How donating to charity affects your tax bill
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Many personal finance columnists suggest that donating to charity, especially towards the end of the calendar year, has its benefits.
It’s not just because of the holiday spirit, but rather because there are tax advantages for many Americans when they donate to charity. For the roughly 15% of Americans who itemize their taxes, a charitable donation often means an additional deduction on their income taxes, which means a charitable donation in December becomes a smaller tax bill in April.
How does it all work? How do you know if you are among the percentage of Americans who will receive tax benefits from charitable donations? Let’s start with the basics of income tax.
Also Read: ZDNet’s Income Tax Guide
You pay taxes on your gross income
When you file your income taxes, perhaps the most important number you use is your gross income. This is the total of what you earned in a given year from anything that made money for you – anything you earned from working, selling investments, allowances unemployment, child support and more.
From this amount you can deduct certain things. One of them is charitable donations. You can also deduct interest on your mortgage, certain medical and dental expenses, and state and local income taxes, among other things. One problem that many people will face since the pandemic has pushed many employees to work from home is the home office expense deduction. Others who have looked into small business and side gigs will want to understand small business tax deductions.
Let’s say Tammy earns $40,000 at her job and also earns $10,000 from a small side business she runs from home. His gross income is $50,000. However, from that she can deduct $15,000 of various things – mortgage interest, small business tax deductions and possibly student loan interest payments. This means that in the end, she will only have to pay tax on $35,000.
Many personal finance documents and experts will refer to Adjusted Gross Income or Modified Adjusted Gross Income. This usually refers to your gross income minus the deductions you can claim. So Tammy’s adjusted gross income is $35,000.
Also Read: ZDNet’s Guide to Filing Taxes
Deductions reduce the amount of income taxed at the highest rate
The reason there is so much emphasis on deductions is that when you can add additional deductions to your taxes, it reduces the amount of your income that is taxed at the top rate. A little explanation of tax brackets is in order here.
Do you remember Tammy? He’s a single person, so his tax brackets look like this in 2021:
- 10%: up to $9,875
- 12%: $9,876 to $40,125
- 22%: $40,126 to $85,525
This means that his first $9,875 of taxable income is taxed at a rate of 10%, then all income from $9,876 to $40,125 is taxed at a rate of 12%, then the rest of his income up to $50,000 she earned is taxed at 22%.
So if she paid taxes on the full $50,000, she would have to:
- 10% of $9,875, plus
- 12% of $30,250 (i.e. $40,125 minus $9,875), plus
- 22% of $9,875 (i.e. $50,000 minus $40,125)
This represents $6,790 in taxes.
Remember that most Americans do not face this bill directly every year. Instead, money is taken from each paycheck to cover this. When you file your tax return, you simply report your income and ensure that the money taken from your check covers that amount.
Now, let’s see how the deductions change this story for Tammy. After deductions, she only pays tax on $35,000. She should :
- 10% of $9,875, plus
- 12% of $25,125 (i.e. $35,000 minus $9,875)
This represents only $4,002.50 in taxes.
Those $15,000 in deductions reduced his taxes by $2,787.50, keeping that money in his pocket.
For most people, these types of deductions result in a tax refund check during tax season. This is because the amount taken from their checks usually assumes that they are paying taxes with limited deductions, so there are a lot of takeouts from their paycheck. If you’re able to deduct a lot, you’ll have paid a little too much on your taxes, resulting in a large tax refund check that could change your life.
In Tammy’s situation, each additional charitable donation would reduce her taxable income. This would reduce that taxed amount to 12% in the example above, so if she donated $100, she would see a lower income tax bill of $12, meaning her donation would not cost her really only $88.
In other words, charitable donations when you already have plenty of deductions reduce your taxes a little (or a lot, if you’re in a high tax bracket).
Also Read: ZDNet’s Tax Guide for Freelancers
For most Americans, the standard deduction is a better option
So what’s the problem ? Why don’t people take advantage of it? The big reason is the standard deduction.
To make tax filing more efficient, the IRS offers all citizens a deal: you can simply take a standard deduction rather than making a long list of all your deductions. You simply choose the highest option for you – either the standard deduction or the total of all the things you can actually deduct, like charity and mortgage interest. The real challenge in determining whether to itemize is simply finding proof of all your deductible expenses.
For a single person, this standard deduction is currently $12,550. This means that if you have zero mortgage interest and haven’t made a single charitable donation this year, you still get $12,550 less on your gross income before taxes are calculated. For married couples, that means $25,100 in deductions, and that’s more than most people can find in their expenses.
For charitable donations to reduce your tax bill, you must have deductions that total more than the standard deduction. As a result, only about 15% of Americans actually itemize their deductions [removed Tax Foundation link since it was already used in the intro]; the rest just takes the standard deduction.
When will charitable donations reduce your tax bill?
If you’re one of the roughly 15% of Americans who won’t benefit from the standard deduction, additional charitable donations will likely lower your tax bill. Who is in this group?
The bulk of this group are homeowners with an active mortgage with a large balance, as interest on residential mortgages is usually a large deduction for most people. For example, a $500,000 mortgage with 4% interest will accrue $19,800 in interest in the first year of payments, which in itself is enough to almost overcome the standard deduction for married couples. In expensive real estate markets, such large mortgages are typical.
Another group that often itemizes their taxes are extremely high-income earners, who often rack up numerous deductions even without needing a mortgage due to the various uses of their wealth.
However, if you are an American with little or no money on your mortgage and you earn something close to a typical American income, you almost certainly take the standard deduction, which means that additional charitable donations have no additional tax. benefit for you.
If you have a big mortgage or a very high income, there are several things you can do to make sure you get as many deductions as possible, starting with saving lots of receipts.
Too long, didn’t you read?
Charitable donations can help lower your tax bill, as you may be able to deduct it from the amount of income you have to pay tax on. However, the government offers a standard deduction that most people take instead. Thus, the tax benefits of charitable donations generally only benefit people with large mortgages or very high incomes. If you are not one of these groups, you are unlikely to receive tax benefits from additional charitable contributions.
Is there a tax deduction limit for charitable donations?
The limit on the amount you can deduct for cash donations is generally 60% of your adjusted gross income. However, a temporary suspension of limits by the IRS allows you to itemize and deduct 100% of your AGI in eligible cash contributions for 2021. Filers can deduct $300 for single filers and $600 for married filers without having detail the donations.
What charities can I donate to to qualify for a tax deduction?
Charities eligible for tax-deductible donations include tax-exempt organizations and non-profit organizations such as churches, museums, foundations and the Red Cross. The IRS has a database of eligible organizations and charities.
Can I deduct non-monetary donations?
In addition to cash donations, you can deduct groceries, clothing, cars, household items, and other property. Most goods can be deducted for the fair market value of the items, as long as they are in good condition. With respect to vehicles, the deduction for donating a car varies depending on whether it was sold at auction or kept by the charity. Be sure to keep receipts or written acknowledgments of donations you have made.