
Going that route avoids the risk of not being able to deduct the full amount of the donation from taxable income in a single year.
Although the taxpayer could carry the extra amount to be deducted into as many as five future years, there would be a risk that they might not have high enough income to make full use of that arrangement because what they earn can fluctuate a great deal.
How and why big donors do this
There are good reasons that rich people can afford to give away most or even all of their official income. People like Oprah Winfrey and Elon Musk are likely to have other resources to finance their lifestyles, such as investment income, immense amounts of savings or even borrowing.
And to be sure, there are many reasons wealthy Americans give away large sums to charity that have nothing to do with tax breaks or accounting conventions.
Just like the rest of us, they may be generous by nature and want to give back by supporting a given cause they care about, whether it’s helping low-income students finish college without piling up lots of debt or increasing public access to the arts.
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This article was updated on Feb. 18, 2022, with news about Musk’s 2021 SEC filings