How does giving money to charity save you money on your taxes?

You don't consider a situation where people give to "charity" that they're heading themselves.

But generally speaking you're correct, the idea is that charity is tax deductible, and people prefer to give their money to their local church where they get the direct benefit of it, rather than to Uncle Sam.

Agreed.

One of the comments for this question Good books for learning about tax strategy/planning uses the phrase:

"Don't let the tax tail wag the investing dog."

It applies to charitable donations. Donate because it is expected by your church; donate because it makes you feel good; but don't donate just to save money on your taxes.

Once you have decided to donate take the steps necessary to be able to deduct your donation. Get the receipt or use a check or credit card so you can deduct the donation.

I'm being taxed at a 40% rate, then I can give $500,000 to charity, write it off, and save $200,000 on my taxes. That's a net loss of $300,000. I may have paid less taxes, but it cost me 300 grand.

Your logic is correct. However, here's another way to think about it. Suppose you are being taxed at a 40% rate. You wish to purchase $500,000 worth of diamonds. How much do you have to make in income to do so? You need to make $833,333 in income, pay 40% of that ($333,333) in taxes, and then spend the $500,000 on the diamonds.

But to spend that $500,000 on a charitable donation, you only need to make an income of $500,000, taxed at a rate of 0%, because donations to charity count against your taxable income.

Or, yet another way to think about it, is that if you make $833,333 in income, you can spend it on $500,000 worth of diamonds, or $833,333 worth of charitable contributions; effectively you get to purchase $333,333 worth of charitable contributions "for free" over the equivalent purchase that is not a charitable donation.

If you have a software company, that can produce a box of software for $5, but the box sells for $100. (You have to make a profit and cover development costs)

But then you give these boxes to charity, that is a cost of $5 each and a tax rebate of $100 x 40% = $40. A profit of $35 per donation of $5.

Notes: You can only do this if you have taxable profit to offset it against. This scheme may not be possible any more. It was used somewhere around the 1980 or 1990.

http://usatoday30.usatoday.com/money/perfi/taxes/2004-01-16-mym_x.htm if you search for donation inflated value IRS audit you'll find more examples and information. – Chris W. Rea

Pub 526 says: If you contribute inventory (property you sell in the course of your business), the amount you can deduct is the smaller of its fair market value on the day you contributed it or its basis. – xuhdev (so may no longer be possible in USA)