Charity and Your Tax Bill

Edit: I made a mistake with the standard deduction math and explanation near the end of the original version of this post. I have since corrected it. Thanks to the readers who pointed it out.

Monica writes in:

Last year, I took the advice of my older brother and made several charitable donations during December to help out my taxes for the year. When I filed them, I did get a return, but it wasn’t nearly as big as I expected. Are charitable donations really a big deal or did I do something wrong?

Charitable donations do provide a reduction in your taxes, but it’s not the huge reduction that many people often think they are or expect that they are.

To understand the benefit that charitable donations give to your taxes, first you have to understand how income taxes work. This is something that many people surprisingly misunderstand.

When you earn ordinary income from working at a job, you have to pay income taxes on it. We all know that, of course. What many people don’t quite understand is how the amount you pay is calculated.

Let’s say you are a single person earning $50,000 this year (we’re not going to worry about issues like personal exemptions and other tax issues that would further complicate the issue – we’ll just look at $50,000 in taxable income after such things). To figure out how much taxes you have to pay, you have to look at the income tax rate table. For 2011, it looks like this for single people (there’s a different table for married couples):

For income between $0 and $8,500, you pay 10% in taxes.
For income between $8,500 and $34,500, you pay 15% in taxes.
For income between $34,500 and $83,600, you pay 25% in taxes.
For income between $83,600 and $174,400, you pay 28% in taxes.
For income between $174,400 and $379,150, you pay 33% in taxes.
For income over $379,150, you pay 35% in taxes.

So, as I mentioned, we’re looking at a single person who makes $50,000 a year.

For the first $8,500 of that (the $0 to $8,500 bracket), that person has to pay 10% of the income in taxes. That’s $850 for this bracket (that’s 10% of $8,500).
For the next $26,000 of that (the $8,500 to $34,500 bracket), that person has to pay 15% of the income in taxes. That’s $3,900 for this bracket (15% of $26,000).
For the rest of his pay ($15,500), that person is in the $34,500 to $83,600 bracket, which means that person has to pay 25% of that portion of his income in taxes. That’s $3,875 for this bracket (25% of $15,500).
To figure up the person’s total tax bill, they simply add together those pieces, which totals $8,625. This person will owe $8,625 on their taxes this year.

Now, how can a person lower that amount? The most common way is through deductions. The government gives out standard deductions each year on a person’s taxes. For 2011, that amount is $5,800 for a single person. How that works is that you simply subtract that deduction from the total amount of income the person earned for the year. So, this person’s income for tax purposes is actually $44,200.

So, let’s look at this person’s actual taxes after their standard deduction.

For the first $8,500 of that (the $0 to $8,500 bracket), that person has to pay 10% of the income in taxes. That’s $850 for this bracket (that’s 10% of $8,500).
For the next $26,000 of that (the $8,500 to $34,500 bracket), that person has to pay 15% of the income in taxes. That’s $3,900 for this bracket (15% of $26,000).
For the rest of his pay ($9,700), that person is in the $34,500 to $83,600 bracket, which means that person has to pay 25% of that portion of his income in taxes. That’s $2,425 for this bracket (25% of $9,700).
To figure up the person’s total tax bill, they simply add together those pieces, which totals $7,175. This person will owe $7,175 on their taxes this year.

So, that person’s standard deduction on their taxes actually saved him $1,450. The standard deduction may be $5,800, but it only saved the guy $1,450 because the deduction just reduces his total income for the year in terms of taxes.

Charitable giving works exactly the same way. Every dollar you donate to a registered charity becomes a deduction on your taxes, just like a standard deduction.

Let’s say the person above donates $5,000 to his church (a 10% tithe) and $2,000 to Doctors Without Borders and another $2,000 to L’arche Tahoma Hope. That’s a total of $9,000 in charitable donations.

So, this person makes $50,000 a year. From that, he can either subtract his standard deduction ($5,800) or he can subtract his charitable donations ($9,000). This means that his taxable income – the amount he pays on his federal income taxes – would likely be $41,000. Let’s look at his taxes now.

For the first $8,500 of that (the $0 to $8,500 bracket), that person has to pay 10% of the income in taxes. That’s $850 for this bracket (that’s 10% of $8,500).
For the next $26,000 of that (the $8,500 to $34,500 bracket), that person has to pay 15% of the income in taxes. That’s $3,900 for this bracket (15% of $26,000).
For the rest of his pay ($3,700), that person is in the $34,500 to $83,600 bracket, which means that person has to pay 25% of that portion of his income in taxes. That’s $1,625 for this bracket (25% of $6,500).
To figure up the person’s total tax bill, they simply add together those pieces, which totals $6,375. This person will owe $6,375 on their taxes this year.

