FROM THE SIMPLEDOLLAR.COM
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. 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 $500 to Doctors Without Borders and another $500 to L’arche Tahoma Hope. That’s a total of $6,000 in charitable donations.
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). This means that his taxable income – the amount he pays on his federal income taxes – is $38,200. 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 $925 for this bracket (25% of $9,700).
To figure up the person’s total tax bill, they simply add together those pieces, which totals $5,675. This person will owe $5,675 on their taxes this year.
In other words, this person’s $6,000 charitable contribution saved them $1,500 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.)
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!
Sunday, December 18, 2011
10 tips worth remembering for year-end tax planning
The window of opportunity for many tax-saving moves closes on Dec. 31. So set aside time with your tax professional to evaluate your situation now, while there’s still time to affect your bottom line for the current tax year. With that in mind, here are 10 things to consider as the curtain closes on 2011.
1. Deferring income to 2012 means postponing taxes. Consider opportunities you might have to defer income to 2012. You might be able to delay a year-end bonus, for example. If you’re able to push what would have been 2011 income into 2012, you may be able to put off paying income tax on the deferred dollars until next year.
2. Paying deductible expenses sooner may help you in 2011. Does it make sense for you to accelerate deductions into 2011? If you itemize deductions, it might help your 2011 bottom line to pay deductible expenses like medical costs, qualifying interest, and state and local taxes before the end of the year, instead of waiting until 2012.
3. Income tax rates will remain the same in 2012. The same six federal income tax rates that apply in 2011 will apply in 2012. So, depending upon your income, you’ll fall into the 10 percent, 15 percent, 25 percent, 28 percent, 33 percent or 35 percent bracket. As in 2011, long-term capital gains and qualifying dividends will continue to be taxed at a maximum rate of 15 percent in 2012. If you are in the 10 percent or 15 percent tax bracket, a special 0 percent tax rate will generally continue to apply.
4. Is AMT a factor?If you’re subject to the Alternative Minimum Tax, special rules apply. For example, the AMT rules can effectively disallow a number of itemized deductions, making it a potentially significant consideration when it comes to year-end planning. You’re more likely to be subject to AMT if you claim a large number of personal exemptions, deductible medical expenses, state and local taxes, and miscellaneous itemized deductions.
5. Consider IRA and retirement plan contributions. Employer-sponsored retirement plans like 401(k) plans and traditional IRAs (if you qualify to make deductible contributions) present an opportunity to contribute funds on a pre-tax basis, reducing your 2011 taxable income. Contributions that you make to a Roth IRA (assuming you meet the income requirements) aren’t deductible, so there’s no tax benefit for 2011. However, qualified distributions are free from federal income tax. The window to make 2011 contributions to your employer plan closes at the end of the year, but you can generally make 2011 contributions to your IRA up to April 17, 2012.
6. Special distribution requirements kick in at age 70½. Once you reach age 70½, you’re generally required to start taking required minimum distributions from any traditional IRAs or employer-sponsored retirement plans you own. It’s important to make withdrawals by the date required. The penalty is steep for failing to do so: 50 percent of the amount that should have been distributed. Barring additional legislation, 2011 will be the last year to take advantage of a provision allowing individuals age 70½ or older to make qualified charitable distributions of up to $100,000 from an IRA directly to a qualified charity (these charitable distributions are excluded from your income and count toward satisfying any RMDs that you would otherwise have to take from your IRA for 2011).
7. Depreciation and expense limits will drop for business owners and the self-employed. If you’re a small-business owner or are self-employed, you’re allowed a first-year depreciation deduction of 100 percent of the cost of qualifying property acquired and placed in service during 2011; this “bonus” first-year additional deprecation deduction will drop to 50 percent for property acquired and placed in service during 2012.
8. Deductions for energy-efficient home improvements will end. This is the last year you’ll be able to claim a credit for energy-efficient home improvements (up to 10 percent of the cost of qualifying property). There’s a lifetime credit cap of $500 ($200 for windows). So, if you’ve claimed the credit in the past, you’re entitled only to the difference between the current cap and the amount you’ve already claimed.
9. Other expiring provisions. Barring additional legislation, this is the last year that you’ll be able to elect to deduct state and local general tax in lieu of state and local income tax, if you itemize deductions. This also will be the last year for both the above-the-line deduction for qualified higher education expenses, and the above-the-line deduction for up to $250 of out-of-pocket classroom expenses paid by education professionals.
10. Get help. Making effective year-end moves requires a solid understanding of the rules that are in effect for both 2011 and 2012. It also requires a comprehensive grasp of your overall financial situation. A financial professional can help you evaluate potential opportunities and can keep you apprised of any last-minute legislative changes. Your tax professional can also prepare a projection to estimate your tax liability.
1. Deferring income to 2012 means postponing taxes. Consider opportunities you might have to defer income to 2012. You might be able to delay a year-end bonus, for example. If you’re able to push what would have been 2011 income into 2012, you may be able to put off paying income tax on the deferred dollars until next year.
2. Paying deductible expenses sooner may help you in 2011. Does it make sense for you to accelerate deductions into 2011? If you itemize deductions, it might help your 2011 bottom line to pay deductible expenses like medical costs, qualifying interest, and state and local taxes before the end of the year, instead of waiting until 2012.
