Sunday, December 18, 2011

Charity and Your Tax Bill.

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!