The great deduction debate.

I came across a person the other day, who suggested that anyone who lists charitable gifts on their taxes is not donating out of the goodness of their heart, but for the selfish benefit of receiving a tax deduction. Upon hearing those words I had a facepalm moment…

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I guess they have a point, the deduction benefits probably do encourage charitable giving. I mean when was the last time you gave more than $500 to a business or organization that didn’t qualify for a deduction?

If you’re like me the answer is almost never.

Sure I give $20 here and there to a homeless person, or I might give $100 to a friend for a missions trip, but I honestly don’t think I’ve ever just walked down to my local coffee shop and been like; “Hey you guys do awesome work and I want to support the business, here’s $500.”

So yes, I guess most of us probably do only give substantial financial gifts to charities that allow us to deduct that gift from our tax obligation, but ultimately I have to disagree with the sentiment.

I might be wrong, but I’d bet most people who make charitable contributions do so because they want to help someone or something out, not because they’ll get a deduction.

It just doesn’t make financial sense.

If I’m in the 25% tax bracket and I give $10,000 to charity over the course of the year, my maximum benefit for making that contribution would be $2,500. Why the heck would I give someone $10,000, so I can save $2,500? It clearly would be to my benefit to never make the contribution, write Uncle Sam a check for an extra $2,500, and keep the remaining $7,500.

And that is exactly the point I want to make today.

Why do people get so pumped on tax deductions like they are best thing ever? I mean people were telling me to keep my student loans because I could deduct some of the interest on the loan.

They literally were trying to convince me to keep paying $2,000 a year in interest to Sallie Mae, so I didn’t have to send the government $500.

I bet some of you with mortgages have probably had similar garbage preached to you, “Don’t pay off the mortgage, you’ll lose the deduction.”

Don’t get me wrong. I love me some deductions. If you are eligible, take ’em. Just don’t do something stupid and give Person A $5,000 so you can avoid giving Person B $1,000… Unless of course you have so much freakin’ money you like wasting it, then by all means waste to your heart’s content.

Have you been told to keep a debt around longer than you wanted because of the tax deduction? Do you regularly give significant financial gifts to non-qualified businesses or organizations? Have you ever given a gift, purely for the tax benefit?

24 thoughts on “The great deduction debate.

  1. The whole deduction topic is basically a litmus test for me when reading articles about mortgages. If the article tells me to keep my mortgage for the deduction, I stop reading. If it says the mortgage deduction is B.S., I keep reading. Same thing should apply to any deductible debt stuff.

  2. Hilarious article, and so true. Sooo many [broke] people were incredulous we would ‘waste’ our tax deduction by paying off the mortgage.

    My standard response became “I figure we’ll just donate the $10k each year to the church instead of giving it to the bank as interest, and we’ll keep the same deduction.”

    THAT shuts them up.

    • I absolutely LOVE this response &am going to use it! It’s funny, not really, how folks with NO money try to give me advice. IF they only knew the total of our investments, they’d be asking us for advice.

      • Rose – honestly I think I stole it somewhere along the line from my favorite guru, Dave Ramsey. This deduction debate always gets him riled up!

  3. You nailed one of my sore subjects about the tax deductions. People say things like “well off course a mortgage is a great deal because of the tax deduction”!

    Why would you pay someone a dollar to get 20-25 cents back? Also, depending on the amount of your interest on a mortgage and other itemized deductions – you might not even qualify.

    You must give based on what your values are – not on what you can deduct. The deduction is only a bonus if you can use it.

  4. Your post leaves out that there are a huge number of people who don’t utilize the tax deduction for their charitable donations since they don’t itemize! I used to prepare returns and I can’t tell you how many people would come in with their Goodwill receipts and no other deductions!

  5. “I bet some of you with mortgages have probably had similar garbage preached to you, ‘Don’t pay off the mortgage, you’ll lose the deduction.'”

    I had several friends run this one by me. At first I would argue, but that usually got uncomfortable as they tried to defend their own actions. Now I just smile and nod and let them believe I agree with their “math”.

  6. This is a bit of an oversimplification, in a couple ways, specifically with regards to mortgage interest and student loans.

    The point of noting that these are tax deductible is not to say that “oooh, keep these debts around forever so you can save 25% of what you pay on them from taxes.” It’s that a 4% mortgage is actually on a 3% mortgage when you factor in the fact that 25% of the 4% interest you pay (i.e. 1%) is tax-deductible.

    This, then, changes (or at minimum influences) the calculus of whether you’re better off paying off that mortgage more aggressively or, instead, investing extra dollars you have. At a 4% interest rate (without tax deductions factored in), if you have an extra $1000, maybe you say “well, I’ll take the safe 4% return and pay down extra on my mortgage.” But at 3% (i.e. your real interest rate when you factor in the tax deductibility), maybe that calculus changes for you and the long term returns of the stock market (7%? 8%? 9%) start to look a lot more appealing, even if they’re less “guaranteed.”

    I mean, you’re not wrong — don’t keep debt just for deductions. But you should definitely FACTOR IN those deductions when making choices between paying down debt more aggressively versus investing (or in regards to which debt you should pay down first — if you had a car loan at 4% and a student loan at 5% and didn’t factor in the deductibility of the student loan, you’d put money towards the WRONG debt in terms of paying off the highest interest loan first.)

  7. I have heard so many people say they will always have a mortgage for the tax deduction. When we looked at getting a mortgage, we had to at least get a $200K 30 year loan to maybe qualify for the deduction and that means we would have to itemize, which means the deduction will have to be bigger than the standard deduction. Hmmmm the math makes no sense to me.