3. Income tax rates will remain the same in 2012. The same six federal income tax rates that apply in 2011 will apply in 2012. So, depending upon your income, you’ll fall into the 10 percent, 15 percent, 25 percent, 28 percent, 33 percent or 35 percent bracket. As in 2011, long-term capital gains and qualifying dividends will continue to be taxed at a maximum rate of 15 percent in 2012. If you are in the 10 percent or 15 percent tax bracket, a special 0 percent tax rate will generally continue to apply.
4. Is AMT a factor?If you’re subject to the Alternative Minimum Tax, special rules apply. For example, the AMT rules can effectively disallow a number of itemized deductions, making it a potentially significant consideration when it comes to year-end planning. You’re more likely to be subject to AMT if you claim a large number of personal exemptions, deductible medical expenses, state and local taxes, and miscellaneous itemized deductions.
5. Consider IRA and retirement plan contributions. Employer-sponsored retirement plans like 401(k) plans and traditional IRAs (if you qualify to make deductible contributions) present an opportunity to contribute funds on a pre-tax basis, reducing your 2011 taxable income. Contributions that you make to a Roth IRA (assuming you meet the income requirements) aren’t deductible, so there’s no tax benefit for 2011. However, qualified distributions are free from federal income tax. The window to make 2011 contributions to your employer plan closes at the end of the year, but you can generally make 2011 contributions to your IRA up to April 17, 2012.
6. Special distribution requirements kick in at age 70½. Once you reach age 70½, you’re generally required to start taking required minimum distributions from any traditional IRAs or employer-sponsored retirement plans you own. It’s important to make withdrawals by the date required. The penalty is steep for failing to do so: 50 percent of the amount that should have been distributed. Barring additional legislation, 2011 will be the last year to take advantage of a provision allowing individuals age 70½ or older to make qualified charitable distributions of up to $100,000 from an IRA directly to a qualified charity (these charitable distributions are excluded from your income and count toward satisfying any RMDs that you would otherwise have to take from your IRA for 2011).
7. Depreciation and expense limits will drop for business owners and the self-employed. If you’re a small-business owner or are self-employed, you’re allowed a first-year depreciation deduction of 100 percent of the cost of qualifying property acquired and placed in service during 2011; this “bonus” first-year additional deprecation deduction will drop to 50 percent for property acquired and placed in service during 2012.
8. Deductions for energy-efficient home improvements will end. This is the last year you’ll be able to claim a credit for energy-efficient home improvements (up to 10 percent of the cost of qualifying property). There’s a lifetime credit cap of $500 ($200 for windows). So, if you’ve claimed the credit in the past, you’re entitled only to the difference between the current cap and the amount you’ve already claimed.
9. Other expiring provisions. Barring additional legislation, this is the last year that you’ll be able to elect to deduct state and local general tax in lieu of state and local income tax, if you itemize deductions. This also will be the last year for both the above-the-line deduction for qualified higher education expenses, and the above-the-line deduction for up to $250 of out-of-pocket classroom expenses paid by education professionals.
10. Get help. Making effective year-end moves requires a solid understanding of the rules that are in effect for both 2011 and 2012. It also requires a comprehensive grasp of your overall financial situation. A financial professional can help you evaluate potential opportunities and can keep you apprised of any last-minute legislative changes. Your tax professional can also prepare a projection to estimate your tax liability.
Monday, December 12, 2011
IRS Announces 2012 Standard Mileage Rates, Most Rates Are the Same as in July
The Internal Revenue Service today issued the 2012 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.
Beginning on Jan. 1, 2012, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:
The standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs as determined by the same study. Independent contractor Runzheimer International conducted the study.
Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.
A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Section 179 deduction for that vehicle. In addition, the business standard mileage rate cannot be used for more than four vehicles used simultaneously.
These and other requirements for a taxpayer to use a standard mileage rate to calculate the amount of a deductible business, moving, medical or charitable expense are in Rev. Proc. 2010-51.
Notice 2012-01 contains the standard mileage rates, the amount a taxpayer must use in calculating reductions to basis for depreciation taken under the business standard mileage rate, and the maximum standard automobile cost that a taxpayer may use in computing the allowance under a fixed and variable rate plan.
Beginning on Jan. 1, 2012, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:
- 55.5 cents per mile for business miles driven
- 23 cents per mile driven for medical or moving purposes
- 14 cents per mile driven in service of charitable organizations
The standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs as determined by the same study. Independent contractor Runzheimer International conducted the study.
Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.
A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Section 179 deduction for that vehicle. In addition, the business standard mileage rate cannot be used for more than four vehicles used simultaneously.
These and other requirements for a taxpayer to use a standard mileage rate to calculate the amount of a deductible business, moving, medical or charitable expense are in Rev. Proc. 2010-51.
Notice 2012-01 contains the standard mileage rates, the amount a taxpayer must use in calculating reductions to basis for depreciation taken under the business standard mileage rate, and the maximum standard automobile cost that a taxpayer may use in computing the allowance under a fixed and variable rate plan.
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