You hear a lot about how “the rich” are using charities to effectively reduce their tax to minimal amounts, among other methods.
On the face of it without digging, it obviously makes people angry and detest the rich. But scratching beneath the surface, I’m not quite sure how exactly they would achieve this? In order to claim the tax back from money donated, you still have to… donate money? Which would still equal more than the money claimed back from tax.
So unless they are actually doing something illegal and funneling money through a charity, claiming tax, and then using that money from the charity to fund purchases not related to the charities mission, how exactly is it benefiting the donor (financially)?
In: Economics
The correct answers here aren’t exactly ELI5, so I’ll take a go at it.
For easy math, let’s say the tax rate is 10%. If you made $100, you would pay $10 in taxes. But there are two types of income: taxable and tax-exempt. What this means is you don’t get taxed on that entire $100. What you pay for health insurance is exempt, for example. Charitable donations are also tax-exempt, so if you donate $10 of your $100 to charity, you are only taxed on the remaining $90. People will often represent this as getting a tax break; using that same $10 charitable donation, people would say you got a $1 tax break because you only owe $9 after making the donation (10% of $90) instead of the full $10 you would owe if you hadn’t made the donation. You’ll notice that you still had to pay $10 to get that $1 less in taxes, so you’re right to question things
The complication comes in with tax brackets and types of income. Say I’m the CEO of ABC Inc. I get a salary of $100 from ABC and I get stocks from ABC. Now, the income tax is not a flat rate; let’s pretend that the brackets are 0% below $20, 5% for $20-$60, and 10% above $60. Stocks are also taxed separately from income, let’s say that’s a flat 2.5% rate.
So I make my $100 income and would owe $6 in taxes between the tax brackets. But I have personal loans and business expenses and other tax-exempt income, so on paper I only have $40 of taxable income. So I donate $20 of that $40 and keep the $20 that I owe nothing on. I still gave away $20, but that donation makes me look good which makes my company look good which makes my stock prices go up. I can sell some of my stock in ABC, making me $180 that is taxed at 2.5%. So overall I owe $4.50 on $240 in my pocket ($60 tax exempt + $20 at 0% tax + $180 from stocks). But wait! While my stock in ABC was profitable, I also had stock in XYZ that took a loss. I can claim those things, so on paper my taxable income from stocks was $0. I still have $280 in my pocket, but now owe nothing in taxes.
People in-general don’t understand tax laws (again, they are rather convoluted; even my examples aren’t perfect partly due to simplification) and certain individuals/media outlets take advantage of that to push untrue narratives; a politician might say I got a $6 tax break because of my donations and deductions, which is true as I owe $6 less in taxes than if I didn’t have those, but they’ll make it sound like the government gave me $6. Sometimes donations are made as genuine humanitarian efforts, sometimes they are made to help shift around tax burdens and manipulate gains/losses/taxable/non-taxable income totals. Some would say that I paid $0 income tax and that’s not fair (which is true, I paid zero income tax because I donated it all), and others would say the 2.5% tax rate on stocks isn’t fair when income tax is 10%.
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