Bunching Charitable Gifts to Maximize Tax Savings
The Tax Cuts and Jobs Act eliminates most itemized deductions on our personal income tax returns but increases the standard deduction to a now generous $12,000 per person. With these changes, bunching charitable gifts and the resulting deductions may be a useful technique to boost the value of the standard deduction and experience tax savings.
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 it work?
The taxpayer reviews their anticipated charitable giving for the current and future year(s), then bunches and pays all the Year 1 and Year 2 contemplated gifts in Year 1. In Year 1, the taxpayer itemizes deductions to reduce her taxable income. In Year 2, the taxpayer makes no further charitable donations and uses the standard deduction on her Year 2 income tax return.
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, if a married taxpayer’s only annual non-charitable deduction is $10,000 of state tax, and they generally makes charitable gifts of $25,000 in each year, then their 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 $14,000 ($24,000 less $10,000 state income tax deduction). The tax savings is equal to $14,000 x their marginal tax rate.
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 is the most effective and convenient way to bunch a large charitable donation today. A contribution to a Donor-Advised Fund of appreciated securities owned for more than one year is deductible at market value in an amount up to 30 percent 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|
|State Tax Deduction||$10,000||$10,000||$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, Jane and Joe’s aggregate deductions over a two-year period total $84,000. The additional $14,000 in deductions represents a tax savings of $3,500 at a marginal tax rate of 25 percent, or $5,180 at a marginal tax rate of 37 percent. If a high-income taxpayer had no deductions other than charitable deductions, the maximum annual savings might be as much as $8,880 (the $24,000 standard deduction taken in non-gift years x the maximum 37 percent tax rate).
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