How does giving to charity reduce tax liability?
September 25, 2014 2:34 PM Subscribe
I understand the literal answer to this question--if I donate $100,000 to charity, I can deduct that amount from my net income for tax purposes, and my tax liability will be significantly less. If I'm well into the 39.6% federal income tax bracket, I will reduce my federal taxes by $39,600. But I'll also have $100,000 less in my account. Can charitable giving increase the total amount I retain, even considering the amount lost by donation?
Anecdotally, I've heard people say that their accountant has advised them to donate to charity to reduce their tax liability. But in the example I gave above, while I will owe the government $39,600 less, I will also have $100,000 less in my bank account. So, are there situations where reducing net income by charitable giving actually increases the total amount retained by the individual, because of the way taxes are calculated?
Anecdotally, I've heard people say that their accountant has advised them to donate to charity to reduce their tax liability. But in the example I gave above, while I will owe the government $39,600 less, I will also have $100,000 less in my bank account. So, are there situations where reducing net income by charitable giving actually increases the total amount retained by the individual, because of the way taxes are calculated?
It works well if it takes you from one tax bracket to another. So from 39% to 33%.
But in the grand scheme of things, it's just an incentive to give. Not only do I feel good about my donations, but it decreases the amount I pay in taxes over all.
I was going to give anyway, the tax help just makes it sweeter.
posted by Ruthless Bunny at 2:40 PM on September 25, 2014 [2 favorites]
But in the grand scheme of things, it's just an incentive to give. Not only do I feel good about my donations, but it decreases the amount I pay in taxes over all.
I was going to give anyway, the tax help just makes it sweeter.
posted by Ruthless Bunny at 2:40 PM on September 25, 2014 [2 favorites]
Well, it leaves you a choice--do you want to give your money to The Man, or to an organization in need? Some people prefer the latter.
posted by Melismata at 2:40 PM on September 25, 2014 [2 favorites]
posted by Melismata at 2:40 PM on September 25, 2014 [2 favorites]
If you have a lot of assets but a low income, you could give your way out of paying any taxes, but you're still probably looking at a net reduction of total worth.
posted by GuyZero at 2:43 PM on September 25, 2014 [1 favorite]
posted by GuyZero at 2:43 PM on September 25, 2014 [1 favorite]
Best answer: It only works when you were going to get rid of that money/stuff anyway.
I claim for 'charitable donations' to things I would pay for even as non-charitable services like the Chicago Architecture Foundation or the Art Gallery. I claim for donating used clothing because I get almost the same amount of benefit from the tax break as I would from a used clothing store like Plato's Cave (less than from a consignment store but also far less hassle). I am small potato lower middle class income but it still adds up to a couple hundred off my taxes for very little money and effort.
It is likely that the accountant advising charitable deductions for things that person is already spending money on in some way but not receiving the tax break benefit for. Giving for the well off can be about more than the just the tax break. It can be social signalling, advertising, membership at elite society events, or business opportunity related. Make it charitable and file the receipt for your accountant and you suddenly get a twofer.
posted by srboisvert at 2:51 PM on September 25, 2014 [4 favorites]
I claim for 'charitable donations' to things I would pay for even as non-charitable services like the Chicago Architecture Foundation or the Art Gallery. I claim for donating used clothing because I get almost the same amount of benefit from the tax break as I would from a used clothing store like Plato's Cave (less than from a consignment store but also far less hassle). I am small potato lower middle class income but it still adds up to a couple hundred off my taxes for very little money and effort.
It is likely that the accountant advising charitable deductions for things that person is already spending money on in some way but not receiving the tax break benefit for. Giving for the well off can be about more than the just the tax break. It can be social signalling, advertising, membership at elite society events, or business opportunity related. Make it charitable and file the receipt for your accountant and you suddenly get a twofer.
posted by srboisvert at 2:51 PM on September 25, 2014 [4 favorites]
Best answer: Using charitable giving to actually increase the total amount retained can be done, but requires some fancy tax planning and the creation of either a trust to give the charitable amount to or a private foundation of some sort.
This is not the type of thing that you can easily do on your own, you'll need a Trust and Estates Lawyer who deals with high income individuals, an accountant, and a period of years to make this work for you. Some plans require the purchase of particular types of insurance as well. I can recommend some books on the subject if you're really interested.
The gifts your giving to the charity will often not be actually received by the charity for a period of decades using this type of planning.
posted by bswinburn at 2:52 PM on September 25, 2014 [6 favorites]
This is not the type of thing that you can easily do on your own, you'll need a Trust and Estates Lawyer who deals with high income individuals, an accountant, and a period of years to make this work for you. Some plans require the purchase of particular types of insurance as well. I can recommend some books on the subject if you're really interested.
