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Cross-posted on Ask A Foolish Question.

Hi. I'm working on estimating tax liability for this year. I will have paid $16k in federal taxes as a result of withholdings and calculate that I owe another $1.6k. After doing some calculations in tax software, I'd have to give $4k in donations to see any drop in tax liability, and the drop in liability is small (about $90). I know that tax deductions are subtracted from the gross income. Is there any way to get a better tax liability amount to donation amount ratio?

PoorPants
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I forgot to mention that I have never done itemized deductions since I'm pretty young and don't own a house, car, etc. and have no debt an no large medical costs.
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Itemized deductions do not reduce income taxes until they exceed the standard deduction. Since you don't own a house or car, you don't have any mortgage, real estate or auto personal property taxes. The only way to increase the tax reduction from charitable deductions is to have other itemized deductions. Sate income tax or sales tax and any local income taxes are your most likely itemized deductions.

Debra
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However, it NEVER makes sense to lose money in order to get the tax deduction... unless your tax rate is over 100%. Now if you wanted to do the good deed anyway, be my guest, but don't fool yourself into thinking that you'll end up with more money at the end.

Even if you were over the standard deduction, you'd only either give $X to the US government, or you give $4X or so to the charity
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Is there any way to get a better tax liability amount to donation amount ratio?

As has been noted, it probably doesn't make sense for you to itemize for 2005. For future reference, you do get an enhanced break when you donate an appreciated asset to a charity rather than selling it and giving them the money. You do not have to recognize a gain on Schedule D and you get a deduction for full market value.

Your projected balance due seems high relative to your total liability. Have you checked your W-4 to make sure your allowances are correct?

Phil
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Right, I don't expect to end up with more money by donating. I wouldn't mind donating a bit more if it means I can pay the government less.

I'm curious, does transferring money into a retirement fund affect tax liability? I should have done it earlier, but I just started putting money into a 401k plan.
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For future reference, you do get an enhanced break when you donate an appreciated asset to a charity rather than selling it and giving them the money.
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Yes, It's an enhanced break, because you never have to realize the gains, pay the tax and then get the tax back, but they are still gains you are giving away, only to save a portion of them. So if you are going to donate, this is very good. BUT

NEVER DONATE TO CHARITY JUST TO REDUCE YOUR TAXES.

Giving away a dollar to save 30¢?

Donate because of social conscience! But make the best financial decision on what to donate.

DrTarr
Who does donate - but they keep giving the kids back!

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I'm curious, does transferring money into a retirement fund affect tax liability?
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Do you mean funding an IRA account?

Yes, it does effect tax liability.

DrTarr
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Right, I don't expect to end up with more money by donating. I wouldn't mind donating a bit more if it means I can pay the government less.

Right, but it also means you end up with less, not the same. That sounds to me like 'spite', and not a financial decision. While no one likes to pay taxes, you may want to rethink the "I'd rather burn money than give it to the gov't" perspective, it could hurt you down the road. (Note: I am not saying that giving to charities is burning money, but searching out charities that you had no intention of giving to just to avoid taxation kinda is).


I'm curious, does transferring money into a retirement fund affect tax liability? I should have done it earlier, but I just started putting money into a 401k plan.

If you're eligible for a Traditional IRA, yes. But with your income level (based on yor tax liability), you won't be. It's a good idea to put money in a Roth IRA, and it avoids future taxation, but won't help you now. The 401K plan is also a good way to avoid taxation (and *help* yourself), so keep doing that.

The only other thing I can think of is if you have any investment with losses. You could sell them and take the loss and reduce your tax liability. But it's not a good idea to do things JUST for the tax reasons. If you like the company/investment, and want to hold on, the you could easily lose out more than the tax benefit. If you were thinking of selling anyway... well, it could be a good idea.
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I know that tax deductions are subtracted from the gross income.

After you exceed the standard deduction. Read the directions for schedule A and some publications about deductions and you'll have a better idea of what goes into that than we can give you, but others have mentioned the most likely cases (mortgage interest, state & local taxes, property tax.)

Is there any way to get a better tax liability amount to donation amount ratio?

Clumping your deductions. This year you make no additional donation to charity and take the standard deduction. Next year you make several year's worth of donations and exceed the standard deduction.