In other words, this person’s $9,000 charitable contribution saved them $2,250 on their taxes. That’s because the person was in the 25% tax bracket before the donation and in the 25% tax bracket after the donation, which means that they essentially saved 25% of their donation on their taxes. (Sometimes, a donation will drop you to a lower tax bracket, which is fine.)

However (and this is where the readers pointed out my mistake in the original version of this post), the standard deduction would save the person $1,450. The actual savings – compared to the standard deduction – for this charitable giving is $800. Charitable giving works best as a tax deduction if it’s coupled with other deductions, such as home mortgage interest.

So, charitable donations are a great thing and they do offer some tax savings, but you don’t save $1 for every dollar you donate. Instead, you often reduce your tax bill roughly a quarter or so for every dollar you donate. That’s still a great little bonus.

Hopefully that clears things up for you!

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  1. matt says:

    thank you for correctly showing how a tax bracket works. Too many people still believe “If you get a $5,000 raise you may actually pay >$5,000 in new income taxes” This is obviously false, but so many finance ‘experts’, websites, etc still try to pass this off as factually correct.

  2. Johanna says:

    “first you have to understand how income taxes work. This is something that many people surprisingly misunderstand.”

    “Many people” apparently includes Trent.

    Trent, you do not get to deduct both the standard deduction and your charitable donations! To get any tax benefit at all from your charitable donations, you have to itemize deductions, which means the standard deduction goes away.

    In the example you give, if the $6000 in donations is the person’s only deductible expense, he replaces the $5800 standard deduction with $6000 in itemized deductions, so he only saves $50 on his taxes, not $1500.

    He may have other deductions he can take, though. He probably paid state income taxes (or sales taxes), and he can add those on to the itemized deductions. If he has a mortgage, he can also include the mortgage interest.

    But if all his itemized deductions add up to less than the standard deduction – if he doesn’t have a mortgage, doesn’t donate that much to charity, and doesn’t pay much in state taxes – then he’s better off just taking the standard deduction. for a person in that situation, charitable donations save him precisely nothing on his taxes.

  3. Misha says:

    I’m sure that’ll get corrected in the article right away, since Trent assured us that he reads all the comments.

  4. kc says:

    What Johanna said! Duh. When you itemize, the standard deduction no longer applies.

    This post really ought to be corrected, Trent (if you are listening).

  5. Alice says:

    This is completely inaccurate information about how the standard, itemized, and charitable deductions work.

    I really hope Trent (or the new owner of this site) puts a huge disclaimer at the top of this post, as people who follow this advise right now as the end of the tax year is approaching could end up with disastrous consequences.

  6. Johanna says:

    You know, I wonder if this is some kind of year-long April Fool’s joke we’re all falling for, where Trent is giving bad information on purpose just to stir things up. How else could it happen that his tax advice is more likely to be wrong than right?

  7. Jonathan says:

    You shouldn’t ever do ANYTHING because of a tax deduction. Do it because you want or need to and any tax benefit is just that, a benefit. So, donate all you want to charity, and if you itemize your taxes, you get “something back”.

    My accountants pat answer to the question, how can I lower my taxes is, make less money!

  8. Tom says:

    Oh Trent. It pains me that you would give out this advice without mentioning that you need to itemize to take a charitable deduction.
    And I agree with Jonathan, don’t ever do anything for a tax deduction.

  9. Becky says:

    I am glad others are pointing out the error regarding itemizing vs. taking the standard deduction. This is a huge misconception that I run into all the time, and I am really disappointed that Trent seems confused about this as well. He got so close, explaining marginal rates correctly, then completely blew it regarding how deductions work.

    If you have no children and don’t have high medical expenses, church tithes, or some other quite large deduction, it’s unlikely that itemizing will get you more than the standard deduction. I’m 42, and although I save receipts and check carefully every year, itemizing has never gotten me anywhere close to the standard deduction. So extra charitable donations would not save me anything at all on my taxes.

  10. valleycat1 says:

    Johanna – interesting you mention that – I’ve posited the same thing in the past. Then, I recently read an old post on one of the sites Trent mentioned in an old interview as a favorite. The advice was on how to drive readers to your blog, and one of the first rules was to be willing to be wrong on purpose. Essentially, the advice was to post an incorrect statement, and sit back & watch the folks flock to correct you.

    However, if this is one of Trent’s approaches, it’s really in poor taste to lead people in the wrong direction when it comes to possibly significant tax ramifications. If a person reads this advice & decides they’re not going to owe that $1500, then most likely they’ll spend it instead of setting it aside for taxes, and then come up short in April when the bill comes due.

  11. valleycat1 says:

    I posted a plea on his facebook page to come back & fix this.

  12. Johanna says:

    “don’t ever do anything for a tax deduction.”

