How Much is That Sweater Worth? It Depends on Your Income

While there are many strange things in the federal tax code, one thing that I find particularly strange is how donations are valued. The strange part about it is that the same item will take on different values depending on who gives it away.

For example, let’s say that a married couple filing jointly with a combined income of $65,000 donates a sweater worth $10 to Goodwill. They would fall into the 15% tax bracket in 2010 (the income they earned after their first $16,751 would be taxed at that rate). So, because of that, donating a $10 sweater to Goodwill would lower their taxable income from $65,000 to $64,990. And, because their taxable income was reduced by $10, their taxes could drop by their highest tax rate, 15%, saving them $1.50. More simply, they’d save $1.50 on taxes through their $10 donation. The same would apply if they cut a check for $10 to their favorite charity.

Now, let’s assume that the same couple made $5,000 more per year, pushing their combined income up to $70,000. Their earnings from $68,001 and up would be taxed at 25% rather than 15%. Now, when they donate the $10 sweater, they’ll knock their taxable income down from $70,000 to $69,990. The $10 in lowered tax taxable income will be taxed at the higher rate, 25%, so they now save $2.50 rather than $1.50 when they donate the exact same sweater.

Assuming that the same couple made more than $373,651 in a year, they would find themselves in the highest tax bracket, 35%, which would allow them to save $3.50 on their taxes when they donate the exact same $10 sweater.

That’s right. We pay the rich more to do the exact same charitable deed as those less well off.

Not a bad deal for high income earners, eh? The more likely you are to be in a position to donate goods and money, the more the government will reward you for doing so.

Of course, high income earners have other deductions they can use beyond $10 sweaters to lower their taxes, such as home mortgage interest deductions. There is a limit on this. You can only deduct interest on up to $1,000,000 in home acquisition debt, which means that a wealthy couple with a $1,000,000 home may only be able to reduce their income by something like $50,000/year in the early years of a new home purchase, (thus receiving nearly $17,000 in tax savings annually in government subsidies for their million dollar home). Check out Bankrate if you want to rn the numbers on how much interest one pays on a $1 million home loan in a year. Someone with a $1 million home loan can reduce their taxable income by the average American’s annual salary under the current home interest deduction criteria.

While becoming rich is no easy task, our government’s tax policies do a fine job helping the rich act rich and stay once they’re rich.

10 thoughts on “How Much is That Sweater Worth? It Depends on Your Income”

  1. Although there are a number of other categories of tax breaks you can’t get once you make a certain income, which far outnumber the benefit of having a charitable deduction knock your income down at the higher tax rate.

    Child tax credit, dependent care credit, earned income tax credit, taxes paid, interest paid, job expenses, and certain other miscellaneous deductions are all subject to income limits.

    For example, you can’t deduct medical expenses unless it is 20% of your income. Which is a lot harder to reach when your income is higher.

    I’m not crying for the rich – but I’m not sure this example proves your point.

    The flip side to your argument is that the rich person’s $10 income is actually only worth $7.50; where the under $70k earner’s $10 wage is worth $8.50.

  2. @Jason, I’ve felt the pain of income limits on a few things, like student loan interest deductions. While frustrating, it wasn’t exactly punitive enough to make me want to make less money.

    The numbers get stranger when one looks at how this plays out for people wealthy enough to live off capital gains. Trust fund kids have it really good.

    I’m trying to understand your flip side argument. If donations were made with post-tax dollars, I could see some rationale for allowing dollars taxed at a higher rate to be deducted at a higher rate, but donations are pre-tax deductions.

  3. You could argue that someone with more income, buys more things, and therefore has more things to give away to charity. That gives some rationale for the current set-up.

    If your argument is that every dollar should be treated alike – my point is that we’re beyond that already. If fairness is the goal – a flat tax might be the right thing to do.

    I don’t think we’ll ever be able to tax the rich at a high enough rate that it would really be a disincentive to get rich, actually. 50% of a million still leaves you with $500,000. Which is better than making $60,000.

    The whole – rich paying their fair share issue is fascinating to me.

  4. @Jason, it seems like the charitable deduction tax scenario allows the rich to disproportionately pick which charities get funded, since they have more money to work with and that money goes much further due to greater deduction values.

    Fairness is a tough thing to quantify, but I think one thing that’s unfair today is the perception that the rich may much more in taxes than they actually do. Factors include greater benefits from deductions, and the general misunderstanding of a variable tax rate.

    It seems to me that there would be a point where tax rates become punitive, but that is likely much higher than what we’re at today. I’ve never heard of someone turning down a promotion or deciding not to sell one more widget because the after tax income they’d earn wouldn’t make it worth the effort.

  5. To Ed’s last point, we should examine effective tax rates when having a discussion around the percentage of income taxes paid by the wealthy. For example, per the IRS (http://www.irs.gov/pub/irs-soi/07intop400.pdf), 72% of the top 400 U.S. earners had effective tax rates below 20%.

    Also, the regressive nature of certain taxes and fees (e.g., sales taxes, car registrations) affect lower income earners at a higher percentage than higher income earners. Those living off of capital gains entirely get a favorable 15% tax rate. Finally, payroll taxes also affect lower income earners at a higher rate than higher earners who only pay on the first $106K (approx.) of income.

  6. The only way to get around it, while retaining the graduated tax system, is to make donations graduated as well = more complicated and riddled with even more loop holes and what not. I think if the author illustrates both sides of the tax equation a very different picture comes through. Every dollar in the 25% tax bracket is worth 10% less than every dollar in the 15% tax bracket. So while the sweater is “worth” a dollar more as a donation in the 25% bracket you also have to show that the same $10 is worth a dollar less when adjusted for after taxes NET value.

  7. The author continues to tell one side of the tax story by focusing on how much “rich” people can save and NOT mentioning how much they actually pay. They also don’t mention that the vast majority of deductions reflect spending of some sort and not just getting money back for “free”. Again, I think this just illustrates either the blatant ignorance of the author or indicates a political agenda.

  8. Alas, The tax system is more about setting public policy then it is about collecting revenue for public programs. And we currently send some very bad messages.

    I have long contended that instead of deductions, the IRS should use a very progressive flat tax with additional flat rate tax levies to add disincentives to the activities they want to discourage.

    This would be a much more simple and honest way of projecting public policy and the transformation could be used to break up some of the outmoded deductions the current system tends to perpetuate.

    At the same time we could end standard Corporate Income Tax for domestic businesses due to the additional revenue from higher income individuals.

    These changes would dis-incentivize the inequities brought about by ungodly salaries paid to executives and spur incentives for corporations to reinvest assets back into the economy (ae..diversification, job creation, or workplace improvement).

    Imagine businesses competing for the best labor rather than overindulging administrations.

  9. Changing the system to give the same benefit to all wage levels is really quite simple, to the point of being rudimentary…

    One possible implementation: take the total at the current bottom of Schedule A. Multiply by 0.15. Subtract from base taxes due based on tax schedule (minimum 0, to make it a non-refundable credit), to determine total income tax due.

    Hardly a difficult process, and implemented with even minimal foresight, significant simplification of the tax code could result (removal or combining of certain deduction limits, AMT streamlining).

    The income tax and the excise tax are the only taxes that are not inherently regressive in their basic nature (i.e. typically costing those with less income more on a percentage basis than they cost those of greater income.) The fact that these are the two taxes that come under attack far more than any other is quite indicative of the actual motivations at play, I think…

Leave a Reply

Your email address will not be published. Required fields are marked *