401k contributions lower your taxable gross income. So you should see that result in a lower tax bill.

and calculate that I owe another $1.6k
Are you concerned about penalties, or is the withholding in 2005 greater than your total tax bill for 2004?

- Megan
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I'm curious, does transferring money into a retirement fund affect tax liability? I should have done it earlier, but I just started putting money into a 401k plan.

The devil is in the details.

Making pre-tax 401(k) contributions reduce your current income taxes because every dollar you put in the 401(k) reduces your current taxable income (reduces W-2, Box 1). However, when you start taking money out of the 401(k) in retirement, it will be counted then as ordinary income.

Likewise, deductible contributions to a Traditional IRA reduce your current income taxes (again, taxable when the money comes out). You should check if you can make deductible contributions to a Traditional IRA before actually contributing; generally, if you cannot deduct contributions to a Traditional IRA but you are able to contribute to a Roth IRA, Roth IRA contributions are more valuable than non-deductible contributions to a Traditional IRA. See IRS Publication 590.

But non-deductible contributions to a Traditional IRA or contributions to a Roth IRA do not affect your current income taxes. All withdrawals from a Traditional IRA, except for the part corresponding to non-deductible contributions, would be taxed when the money comes out in retirement. However, all withdrawals from a Roth IRA, as long as you follow the appropriate rules, are tax free (e.g., had a Roth IRA for at least 5 years and the withdrawal takes place after one has turned 59.5 years old).

I am contributing up to my legal limit to my 403(b) (think of this as roughly the non-profit equivalent of a 401(k)--I work for a community college and we don't have a 401(k) available to us) so my current taxes are far less than they could be (but will be paid in retirement as I withdraw those funds at that time). I and likewise I am contributing up to my legal limit into my Roth IRA, which doesn't affect current taxes but, at least under current law, would be tax free when I retire. A couple years ago I did some restructuring of my portfolio so the taxable investments are more tax friendly than they were three years ago, plus when I did that I ended up realizing a good chunk of capital losses that are reducing taxable income at a tune of $3,000/yr until the capital losses are used up against capital gains (which I should be realizing just a little each year) and up to $3,000/yr of income. Plus living in a relatively high income tax state (9% state marginal tax rate), paying mortgage interest and property tax on my principal residence and making 501(c)(3) contributions to causes I believe in add up on Schedule A so that helps the tax bite.
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For future reference, you do get an enhanced break when you donate an appreciated asset to a charity rather than selling it and giving them the money.

But that applies only to assets that you have had for long term (a year and a day, or longer), doesn't it? I thought I read somewhere that if you had held it short term (up to 1 year) that you still have to declare the short-term gains if you donate it.
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Based on this exchange, I would be curious in what state you live?

If you live in almost any state with a state income tax, your state income tax deduction (based on 80-90k of income) should put you near or over the standard deduction threshhold (5K if you are single).

From a purely financial standpoint, giving to charity, reduces your bottom line. Obviously, the decision to give to charity is a weighing of nonfinancial factors.

Something else to consider if you are unable to get a serious tax benefits this year from charitable contributions - try doubling up next year. Make your 2005 contribution in January 2006 and then your 2006 contributions as the year goes on.

Now, ignore everything I just said and focus on this.

The single most important thing you can do financially and tax-wise is to maximize the benefit of your existing employee benefits. Start with your 401(k) plan. At a minimum you should find out if your employer has a match on employee contributions and you should maximize that match. Next, consider that your 401(k) contribution, up to the statutory limit of $14,000 in 2005 will reduce your income on a dollar for dollar basis by that amount. There are all sorts of benefits that might be available to you which might reduce either your tax liability or enhance your financial position.

If you desire further feedback [without cost, feel free to follow up off line.]
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>> But that applies only to assets that you have had for long term (a year and a day, or longer), doesn't it? I thought I read somewhere that if you had held it short term (up to 1 year) that you still have to declare the short-term gains if you donate it. <<

If you've held the securities for more than a year, you can deduct the full current market value. If you donate them within a year, you can only deduct the cost basis.

#29
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But that applies only to assets that you have had for long term (a year and a day, or longer), doesn't it?

Yes.

Phil
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