The gifts your giving to the charity will often not be actually received by the charity for a period of decades using this type of planning.
posted by bswinburn at 2:52 PM on September 25, 2014 [6 favorites]
Make sure you remember that tax brackets are progressive -- if you are in the 39% tax bracket, you are only taxed at 39% for the amount of income you made over the the 35% bracket. So you're reducing your total paid to the government, but you will always have less money.
The only difference is if you were to pay into a trust, as already mentioned, as that makes the money not yours, per se, and offsets the tax liability until the money is taken out, where it may be taxed at a lower rate.
posted by mikeh at 2:53 PM on September 25, 2014 [5 favorites]
The only difference is if you were to pay into a trust, as already mentioned, as that makes the money not yours, per se, and offsets the tax liability until the money is taken out, where it may be taxed at a lower rate.
posted by mikeh at 2:53 PM on September 25, 2014 [5 favorites]
Best answer: It's possible but you'd wind up paying that money to your tax person or accountant to make it happen. There are a sliver of people I know for whom this would be true for but it would have to do with being just on the line where the Earned Income Credit comes in. The big deal, as people said above, is that in your situation you get to give 100,000 to charity and it only "costs" you 60,400.
I'm self-employed for at least part of my money, so I pay a big chunk in taxes relative to my bracket because I'm paying SSI on top of it. So the more I can deduct stuff--charitable donations, stuff for work, etc--the more I get to spend the money I earned on me and not on taxes. For most people you still have to spend the money, you don't get to literally keep it.
posted by jessamyn at 2:54 PM on September 25, 2014
I'm self-employed for at least part of my money, so I pay a big chunk in taxes relative to my bracket because I'm paying SSI on top of it. So the more I can deduct stuff--charitable donations, stuff for work, etc--the more I get to spend the money I earned on me and not on taxes. For most people you still have to spend the money, you don't get to literally keep it.
posted by jessamyn at 2:54 PM on September 25, 2014
Say you want to give away $50,000 in the next three years and you're going to make $60,000 one year, $90,000 the next (because your book came out) and $70,000 the third year. You'd try to give as much in the year with the most income because it would reduce taxes on the money taxed the hardest due to progressive income.
If you're a stone-cold bastard you'd use other tricks - charity to reduce taxes is for people who want to give the money away and save the most on taxes at the same time.
posted by michaelh at 2:54 PM on September 25, 2014 [1 favorite]
If you're a stone-cold bastard you'd use other tricks - charity to reduce taxes is for people who want to give the money away and save the most on taxes at the same time.
posted by michaelh at 2:54 PM on September 25, 2014 [1 favorite]
Best answer: It works well if it takes you from one tax bracket to another. So from 39% to 33%.
This is a common misconception, but tax brackets don't work that way. The first X dollars are taxed in one bracket, the next Y dollars are taxed in another, the next Z dollars are taxed at a higher rate, and so on; if you make fewer total dollars, that reduces the number of dollars which are taxed at the highest applicable rate, but it has no effect on the dollars which are taxed at lower rates.
posted by Mars Saxman at 3:09 PM on September 25, 2014 [20 favorites]
This is a common misconception, but tax brackets don't work that way. The first X dollars are taxed in one bracket, the next Y dollars are taxed in another, the next Z dollars are taxed at a higher rate, and so on; if you make fewer total dollars, that reduces the number of dollars which are taxed at the highest applicable rate, but it has no effect on the dollars which are taxed at lower rates.
posted by Mars Saxman at 3:09 PM on September 25, 2014 [20 favorites]
Best answer: Agreed with all the answers before that in general, you don't "save" money by donating to charity, but there are a couple of corner cases.
Say you have no salaried income, and choose to realize long-term capital gains on the order of $35,000 after your other deductions. Let's also assume the standard deduction is a wash vs. itemized deductions (regardless of which you use, you're at $35,000 of income). Now, the capital gains tax rate jumps from 0 to 15% at $33,951, but you're paying a flat 15% across your entire capital gains, unlike the way the rest of taxable income in the US works. As a result, you owe Uncle Sam $5,250 in capital gains taxes at the 15% rate. Now, if you were to donate $2,000 of your money, and claim that as a deduction, your taxable income goes down to $33,000, your capital gains tax rate goes to 0%, and your new tax liability is $0.
So if you don't donate, you pay Uncle Sam $5,250 and walk away with $29,750 in your pocket. But if you donate $2,000, you pay Uncle Sam $0, and walk away with $33,000 in your pocket, profiting $3,250 by moving yourself into a lower long-term capital gains tax bracket.
