Question

Dakota, a single taxpayer, is contemplating making a charitable contribution of $20,000 to either a public charity or a private non-operating foundation in 20x1. Dakota is subject to a flat income tax rate of 32% in 20x1 and 35% in 20x2. Dakota's AGI is $50,000 each year, and Dakota also pays $8,000 in mortgage interest intense (mortgage loan is for $400,000) annually. Assume his standard deduction is $12,200 in 20x1 and 20x2, and he has no other itemized deductions in either year. Use a 10% interest rate for your PV calculations.

a. What is the PV of Dakota's total tax liability for both years if he donates to the public charity?

b. What is the PV of Dakota's total tax liability for both years if he donates to the private non-operating foundation?

c. Should Dakota make the donation to the public charity or the private non-operating foundation?

Hint: for this problem, you have to compute the taxable liability for both years (20x1 and 20x2) under both scenarios.

Answer 1

a. PV of Dakota's total tax liability for both years if he donates to the public charity:

Dakota is a single person with a flat income tax of 32% applicable in the year 20x1 and 35% in the year 20x2 respectively. It is important to note that the Charitable Contributions, as per Section 501(c)(3), cannot be more than the 60% of donor's Adjusted Gross Income (AGI). In the given case scenario, Dakota wants to donate $20,000 which is less than 60% of his total AGI, that is, $30,000 (=$50,000*0.60). Thus, Dakota is eligible for tax deductibility for the same amount.

Particulars	20x1 ($)	20x2 ($)
Adjusted Gross Income	50,000	50,000
Less: Deductions: Mortgage interest expense	(8000)	(8000)
Less: Standard Deductions	(12200)	(12200)
Less: Public Charity Contribution	(20,000)	(20,000)
Taxable income	9800	9800

Thus, the PV of Dakota's total tax liability = $9,800+ ($9,800/((1.10)^2))

=$9,800+ ($9,800/1.21)

=$9800+$8099.17

=$17,899.17 or $17,900

a. PV of Dakota's total tax liability for both years if he donates to the private non-operating foundation:

Private Operating Foundations are usually involved into making contributions to other charitable institutions and have a similar tax treatment as the Public Charity. Hence, It is important to note that the Charitable Contributions, as per Section 501(c)(3), cannot be more than the 30% of donor's Adjusted Gross Income (AGI). In the given case scenario, Dakota wants to donate $20,000 which is less than 60% of his total AGI, that is, $15,000 (=$50,000*0.30). Thus, Dakota is not eligible for tax deductibility for the same amount.

Particulars	20x1 ($)	20x2 ($)
Adjusted Gross Income	50,000	50,000
Less: Deductions: Mortgage interest expense	(8000)	(8000)
Less: Standard Deductions	(12200)	(12200)
Taxable income	29800	29800

Thus, the PV of Dakota's total tax liability = $29,800+ ($29,800/((1.10)^2))

=$29,800+ ($29,800/1.21)

=$29800+$24,628.099

=$‭54,428.099‬ or $54,428

c. Recommending donation to charity:

Based on the above calculations, it is feasible to recommend the a. option, that is, Dakota should donate to a Public Charity as it is not only reducing his total tax liability for both years but is also a much more flexible alternative in comparison to the Private non-operating foundations. Thus, enabling Dakota to save a substantial amount worth $‭36,528.929‬ (=$54,428.099-$17,899.17).