  8. I see nothing wrong with deriving tax benefits from charitable giving; the deduction was obviously intended as an incentive, and if I can benefit both myself and the organization what is the harm? Still, I pick and choose my charities very selectively, and wouldn’t contribute to any I didn’t personally support. (One type of organization I have stopped giving to is my colleges. Decades after graduation, they still feel entitled to pester me year after year for alumni donations. Enough already.)

    As for mortgage vs. charitable, these are two very different categories of deductions. One is debt-related, and I see no good reason to keep a mortgage merely for the deduction. (As it is, the longer you hold the property, the more your payments count towards the principal. I have kept my home long enough that I am paying very little interest anymore.) Property owners, however, can also deduct real estate and property taxes, which will also help their tax situation.

    But whether or not you can itemize (which is the only real tax issue here) is a matter of your total tax picture, not any one type of deduction. It should not be forgotten that even if you don’t have a mortgage, even if you contribute nothing to charity, even if you have no state income or sales tax, you still have a respectable standard deduction in which the government treats you as if you have various deductible items; you just are not over the threshold whereby you have to itemize.

    And as for giving $500 or whatever to an organization that does not qualify for a deduction, yes I have made a number of small political contributions, which are not deductible.

  9. I should point out that whether you itemize is not invariably a matter of crossing a tax threshold. There are circumstances where taxpayers must itemize (such as non-resident aliens), and other cases where you might prefer the standard deduction (perhaps because you didn’t keep adequate records). As it is, 2/3 of taxpayers take the standard deduction.

  10. My argument for not paying off a mortgage or car loan is that I can make more money investing the money then I can by paying off the debt.

  11. With a 25% deduction on charitable giving, if I want to give $100 from my own money, I can actually give the charity $133. Uncle Sam will pay the $33 in the long run, when I file my taxes. So in this way, the charity will end up with more money than what I gave them.

  12. This is exactly why you need to be able to perform 5th grade math in the real world. You’re right, the idea of KEEPING your mortgage or student loan for the tax write-off is crap. If you are paying down your debt, then of course take the write off. Duh! But don’t hold onto debt because you want the write off. If you think this is a good idea, buy a new calculator. Great read my friend!

  13. The mortgage and student loan interest deduction kill me. When I hear that I know excuses are just going to keep coming, might as well start telling me your fishing stories because those are more believable.

  14. I kind of got wrapped around the wheel on the mortgage deduction.. but not because I really wanted to give that money away.. but out of college with $20k to my name you can’t exactly our right by a house… So you get a mortgage..

    I’ve let it go several years and kept looking at the deduction benefit… hahah such a joke… Mortgage is about to under $100k and my focus now is on accelerating payments to that…

    I did get into a 15 year at 3% so when I look at the interest its not that bad… But soon that interest will be low enough that I might not qualify for the deduction.. so I’m just going to get it paid off…
    cheers!!

  15. I’m with you…I don’t really give for the tax deduction. Honestly, it never crosses my mind until it’s time to do my taxes and I’m like, “Oh hey, yeah I have all these receipts here that I should enter.”

  16. You know who else hates deductions, me. A tax system built around deductions (WTF- Standard deduction??) is built for tax evasion, special interests, and all kinds of political BS.

    I shouldn’t have to predict my tax rate- it should be a very simple and straightforward calculation based on my earnings. Even though i’m a big believer in charitable giving, I also don’t think that should be a deduction.

    Sure, I’ll pay someone to take advantage of my myriad of deductions, but not because I think that’s a good system.

  17. I agree in not giving money just for a tax deduction. As a CPA, I see people always worried about that. However, there is one point that you aren’t mentioning that does make giving to charity important if you own stocks that have significantly appreciated in value since you purchased it. You can get a charitable deduction for donating the appreciated stock at it’s fair market value and not pay capital gains tax on that appreciation yourself. Not everyone can do this, I certainly can’t but it is an advantage. Plus for people over 70 1/2 who have big IRA balances, they are subject to required minimum distributions. These people can give up to $100K to a charity out of their IRA directly and not have to pay tax on the withdrawal. They can’t use it as an itemized deduction but it is a way to not pay tax at all on money they would are required withdraw and pay tax no tax on the withdrawal. Giving to charity shouldn’t be just for the tax benefit of the deduction, it should be to “help” in a cause that you strongly believe in. The deduction is only a side benefit. By giving to some charities, you are taking the burden off of the goverment to take care of people. They are giving you an “incentive” to be charitable so that you don’t have to pay more taxes instead.

    • Tony,

      The stock donation is also a good idea for when an company, in which you have stack, is about to get bought out. By donating your shares before the buyout, you’re able to avoid having to pay capital gain tax on the appreciation on those stocks.

      I read somewhere that people, in buyout situations, at times “donate” those stocks to universities in exchange for future annuity re-payments. This helps both the university and donor. Do you know anything about this?

      • I think you are talking about a CRAT or CRUT. These are Charitable Remainder Annuity Trust or Charitable Remainder Uni Trust. They are a good idea but more complex than I can explain in plain english. Without knowing all the facts, it is hard to give advice on them.

        To get back to the point though, giving should never be about the tax benefits you get from them, it should be about your passion for the cause you are giving to. The tax benefit is just a “bonus”.

  18. For charitable donations, I always consider it a two-step process: 1) do I want to give the charity something (yes); and later 2) do I want to give the U.S. government something by not deducting the donation (no). This year we may not itemize, and it hasn’t changed our charitable donation strategy at all.

    Regarding mortgages (and car loans etc.) – I would question anyone who says they can “earn more” by keeping that debt in place. If you adjust for risk, I think it’s almost impossible to find a risk-free return comparable to the cost of any of your debt, even mortgage interest (deductible) debt. Unless your asset allocation calls for 100% equities or similar, paying off debt is probably one of the best risk-weighted investments anyone can make.

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