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I regularly hear about people giving money to charity to decrease their tax burden in the US. I don't understand the math of this. If I'm being taxed at a 40% rate, then I can give $500,000 to charity, write it off, and save $200,000 on my taxes. That's a net loss of $300,000. I may have paid less taxes, but it cost me 300 grand. It seems similar to the stereotype of the shopper who comes home with bags full of stuff and says "Everything was on sale, look how much I saved!"

Of course, if you want to give charitably, then the tax break is an added bonus, but when I hear about someone giving to charity in order to decrease their tax burden, I feel like one of us is missing something significant. Is there something here that I don't understand?

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possible duplicate of Can making a donation reduce your tax bill? –  JoeTaxpayer Apr 6 '12 at 21:01
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This is an instance where "Read my lips" needs to be taken to heart. Making a charitable donation will reduce your tax bill exactly as you hear people say. Their statements do not claim that making the donation and taking the charitable deduction will increase your wealth, and so don't go hearing what you want to hear. For every itemized deduction that reduces taxes, the money has to be spent first whether in making mortgage payments, paying your doctor, your state income tax, your favorite charity, etc., and your tax bill goes down, as does your net worth. –  Dilip Sarwate Apr 7 '12 at 23:17
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This question reminds me of having a mortgage solely for the tax savings. :) –  Alex B Apr 8 '12 at 20:57
    
I'm a little confused on how the taxes end up working out, but is it possible to actually end up with more money by using a charitable remainder trust? –  Jeremy Stein Apr 17 '12 at 20:22
    
The real way to save money with charitable donations is to run the charity to which you're donating (or have a close friend/relative run it for you). This way you're getting the tax write-off and can still spend the money. From what I can tell, this is how it really works. Why else would every rich person have a "foundation" or charitable organization that their spouse/sibling/children run? You can throw "fund raiser" parties tax free and little money actually goes to the cause. This is why you need to check the administrative overhead of any charity you donate to. –  FistOfFury Dec 11 '13 at 21:09
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4 Answers

I'm being taxed at a 40% rate, then I can give $500,000 to charity, write it off, and save $200,000 on my taxes. That's a net loss of $300,000. I may have paid less taxes, but it cost me 300 grand.

Your logic is correct. However, here's another way to think about it. Suppose you are being taxed at a 40% rate. You wish to purchase $500,000 worth of diamonds. How much do you have to make in income to do so? You need to make $833,333 in income, pay 40% of that ($333,333) in taxes, and then spend the $500,000 on the diamonds.

But to spend that $500,000 on a charitable donation, you only need to make an income of $500,000, taxed at a rate of 0%, because donations to charity count against your taxable income.

Or, yet another way to think about it, is that if you make $833,333 in income, you can spend it on $500,000 worth of diamonds, or $833,333 worth of charitable contributions; effectively you get to purchase $333,333 worth of charitable contributions "for free" over the equivalent purchase that is not a charitable donation.

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great analogy.. –  JohnFx Apr 6 '12 at 22:58
    
Hmm; so charitable buying power is up to 40% greater than all other types –  makerofthings7 Apr 8 '12 at 7:14
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That's actually not exactly true, charitable deduction is limited to at most 50% of income. You'll need 833333 in income to buy 500000 worth of diamonds, but you'll need 1M in income to make a 0.5M donation. But good as an analogy, I guess:) –  littleadv Feb 25 '13 at 18:47
    
Also, remember that the tax rates are marginal, so in theory your marginal savings decline if you give over a certain threshold. –  JAGAnalyst Feb 25 '13 at 23:41
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Agreed.

One of the comments for this question Good books for learning about tax strategy/planning uses the phrase:

"Don't let the tax tail wag the investing dog."

It applies to charitable donations. Donate because it is expected by your church; donate because it makes you feel good; but don't donate just to save money on your taxes.

Once you have decided to donate take the steps necessary to be able to deduct your donation. Get the receipt or use a check or credit card so you can deduct the donation.

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+1, donate because it makes you feel good; but don't donate just to save money on your taxes. –  f1StudentInUS Apr 6 '12 at 20:00
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Excellent quote. And +1 for the answer. Charity for the tax benefit is like buying the baseball cards for the stick of gum. My donations get me a bit of refund I can then send to the next charity. Nothing more. –  JoeTaxpayer Apr 6 '12 at 21:45
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You don't consider a situation where people give to "charity" that they're heading themselves.

But generally speaking you're correct, the idea is that charity is tax deductible, and people prefer to give their money to their local church where they get the direct benefit of it, rather than to Uncle Sam.

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Can you elaborate on the scenario where one would benefit by giving to a charity they head? What circumstances must exist for this to be a benefit? –  Freiheit Apr 6 '12 at 23:08
    
@Freiheit none if you're honest. But honest people seldom become rich. You can fly to the Kenya Safari on a "humanitarian mission", for example... –  littleadv Apr 6 '12 at 23:11
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honest people seldom become rich: I wouldn't take it that far unless you had facts to back it up. Other than that, you are right, this can be used dishonestly. –  musicwithoutpaper Apr 7 '12 at 21:59
    
@musicwithoutpaper most of the forbes-100 members we sued one way or another because of their business practices. Should I remind you the Microsoft monopoly that made Bill Gates one of the richest people on Earth? And yes, he's contributing a lot to a charity he's a head of. –  littleadv Apr 7 '12 at 22:12
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Actually I thought of Bill Gates before writing my comment, but I also thought of "The One Percent" (documentary), and how some (only some) of those interviewed seemed quite reasonable, and I thought of a couple Fox News commentators I watch, and this year's four Republican presidential candidates (yes, I'm anti-Obama), and other folks I see in the news, and I see it differently. I know that does not mean any one of them are honest, but I wouldn't say that honest people seldom become rich. So I question your assertion. But on the other hand I might be overly-optimistic. –  musicwithoutpaper Apr 7 '12 at 23:36
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If you have a software company, that can produce a box of software for $5, but the box sells for $100. (You have to make a profit and cover development costs)

But then you give these boxes to charity, that is a cost of $5 each and a tax rebate of $100 x 40% = $40. A profit of $35 per donation of $5.

Note: You can only do this if you have taxable profit to offset it against.

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This sounds like an intentional abuse of the system. The IRS often investigates schemes where non-cash assets are donated for an inflated "full value". –  Chris W. Rea Apr 7 '12 at 16:24
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and so they should, but it still happens. –  richard Apr 7 '12 at 18:52
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protected by Chris W. Rea Feb 26 '13 at 14:30

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