How Tax Brackets Work
To keep this discussion straightforward, we'll pretend the tax system is simple. In particular, we'll suppose there are only two tax brackets:
|$0 - $100k||20%|
and two tax brackets for capital gains income:
|$0 - $100k||5%|
If you just make labor income, computing how much these tax brackets say you owe is straightforward. For instance, if you earn $80k, you owe 0.20 * $80k = $16k.
Likewise, if you make $60k in capital gains, the math is similar: 0.05 * $60k = $3k.
However, what if you earn $80k in labor income and $60k in capital gains income? The way to compute it in this case is slightly more complicated.
First, you compute your labor income taxes ($16k). Then, you compute your capital gains incomes taxes but start at your labor income level.
For instance, in this case, the first $40k of your capital gains is taxed at the lower 5% rate while the last $20k of your capital gains is taxed at the higher 15% rate.
So your overall tax is $16k from labor income and $5k from capital income for a total of $21k.
Donating Appreciated Assets
Suppose you bought $20k in stocks a while back and they're now worth $30k. Suppose you made $60k last year from working. Finally, suppose you want to donate $30k this year.Option 1
The simplest option is to donate $30k from your labor income. This will result in you having to pay $6k in taxes this year, which means at the end of the year you'll have $24k in cash and $30k in stocks. Note the $30k in stock is really only worth $29.5k since you'll lose $500 when you sell it, so you effectively own $53.5k.Option 2
Another option is to sell the $30k in stocks and then donate the stocks. In this case, you will pay capital gains tax on the $10k gains and you can still deduct the donation on your labor income. So, you'll pay $0.5k in capital gains taxes and $6k in labor income taxes. So, you'll end the year with $53.5k in cash.
Note, options 1 and 2 are equivalent.Option 3
Suppose, instead, that you donate the stocks directly. In this case, you realize no capital gains. It also means you can still deduct the $30k from your labor income. This means you pay 0 capital gains taxes and the same $6k in labor income taxes. So, at the end you have $54k in cash, which is $0.5k more than in options #1 and #2.Conclusion
In general, if you donate a stock directly instead of donating cash, you can save money equal to the capital gains tax rate times how much the stock appreciated.
Tax Loss Harvesting
If you lose money one year in your investments, you can deduct that against gains in a future year. This was added to reduces distortions that cause investors to sell a stock only to buy it the same day, and if you plan on spending all your money before you die, this ability to carry over effectively does eliminate that distortion.
However, if you want to leave a large state to other people/organizations when you die, the ability to carry forward loses does have interesting tax implications.
You can also deduct up to $3k of capital losses on your labor income. Since labor income is taxed at a higher rate than capital income, you save more from deducting it in this way when you can.
For instance, if you lost $9k in 2020, you can deduct $3k from your labor income taxes in 2020, 2021, and 2022. Using our tax brackets, you'd end up saving $1.35k more than if you had used your losses to offset capital gains.
Capital Income Taxation