    I get what you’re saying, Tom and Jonathan, but I wouldn’t go that far. For example, because of the tax deductions involved, it’s usually a good idea to put your retirement savings in a 401(k), IRA, or similar account, rather than in an ordinary taxable account.

    But almost all of the examples I can think of (including that one) involve something you would be doing anyway (like saving for retirement), but where the tax consequences just affect questions of when, how, or how much.

  13. Sara says:

    When I first started reading this post, I thought it was a great idea because, indeed, many people do not understand how charitable tax deductions work. It really bugs me when people think that the rich give to charity because it saves them money. Yes, it reduces their taxes, but by less than the amount they donate. They are still being generous by giving up money that they otherwise could have kept.

    But, as other comments have pointed out, the second half of this post is very wrong. You have to itemize deductions to get anything back from charitable donations, and you don’t get the standard deduction if you itemize deductions. In some cases, one’s itemized deductions might actually add up to less than the standard deduction, and as a result, charitable donations would not result in any tax savings whatsoever. For example, if your only deduction is a $5000 charitable donation, you’re better off taking the standard deduction, so that $5000 donation makes no difference in your taxes.

  14. Nick says:

    Hey new site owners… you should start fact-checking these articles.

    “So, this person makes $50,000 a year. From that, he can subtract his standard deduction ($5,800) and he can also subtract his charitable donations ($6,000).”

    Just no. Absolutely not. They can do one or the other.

    Marginal rate analysis is really good though. A lot of people are confused about how that works.

  15. Dee says:

    My mouth dropped open when I read the post because it’s so wrong! I’m glad Johanna and other commenters got in here swiftly, though I hope people who Google and wind up here read the comments, too.

    Wow.

  16. Riki says:

    I’m quite convinced that Trent makes these mistakes on purpose to drive traffic to his blog. He would never generate the interest he gets based only on the content of his articles.

    The other alternative, that he really is misinformed, seems . . . unlikely given how much reading he does on personal finance. At least, I really (really, really) hope it’s unlikely. But one never can tell.

  17. Andrew says:

    At least Trent isn’t giving out medical advice. I can’t imagine–

  18. Kacie says:

    Correct this post, Trent!

    Here’s something else to look into if you are looking for charities and also want to have a tax boost. In my state (Indiana) there are NAP tax credits available for certain charities.

    So take Stone Belt, an organization in Bloomington that works with mentally disabled adults.

    If I go to that charity and tell them I want to get a NAP credit they give me a form, I make a donation, and I get a 50% tax CREDIT back on my Indiana state taxes.

    So, donate $200, get $100 off my state income tax. Not bad!

  19. AnnJo says:

    Plenty of commenters have caught the error about deducting both the standard deduction and charitable contributions, but there is aother mistake Trent made that, while less significant, also affects the math he did.

    In addition to the standard deduction or itemized deductions, anyone earning $50,000 a year will be entitled to one personal exemption for him/herself and one for any child who is a dependent. For 2011, the personal exemption is $3,700.

    So when Trent says that, in his example, the person’s income for tax purposes is $44,200 ($50,000 minus the standard deduction of $5,800), he’s off by $3,700. The person’s taxable income is $40,500.

    Trent’s example also assumes that the person had no adjustments to income, such as IRA contributions, moving expenses, student loan interest, self-employment tax, or alimony paid, all of which get deducted whether or not you use the standard deduction or itemized deductions.

    There are free tax calculators online and anyone who wants to know the effect of a charitable contribution on this year’s taxes need only go to one of them and run the numbers. It’s worth considering, also, that if you plan to itemize, at higher tax brackets where a charitable deduction is worth more, itemized deductions start to phase out, so short of running the calculations there’s no easy way to predict the value of the deduction in saving money.

  20. AnnJo says:

    In the last line of my previous post, I should have said “reducing taxes” rather than “saving money.” Obviously, you’re not saving money by making a charitable deduction.

  21. Alice says:

    I hadn’t thought about the possibility that Trent was deliberately posting incorrect information to drive traffic; I’m hoping he’ll actually correct this post to prove people wrong.

    If this is deliberate misinformation to drive traffic, then Trent’s about as reputable as a used car dealer selling a clunker to a naive senior citizen. I hope really hope that’s not the case.

  22. lurker carl says:

    Ann Landers and Dear Abby built long and successful careers writing advice columns based on common sense, exhaustive research and consulting experts for factually correct answers to readers’ questions. Habitually giving misinformation makes for an unreliable advisor. I hope “intentional errors will increase website hits” is not part of Trent’s business model.

  23. DrFunZ says:

    Let’s get serious. Trent is a published author and has had this blog for years. Rarely does he make big mistakes and it would not be in his best interest to post misinformation purposely. If he made an error, then he will correct it.

