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Trusts & Estates

October 13, 2021

Bunching Charitable Gifts to Maximize Tax Savings

Current tax law eliminates most itemized deductions on personal income tax returns but makes available a standard deduction of $12,550 per person. This means many individuals will not need to itemize to receive the largest possible income tax deduction, but charitably-minded persons can still consider bunching charitable gifts over a period of years to make these gifts more tax-effective.

What is bunching?

Bunching is the grouping of charitable gifts one intends to make over a future period into a single year so the charitable deduction is large in the year of gifting and zero in the years no gifts are made.

How does bunching work?

Bunching is not tax-effective for taxpayers with aggregate noncharitable deductions greater than the $12,550 standard deduction for individuals or $25,100 for married couples. Nor is it effective if aggregate deductions, including bunched charitable gifts, are not more than the standard deduction. Deductions which count toward aggregate deductions include:

• Medical deductions greater than 7.5% of income
• $10,000 of state and local income and/or property tax
• Home mortgage interest expense (may be limited)
• Investment interest expense
• Casualty losses incurred in a federally declared disaster area

What is the tax savings?

The tax savings is generated by using the maximum standard deduction in the years no charitable gifts are made. For example, a married taxpayer’s joint standard deduction is $25,100. If a married taxpayer’s only annual non-charitable deduction is $10,000 of state tax, and the taxpayer generally makes charitable gifts of $25,000 in each year, it makes sense to “bunch” the Year 1 and Year 2 gifts together for one larger $50,000 gift. Year 1 tax would be reduced by a deduction for bunched charitable gifts of $50,000. In Year 2, a tax savings is generated by the “excess” standard deduction of $15,100 ($25,100 less $10,000 state income tax deduction). The tax savings is equal to $15,100 times their marginal tax rate of income tax. A couple in the 25% bracket would save $3,775.

Can a taxpayer bunch more than two years of charitable donations?

Most certainly, but often it is hard to predict future charitable gifts. In any case, where a donor is not entirely certain of the amounts or recipients of future year donations, a Donor Advised Fund (DAF) is the most effective and convenient way to bunch a large charitable donation today.

A contribution to a DAF of appreciated securities owned for more than one year is deductible at market value in an annual amount up to 30% of adjusted gross income. The donor retains flexibility to make any number of payments to charities, through the DAF, in amount(s) of the donor’s choosing over a period of years. A large charitable gift through a DAF today could easily accommodate four or five years of future giving and create the tax savings discussed above for each non-gift year. A comprehensive giving plan may anticipate, for example, a significant DAF gift every four or five years. As with many tax-saving techniques, however, individual circumstances must be taken into consideration, and tax projections should be run in each instance to fully understand the impact personally.

A simple illustration

Few of us have lives this uncomplicated, but this example illustrates the technique. Jane and Joe have aggregate earned income of $250,000 annually and $25,000 of investment income. They have no mortgage but pay state income taxes and property tax greater than $10,000 annually. They give faithfully to their favorite charities, about $25,000 per year.

No Bunching – Each Year Bunching Year 1 Bunching Year 2
Wage Income $250,000 $250,000 $250,000
Investment Income $25,000 $25,000 $25,000
Deduction Taken $35,000 $60,000 $24,200
Comprised of:
Standard Deduction $0 $0 $25,100
State Tax Deduction $10,000 $10,000 $0
Charitable Deduction $25,000 $50,000 $0

 

Over a period of two years, Jane and Joe take $70,000 in deductions if they decide not to bunch charitable gifts. With bunching, however, their aggregate deductions over a two-year period total $85,100. The additional $15,100 in deductions represents a tax savings of $3,775 at a marginal tax rate of 25%, or $5,587 at a marginal tax rate of 37%. If a high-income taxpayer had no deductions other than charitable deductions, the maximum annual savings might be as much as $9,200 (the $25,100 standard deduction taken in non-gift years x the maximum 37% tax rate).

 

 

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