海角大神

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鈥檛 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鈥檚 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鈥檛 quite understand is how the amount you pay is calculated.

Let鈥檚 say you are a single person earning $50,000 this year (we鈥檙e not going to worry about issues like personal exemptions and other tax issues that would further complicate the issue 鈥� we鈥檒l 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鈥檚 a different table for married couples):

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

So, as I mentioned, we鈥檙e 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鈥檚 $850 for this bracket (that鈥檚 10% of $8,500).
聽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鈥檚 $3,900 for this bracket (15% of $26,000).

聽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鈥檚 $3,875 for this bracket (25% of $15,500).
聽To figure up the person鈥檚 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鈥檚 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鈥檚 income for tax purposes is actually $44,200.

So, let鈥檚 look at this person鈥檚 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鈥檚 $850 for this bracket (that鈥檚 10% of $8,500).
聽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鈥檚 $3,900 for this bracket (15% of $26,000).
聽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鈥檚 $2,425 for this bracket (25% of $9,700).
聽To figure up the person鈥檚 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鈥檚 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鈥檚 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鈥檃rche Tahoma Hope. That鈥檚 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 鈥� the amount he pays on his federal income taxes 鈥� would likely be $41,000. Let鈥檚 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鈥檚 $850 for this bracket (that鈥檚 10% of $8,500).
聽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鈥檚 $3,900 for this bracket (15% of $26,000).
聽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鈥檚 $1,625 for this bracket (25% of $6,500).
聽To figure up the person鈥檚 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鈥檚 $9,000 charitable contribution saved them $2,250 on their taxes. That鈥檚 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 鈥� compared to the standard deduction 鈥� for this charitable giving is $800. Charitable giving works best as a tax deduction if it鈥檚 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鈥檛 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鈥檚 still a great little bonus.

Hopefully that clears things up for you!