  24. justin says:

    This site is for entertainment purposes only. Trent is not a financial advisor and no information found on this site should be construed as financial advice.

    you all forgot to scroll to the bottem of the website. lol

  25. Kevin says:

    Yeah, no, that’s not even remotely close to accurate.

  26. Riki says:

    DrFunZ . . . don’t hold your breath.

    “Rarely does he make big mistakes”? If only that were the truth. I’m not even an American and I knew Trent was wrong in his post.

  27. Kerry D. says:

    And too bad about the absurd mistake, because it entirely distracts from the part about how the incremental tax brackets work… and many taxpayers don’t know or understand that part, and it would be useful to get that.

  28. Johanna says:

    Almost every time Trent writes about taxes (mostly in the reader mailbags) he gets something wrong or other. As far as I know, he’s never corrected any of those posts. With the new site management, I would love to see that trend reverse.

  29. kc says:

    Trent is compensated on ad views, not clicks.

  30. kc says:

    Actually, page views would be more accurate; sorry.

  31. Kacie says:

    Glad to see the edit!

  32. kc says:

    Agree! Wonder of wonders.

  33. Johanna says:

    I too am glad to see the edit. But why change the amount of the donations from $6k to $9k?

  34. kristine says:

    “I recently read an old post on one of the sites Trent mentioned in an old interview as a favorite. The advice was on how to drive readers to your blog, and one of the first rules was to be willing to be wrong on purpose. Essentially, the advice was to post an incorrect statement, and sit back & watch the folks flock to correct you.”

    So smart, but so wrong. It’s manipulative and dishonest, and has probably harmed at least one or two readers, despite disclaimer. Integrity matters. I am glad to see this was corrected, but I also have never seen a post corrected before the blog was sold, and I will bet it is because of that comment. Between now knowing that, and the hawking of his buddy’s copyright infringing products on this blog, I have lost all respect. I can never trust another answer on here. I have no interest in being played for a buck. Sad. I will miss some of the regular commenters. What a bummer.

  35. jim says:

    I’m not cynical enough to think Trent states unfactual information in some diabolical plan to make us read him more.

    I don’t really see how posting incorrect things would drive traffic to the blog. It won’t drive google traffic here. It won’t retain new readers. All it does is cause the regular readers to react. Getting your facts wrong too much will lower your credibility and you drive away your readers.

    Controversy is another matter. I can see how controversial stuff can create more traffic and activity. But controversy and getting your facts wrong aren’t equivalent.

  36. David says:

    “But why change the amount of the donations from $6k to $9k?”

    Well, it is Christmas after all.

  37. Tom says:

    “But why change the amount of the donations from $6k to $9k?”

    Let’s not troll too hard here, I think it’s reasonable to assume that your comment #2…

    “In the example you give, if the $6000 in donations is the person’s only deductible expense, he replaces the $5800 standard deduction with $6000 in itemized deductions, so he only saves $50 on his taxes, not $1500.”

    …is the reason for the change. No one would get too excited over a $50 savings on a $6000 outlay.

  38. Tom says:

    …or he just wanted the rest of the math already in the article to stay the same.

  39. Kevin says:

    As a 26 year old, working for 2 years, renting, I never found itemized deductions to approach the standard deduction.

    Interesting note: in Canada you can deduct charitable donations, political contributions and more in addition to your “standardized” deduction.

  40. valleycat1 says:

    Thanks, Trent, for editing this. I know that on the Kindle version the comments don’t show up, so editing the actual article is the only way those subscribers might see the corrected info.

  41. Johanna says:

    @Tom: It’s not trolling. The whole point of the post is that you shouldn’t get too excited about donating to charity to save money on your taxes. Why change the numbers to obscure that point?

  42. jim says:

    Johanna seriously… who cares? You’re not trolling but I think you’re at least being unnecessarily nitpicking now.

    Its all just made up numbers to make a pretend example. It doesn’t really matter much at all if he uses 6000, 9000, 7128 or 8000 or anything in between.

  43. Brittany says:

    So many errors… wow… wow…

    Seriously, you left off personal exemptions AND screwed up the standard deduction?

    Why do we still read this guy?

    (Oh, right–it’s one of the few places on the internet with a respectful, intelligent, lively, interesting comment board.)

    At least he half-fixed it?

  44. Annie says:

    I am just getting to read this article today. Boy is the information Trent presented outrageous. I wonder why if someone emails you with this kind of question, why not ask a Tax Accountant for advice and add that information to the blog instead of giving your own interpretation. You can really mislead and give wrong information to the readers out there but it looks like most of your readers know more than you about taxes, 401K and other topics. Some areas are just not your expertise. sorry.

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