At this time of year, many people decide to make some sort of donation to charity. In the UK they have found a 5% increase in the number of people donating to charity at Christmas time. It would be similar here in Australia.
As financial advisers, we want you to manage all of your financial affairs as effectively as possible. So, we want to explain a simple but powerful concept that makes sure that any donation you give does as much good as possible.
The idea is to give donations to charities for which you can claim a tax deduction. It sounds simple – it is simple – but it is also enormously effective.
Let’s say you are happy to give $100 as a donation to charity. For most people, what that actually means is that you are happy to give up spending $100 on yourself or your family. Put another way, you would be happy to take $100 out of your wallet or purse and give it to someone else.
The problem is, when you spend money on yourself or your family, you have to pay tax on that money first. The money in your wallet or purse gets taxed before you put it there. If you are a taxpayer, this means you have to earn more than $100 in order to have $100 left to spend. Here is how much you need to earn at each marginal tax rate (this rate includes the Medicare levy):
| If your marginal tax rate is… | You have to earn… | And pay this much as tax… | In order to have this much left to spend on yourself… |
| 19% | $123 | $23 | $100 |
| 32.5% | $148 | $48 | $100 |
| 37% | $158 | $58 | $100 |
| 47% | $189 | $89 | $100 |
So, to give $100 to a charity for which you do not receive a tax deduction, you actually have to earn more than that. If you are in the top tax bracket (and we hope you are!), you have to earn $189 in order to have $100 left to donate in such a way.
But if the recipient of your donation is registered for tax purposes, things are very different. The tax office is happy not to impose tax on the donation. This gives you two ways to respond. Firstly, you might still make a donation of $100, and then claim a tax deduction. The ATO will then give you back an amount equal to your tax rate times $100. If your tax rate is 32.5%, you will get a payment of $32.50 when you lodge your tax return. This means that you only actually gave up $67.50 of personal spending to make the $100 donation. You only have to take $67.50 out of your wallet to give the $100.
This is good – but maybe not in keeping with the spirit of the gift, which is to help someone else. A better response would be to ‘gross up’ the value of your gift. The ‘grossed up’ value is the amount that you have to actually earn before tax. So, if your tax rate is 32.5%, the grossed up value of $100 is $148. When you give the grossed up value, then the amount that ends up in your pocket is the same as the gift you intended to give. For example, if you give the charity $148 and they give you a tax deductible receipt, then when it comes time to lodge your tax return you get $48 back.
This means that you are personally only out of pocket $100, which was the amount you initially decided to give (actually, it is the amount you initially decided to ‘give up’). But the charity got $148! Your gift is almost 50% more helpful.
Not every charity can give you a tax deduction. For a start, charities need to be reasonably big to warrant the effort of registering with the ATO. So you might find that you want to make a gift that is not tax deductible. In those cases, given that the cause is obviously one you really think is important, you might just accept the fact that your donation has to be made after-tax. Alternatively, you might find other ways of making a contribution that is ‘tax effective.’ If you run a business, one way might be to make a donation ‘in kind’ (ie not as cash). For example, if you run a bakery and you give some unsold bread to a local recipient, then you can still claim all the costs of baking the bread when working out your tax bill. The ATO won’t ask you to identify the bag of flour that you used to bake the bread that you did not sell! If you are plumber and you get your apprentice to fix the taps in a local women’s refuge for no charge, then the wages you pay the apprentice are still deductible. If you run a shop and you donate some goods to a local charity for them to raffle off, you can still claim the cost of those goods as an expense of your business.
You get the picture. And you can see that it always pays to think about the tax effect of your giving. Once you have decided to give something, it makes sense to make that gift as effective as possible.
We hope you enjoy the summer break and we look forward to seeing you in 2017!