Stories about millionaires and billionaires who pay little or no income tax make great headlines, especially when these people have committed tax fraud. However, the methods that most wealthy taxpayers use to reduce what they owe are perfectly legal tax-lowering strategies that anyone can use.
Taxpayers may donate up to 50% of their adjusted gross incomes (AGI) according to IRS publication 526, Charitable Contributions. Deductions for donations exceeding 50% of a taxpayer’s adjusted gross income can be carried over for the next five years until they are used up. When carryovers are included, contributions are still limited to 50% of AGI per year. Most people cannot afford to donate anywhere near 50% of their AGI, but the super-rich have this option.
While making a large charitable donation helps wealthy taxpayers significantly lower their tax bills, it’s not as if these taxpayers are keeping the money for themselves and not paying taxes on it. The government may not get as much revenue, but it has granted taxpayers permission to give it less revenue in this circumstance.
Both the government and private charities run many programs intended to help people with limited means. Well-managed charities have lower administrative costs than government bureaucracies, and that means they can do more good with the same amount of money. Charities also have an incentive to use donated funds as efficiently as possible because they must compete with each other for contributions, whereas government welfare agencies have a monopoly. Thus, we shouldn’t be upset when the wealthy pay lower taxes because of their large donations to charity. This tax deduction helps to provide more assistance to people who truly need it.