The numbers in this example are carefully selected to highlight an edge case, and many taxpayers will never find themselves in this situation, but there are many other situations where carefully donating will certainly result in an amplified donation effect, even if you don't necessarily "save" money.
posted by onalark at 3:13 PM on September 25, 2014 [6 favorites]
Say you have no salaried income, and choose to realize long-term capital gains on the order of $35,000 after your other deductions. Let's also assume the standard deduction is a wash vs. itemized deductions (regardless of which you use, you're at $35,000 of income). Now, the capital gains tax rate jumps from 0 to 15% at $33,951, but you're paying a flat 15% across your entire capital gains, unlike the way the rest of taxable income in the US works. As a result, you owe Uncle Sam $5,250 in capital gains taxes at the 15% rate. Now, if you were to donate $2,000 of your money, and claim that as a deduction, your taxable income goes down to $33,000, your capital gains tax rate goes to 0%, and your new tax liability is $0.
So if you don't donate, you pay Uncle Sam $5,250 and walk away with $29,750 in your pocket. But if you donate $2,000, you pay Uncle Sam $0, and walk away with $33,000 in your pocket, profiting $3,250 by moving yourself into a lower long-term capital gains tax bracket.
The numbers in this example are carefully selected to highlight an edge case, and many taxpayers will never find themselves in this situation, but there are many other situations where carefully donating will certainly result in an amplified donation effect, even if you don't necessarily "save" money.
posted by onalark at 3:13 PM on September 25, 2014 [6 favorites]
According to this article, the capital gains below the marginal rate are taxed at 0%, so there is no way to increase the money in your pocket this using the tax situation I described.
posted by onalark at 3:21 PM on September 25, 2014 [2 favorites]
posted by onalark at 3:21 PM on September 25, 2014 [2 favorites]
Best answer: There are vanishingly few occasions where passing an income threshold for some type of income will make the whole of that type of income taxable, rather than just the amount of the income that exceeds the threshold. This is because the flip side of gaining more by earning less (which, in tax terms is exactly the same as offsetting charitable donations) is that people may earn more but receive less pocket. That would have a chilling effect way beyond any gains, as people on variable incomes would turn down work well before they reached the threshold, because the risk of reaching the threshold and working for negative money is so terrifying. And of course it would be seen as massively unfair.
But the legend remains, and you'll see plenty of people acting on it (or its cousin, buying work related goods because you can put them on your tax return). These people are flat out wrong. Look at it as a simpler version of the Monty Hall problem.
The most obvious case where there are "slab" tax bands I know of is the UK's property sales tax, where e.g. a house that sells for £124,999 pays no tax and one that sells for £125,000 has a £1,250 tax bill. It survives because property transactions are fraught enough that no one's going to invite trouble by fudging the figures to artificially come in under the threshold. But you don't see a lot of houses (well, flats) coming in at the £125,000-£130,000 mark.
TL;DR - This doesn't happen because a system which did this would be perceived as heinously unfair. People think it can happen because we're so attuned to spotting this kind of unfairness we see it where it doesn't exist.
posted by ambrosen at 3:58 PM on September 25, 2014 [2 favorites]
But the legend remains, and you'll see plenty of people acting on it (or its cousin, buying work related goods because you can put them on your tax return). These people are flat out wrong. Look at it as a simpler version of the Monty Hall problem.
The most obvious case where there are "slab" tax bands I know of is the UK's property sales tax, where e.g. a house that sells for £124,999 pays no tax and one that sells for £125,000 has a £1,250 tax bill. It survives because property transactions are fraught enough that no one's going to invite trouble by fudging the figures to artificially come in under the threshold. But you don't see a lot of houses (well, flats) coming in at the £125,000-£130,000 mark.
TL;DR - This doesn't happen because a system which did this would be perceived as heinously unfair. People think it can happen because we're so attuned to spotting this kind of unfairness we see it where it doesn't exist.
posted by ambrosen at 3:58 PM on September 25, 2014 [2 favorites]
Best answer: while I will owe the government $39,600 less, I will also have $100,000 less in my bank account.
Not necessarily. Your bank account could be untouched, and an asset worth $100,000 could be donated. Or... an asset "worth" $100,000 could be donated.
Or an asset that is demonstrably worth $100,000 to someone, somewhere, but was of no value - or was even a financial burden - to you.
One morally questionable (but legal?) tale I read about: Someone bought (say) a box of hundred antique prints, for next to nothing. Try to sell all hundred of them individually, you'd probably have to price them at a few bucks each. So instead they put all their effort into selling just one at a high price. They had one framed, put it in an art gallery, eventually sold it for $1000, and used that sale as evidence that establishes the market value of the prints, the remainder of which were then donated, created a $100,000 tax write-off.
