Friday, 27 July 2012

Donating to charity: Save tax and benefit society at the same time

In many countries' tax code there is a deduction available if you donate money to organisations that have charitable status.  What this means is that it costs you much less than you are actually giving and still yields the same benefit (because effectively the government contributes your marginal tax rate).  I don't think this would surprise anyone but it does mean that you can do the most good by planning your charitable givings a little.

Overview: Tax deductions for charitable donations

Where a deduction is available for a charitable donation the system works as follows
  1. You donate money that is recognised by your tax system as being a charity.  Charities have to apply for a special tax status for this to be the case but nearly all reputable charities have this already in place.
  2. You claim this deduction back on your taxes at the end of the year
  3. Note that you have to keep your proof of donation (either through a receipt or summary statement sent to you by your charity) in case you get audited.  For example in Australia you need to keep all your tax records for a minimum of 7 years.
  4. You receive back your marginal tax rate from the government in the form of a tax return.  If your marginal tax rate is 30% therefore this means you are only donating 70c of your own money for every dollar of good that your donation is doing

Structuring your donations for tax purposes

Governments intentionally make it easy to claim back donations on tax because charities perform social functions that governments are either unable to or don't have the funds to do (keep in mind that it only costs the government your marginal tax rate to see the charitable services provided).  The only slightly annoying thing is keeping records for tax purposes.

If you donate money to a stall on the street or to collectors that you pass on the street the issue is around proof of donation.  I don't know many people that would stay around and wait for a receipt for a $20 donation because it perceived as too much effort.  I'm the same - if I donate money to a charity that is collecting on the roadside etc then I would never ask for a receipt even though your charitable donations add up (as does the amount you receive back from the tax office)

The best way to structure your donations therefore is through regular payment plans
  • You can donate however much you like through the payment plans.  Charities always push you for larger amounts but just stick to what you can afford
  • At the end of the year they send you a receipt totalling your donations throughout the year
  • They also have your donations on file should you ever lose your receipt and need it in the future
  • You also have proof through your bank and credit card statements should the tax office ever require it
  • Most importantly it is much better for the charity because then they have more certain cash flows and are able to plan their activities much better

Keep in mind that some activities by charities are not tax deductible

This varies on a country by country basis and the charity you are donating to, especially if they are a large reputable one will explain to you what is deductible and what is not. 

For example in Australia if you donate to a religious charity they will often ask you whether you want your donations to come with a tax receipt.  This is because tax deductible donations can only be used for certain purposes such as health services, education, helping the poor.  They cannot use tax deductible donations to provide religious services such as missionary services.  You may want to provide these missionary services so would opt not to receive the tax benefit back.

The best way is to ask the charity and they will tell you up front what they can and cant do with the money.  As long as you are informed about your choice then I think either option is fine. 

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