From the IRS: Tax deductable donations are for sissies and home owners.

March 6, 2008

Warning: I’m about to teach you something about taxes. Most you of won’t care. It’s safest to leave now before the boring reaches dangerous levels.

By the way I’m not an accountant. I’m about as likely to be fully correct on the statements below as Neil Patrick Harris is to correctly diagnose your colon cancer. That won’t, however, stop me from trying.

Doogie Howser: not a real doctor.
Nathan Bell: not a real accountant.

I’ve left out a few details because a) I want to keep the examples simple and b) talking about them won’t change the main point:

For large swaths of givers, charitable donations are not incentivized by the government.

Guess what, my donations don’t make a damn of a difference on my taxes. And unless you pay an obscene amount in mortgage interest neither do yours.

Here’s what I learned: You have two options when you fill out your 1040.

  • Option A: Take a standard deduction of $5,350. Every renter does this because it’s simple and gives you a very large deduction.
  • Option B: Itemize your deductions. This only makes sense if your deductions add up to more than $5,350.

Only if you chose Option B can you deduct:

  • Either state sales tax or state income tax (choose one).
  • Mortgage interest payments
  • Donations made to non-profits

This has huge tax implications for renters who donate a significant portion of their income to tax exempt entities.

Let’s be generous

Let’s pretend you’re a renter. I’ll also give you the benefit of the doubt and assume you’re a generous person. Last year you decided you were spending way too much money on booze and hookers and you instead donated $4,000 to a worthwhile cause. Las Vegas mourns the lost income. Also, you paid $1,500 in state income taxes.

What kind of break will the government give you for not being such a worthless hedonist this year?

We’ll approximate: most of you with jobs are either in the 15% or 25% tax brackets. That means for every $1 you make above a certain amount you’ll normally be taxed at either 25% (for my friends who majored in engineering) or 15% (for my friends who majored in English). But if that $1 is deductible then it won’t be taxed at all (via income tax, at least).

$4000 donation + $1500 state income tax deduction = $5500 x 25% = $1375 off of your taxes

Wow, your donation just saved you $1375 on your taxes! Except it really hasn’t because you could have always chosen the standard deduction:

Let’s be greedy

What if, instead, you had kept all that money? Forget the children, you want a big screen.

Well then you would have skipped all that deduction nonsense and instead taken the standard deduction of $5350.

($0 donation deduction + $1500 state tax deduction + …) x 0 (You chose Option A, so you can’t claim any of these) + $5350 standard deduction = $5350 x 25% = $1337.50

Tax credit when you’re generous $1375.00
Tax credit when you’re greedy $1337.50
Tax difference for all you generosity $37.50

Greed wins!!!

Even if you own a home your mortgage interest payments have to be approaching $4000 a year before tax incentives for donations kick in.

Does greed win?

So, fine. It seems that the government has stopped incentivizing donations for all but the very rich. But why?

I’m still trying to figure that out. What I’ve found is this:

  • The government doesn’t like to give up revenue. We already knew that.
  • The government trusts that despite not getting a tax break, you’re going to make that donation anyway. This is backed up by research done here.
  • The above research is hardly definitive, as shown here, here and here.

It all revolves around one very important question: what is the price elasticity of charitable contributions? In other words, are people likely to donate more if there is a tax deduction that comes along with it?

If you can answer that, then you can answer an even more important question: is it more efficient for the government to encourage people to donate to non-profits, or to take the money itself to provide additional services and hand out grants?

I know what I hope the answer is, and I intend to learn more about this. Stay tuned.


4 Responses to “From the IRS: Tax deductable donations are for sissies and home owners.”

  1. Mike Harmon Says:

    I found your site on technorati and read a few of your other posts. Keep up the good work. I just added your RSS feed to my Google News Reader. Looking forward to reading more from you.

    Mike Harmon

  2. smarkey Says:

    Getting the government to actually CHANGE its policy and the way it handles deductions overall (for renters, poor, homeless(?), or whoever) in a timely fashion…good luck. YAY GREED!

  3. AdamD Says:

    Here’s what the gov would take from your post: eliminate the standard deduction–it’s unfair to the generous renters.

    I’ve always been very happy to take the standard deduction. I’m glad it exists. But this is my last year taking it. I entered into home ownership.

    My house is not extravagant and compared to the rest of the west coast, my city (Portland) is not expensive. But, I’ll have no problem surpassing the standard deduction in 2008. In fact, I think I already have with three mortgage payments.

  4. sandrar Says:

    Hi! I was surfing and found your blog post… nice! I love your blog. :) Cheers! Sandra. R.

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