This is a question we often hear from individual tax return clients. When we send out tax organizers, we ask how much was contributed to charitable organizations in the form of cash, checks and credit cards. We also ask how much was donated in the form of non-cash items, like clothes and household items donated to Goodwill. Charitable contributions do make a difference on most tax returns we prepare for clients, although you might be surprised by how little tax is saved.
The rules have changed recently, and more of our clients are benefiting from making charitable contributions. However, in most cases, the amount of tax dollars individuals now save is less than they used to save.
There are two ways charitable contributions may save you taxes on your federal tax return. The first is by itemizing deductions.
Here’s an overview of how this process can work: when preparing a tax return, the first step is to calculate Adjusted Gross Income (AGI) by adding up all sources of taxable income and then subtracting certain allowed deductions, which are sometimes called “above the line” deductions when calculating AGI. Next, all taxpayers can deduct an additional amount, either the standard deduction or the total of itemized deductions— whichever amount is larger. To minimize the amount of tax, we want to deduct the largest amount possible, because this will result in the lowest possible taxable income and the lowest tax amount.
What’s included in itemized deductions? The most common ones are out of pocket medical expenses, real estate taxes, state income taxes, home mortgage interest, and charitable contributions. To complicate things further, certain limits apply in some cases.
To illustrate how itemized deductions add up, here is what a married couple with a combined average income in Northeast Wisconsin might have for itemized deductions:
|Real Estate Taxes ||$3,000 |
|State Income Taxes ||$4,000 |
|Home Mortgage Interest ||$7,000 |
|Charitable Contributions ||$2,000 |
|Total ||$16,000 |
In this example, we have determined this married couple can deduct $16,000 from their AGI if they choose to itemize deductions. The next step is to compare their itemized deduction to how much they can deduct when instead using the standard deduction. Starting in 2018, the standard deduction was substantially increased. Each year, the standard deduction is increased for inflation. For tax year 2021, the standard deduction for a single person is $12,550 and $25,100 for a married couple. For the married couple in this example, they have the option of deducting either the total itemized deductions of $16,000 or the standard deduction of $25,100. Using the standard deduction results in the lowest taxable income, which means the least amount of tax paid. The couple in this example would only benefit from itemizing deductions if they had deductions of more than $25,100.
Above the Line Deductions
This example mirrors many of the clients we work with. Fewer than 15% of our clients benefit from itemized deductions, because the standard deduction is typically much higher than the total itemized deductions. While most of our clients do not save taxes by deducting charitable contributions as an itemized deduction, there is another way to benefit. Starting in 2020, taxpayers are allowed to deduct up to $300 of charitable contributions as an “above the line” deduction. It’s not a huge amount, yet this deduction reduces taxable income even when there aren’t enough itemized deductions to exceed the standard deduction. For 2021, married couples are allowed an “above the line” deduction of $600, while single taxpayers are still limited to $300.
The option to take an above the line deduction will end in 2021, unless legislation is passed to extend it. This is a fairly small deduction, and there haven’t been a lot of politicians discussing it publicly. It’s possible it will be extended, or even enhanced, as part of a larger tax package; or maybe, this deduction will be allowed to expire in 2022. We are keeping an eye on legislation and will provide updates as changes take place.
If you have questions about itemized deductions or how charitable contributions might affect your taxes, the tax advisors at KerberRose are here to help. Contact our team of tax professionals today!