By Mr. SixFiguresUnder
A few weeks ago, we met with a tax advisor for the first time ever. Our income has become varied enough, and high enough, that we wanted a professional to help us see what we could do to ensure we’re not paying more than we need to in income tax. He gave us some great advice which I’m excited to share with you.
It’s a lot all at once, so today I’ll start with just one idea.
2016 will be the first year we are itemizing deductions on our tax return. One of the largest deductions will be charitable gifts. In an esoteric tax-professional way, adjusting the timing of our donations could save us thousands of dollars!
Let me step back just a little bit to show you how. The tax code allows you to deduct from your income the amount you donate to qualified charities, up to 50% of your annual income. In 2015 we made cash charitable donations of $7,087.91, mostly due to our monthly tithe of ten percent of our income. Adding in our other deductions, we could have itemized just over $11,000 in deductions. However, the standard deduction offered by the IRS is $12,600. For tax year 2015 we are taking the larger standard deduction because itemizing would leave us with a larger tax bill.
2016 will be different. Let’s assume that our family income is $100,000 this year. (It still seems crazy to talk like that, but we’re well on our way.) By the end of the year we would have paid ten percent, $10,000, in tithing. Assume that between other charitable gifts and other deductions, our itemized deductions total $14,000. That’s more than the standard deduction of $12,600. By itemizing deductions we would have an extra $1,400 that would not be counted as taxable income to us in 2016. At the 25% tax bracket, that would be a real tax savings of $350.
Now, just for simplicity, we’ll say we do that all over again in 2017, for another $350 real tax savings over the standard deduction.
Now let’s do something completely crazy.
What if we paid our normal $10,000 of tithing this year, but at the end of the year, we paid another $10,000 toward next year’s expected tithes? With all else staying the same, our itemized deductions would go up by $10,000 to $24,000, a total of $11,400 over the standard deduction. At the 25% tax bracket, that’s $2,907 in real tax savings for tax year 2016.
For tax year 2017, having pre-donated most of our tithing the previous year, we should have low itemized deductions and will just take the standard deduction.
Paying tithing on a traditional schedule, we itemize deductions both years and save $350/year over the standard deduction. By pre-paying an extra $10,000 of tithing, lumping two years of tithing into one tax year, we save $1435/year over the standard deduction. As a strict tax-minimization technique, it’s a winner.
Now that may seem absolutely bonkers. Couldn’t that $10,000 be used for something else? Is the church ok with this? What if something goes wrong? Isn’t it awfully mercenary to talk about tithing like an expense instead of a heartfelt sign of devotion to God and thanks for his blessings?
Stay with me a little longer.
Couldn’t that $10,000 be used for something else?
Of course it could. Hopefully, we won’t need it for anything else.
We could spend it on a more expensive lifestyle, but we won’t. After our loans are completely gone, our next goal is to be back in a home of our own. Any major lifestyle changes come after our home purchase.
We could put it toward our down payment, but it wouldn’t make a huge difference. Homes in California aren’t cheap. A 20% down payment on a $400,000 home means we need to save $80,000. It won’t matter whether the $10,000 goes into that down-payment fund at the end of this year or over time next year (as we pay into it the $10,000 we would otherwise have been paying in 2017 tithing). It will still take us at least a year to get there, so we’ll end up with the same down payment total at the same time as if we paid tithing on a normal schedule.
We could invest it, but it wouldn’t be more profitable. The one-year return on investment is over 25% in tax savings. If our income ends up over $100,000, our normal tithing amount and our end-of-the-year pre-paid tithing amount both go up, and so does the return on investment.
Is the church ok with this?
It might look like financial shenanigans, but the recipient of pre-paid donations actually comes out better off. The total amount of tithing is the same, it’s just coming earlier. A dollar now is better than a dollar next year, so the church has no complaints. Just to make sure we talked with our bishop, who is fine with the idea.
What if something goes wrong?
It’s quite likely that not everything will go as expected. It could go better or it could go worse. If by the end of the year, the idea no longer makes sense, we drop it. We have until December 31 to decide. If our income doesn’t keep up, or we end up having a major expense this year, or we know of a major expense coming in early 2017, we adjust accordingly. Our bills today come ahead of potential tax savings tomorrow.
The only way it could go really wrong would be if we paid the extra $10,000, and early in 2017 we suddenly need the funds badly. If that happens, between our emergency fund and living on last month’s income, we have a buffer to help us get through a financial disaster. Hopefully we won’t have to, but it’s nice to have something to fall back on.
Isn’t this all a bit mercenary?
For us, tithing is about devotion, obedience, gratitude for God’s blessings to us, and faith that he will continue to take care of us, as he has so well for so long. Taxes are about funding the government’s activities as required by law. Tithing is simple to calculate. It’s (amount of income) x (10%). Taxes are not simple to calculate; the tax code frequently allows a lot of flexibility. Tithing is a joy to pay. Taxes are a civil responsibility. Where the law has been written to allow us to pay fewer taxes, we will. Where it actually allows us to pay more tithing up front, enhancing the benefit to the church, doing it in a non-traditional schedule doesn’t bother me at all.
So what does this have to do with me?
The underlying principle of this idea is that changing the timing of income, expenses, and deductions can dramatically change your tax outcomes. Shifting deductible items into a single year to increase the difference between the standard deduction and your itemized deductions can create substantial tax savings.
For us, the deductible item we can pre-pay is tithing. For you, it could be a combination of mortgage interest, dental expenses, and charitable gifts. The list of deductible items is long. While potential tax savings shouldn’t dictate the timing of the rest of your life, if it’s merely a question of taking the time to do a little planning, it’s worth the effort.
Note: Just to be clear, the above is not tax advice. Tax advice is applying tax law to a particular taxpayer’s individual circumstances. I don’t know your circumstances and cannot advise about how the law might apply to them. If you think any of these tips might work for you, do some research or find some professional advice.
What do you think?
- If you itemize, have you ever thought of timing charitable contributions?
- What other deductible items could you time to save on taxes?