(I have no idea if there is a capital gains liability created in there, but even if there were, the scammer still comes out ahead.)
posted by anonymisc at 4:40 PM on September 25, 2014 [2 favorites]
Not necessarily. Your bank account could be untouched, and an asset worth $100,000 could be donated. Or... an asset "worth" $100,000 could be donated.
Or an asset that is demonstrably worth $100,000 to someone, somewhere, but was of no value - or was even a financial burden - to you.
One morally questionable (but legal?) tale I read about: Someone bought (say) a box of hundred antique prints, for next to nothing. Try to sell all hundred of them individually, you'd probably have to price them at a few bucks each. So instead they put all their effort into selling just one at a high price. They had one framed, put it in an art gallery, eventually sold it for $1000, and used that sale as evidence that establishes the market value of the prints, the remainder of which were then donated, created a $100,000 tax write-off.
(I have no idea if there is a capital gains liability created in there, but even if there were, the scammer still comes out ahead.)
posted by anonymisc at 4:40 PM on September 25, 2014 [2 favorites]
Using charitable giving to actually increase the total amount retained can be done, but requires some fancy tax planning
I'm a fancy tax planner. AFAIK charitable giving always leaves you poorer. Not in spirit though.
posted by jpe at 6:48 PM on September 25, 2014 [9 favorites]
I'm a fancy tax planner. AFAIK charitable giving always leaves you poorer. Not in spirit though.
posted by jpe at 6:48 PM on September 25, 2014 [9 favorites]
A lot of people look at their taxes as a bill they have to pay, rather than just a line item on their paycheck. So they can get $100,000 worth of glory, AND reduce their tax bill by $40,000.
Another scenario would be if you had $100,000 in wage income and $1,000,000 in cap gains income. You might donate $100,000 to offset your wage income to zero and then only pay cap gains. Which might allow for other savings/loopholes.
posted by gjc at 6:51 PM on September 25, 2014
Another scenario would be if you had $100,000 in wage income and $1,000,000 in cap gains income. You might donate $100,000 to offset your wage income to zero and then only pay cap gains. Which might allow for other savings/loopholes.
posted by gjc at 6:51 PM on September 25, 2014
jpe: I used to be a fancy tax planner trust and estates type. You don't think that an investment using an irrevocable, basis only, trust, won't leave you richer off over an regular investment of the same basis over, say, a decade or three assuming a reasonable rate of return?
Because that may be the case, but if so the law has changed since I've been at it. Which, as I haven't done that work in over a decade, it very well might have.
But when I was doing this, in 2004, you could definitely set up some vehicles which would pay off over the long run. But, I stress, this is over the long run. Nothing that's going to help you out in the year of the gift.
posted by bswinburn at 8:53 PM on September 25, 2014 [1 favorite]
Because that may be the case, but if so the law has changed since I've been at it. Which, as I haven't done that work in over a decade, it very well might have.
But when I was doing this, in 2004, you could definitely set up some vehicles which would pay off over the long run. But, I stress, this is over the long run. Nothing that's going to help you out in the year of the gift.
posted by bswinburn at 8:53 PM on September 25, 2014 [1 favorite]
The scumbag Walmart heirs have made an art at of profiting from fake philanthropy. PDF link
posted by any major dude at 10:24 AM on September 26, 2014 [2 favorites]
posted by any major dude at 10:24 AM on September 26, 2014 [2 favorites]
I am familiar with at least one exception to the general rule that you don't come out ahead; don't know how common it is and it involves both Federal and state taxes. The Georgia Goal Scholarship Program funds scholarships to private schools throughout the state. Deductions up to a certain limit ($1000.00 for individuals, higher limits for others) count as as state tax credit; that is, a dollar for dollar reduction of your tax liability. So if I give $1000.00, I take $1000.00 off my state taxes. So far I'm even. But the $1000.00 is also deductible on Federal taxes as a charitable contribution, so for those in a 36.9% bracket they end up paying $369.00 less in federal taxes for a total tax savings of $1369.00 for a $1000.00 donation. Not a bad deal; they even use those numbers in some of their promotional literature. Things like AMT can change the final result, but at least for some people, you come out ahead.
posted by TedW at 2:07 PM on September 26, 2014
posted by TedW at 2:07 PM on September 26, 2014
This thread is closed to new comments.
That said, at higher income tax brackets giving money "costs" less because the marginal tax rate is higher.
posted by 2bucksplus at 2:38 PM on September 25, 2014 [4 favorites]