Sponsored by – DonorsTrust
By – Jeff Zysik
Since the 2017 Trump tax cuts, you may have seen tax experts and financial advisors promote the charitable “bunching” strategy. The bunching strategy arose when the standard deduction doubled for tax years beginning with 2018.
The strategy allows charitable taxpayers to maximize their overall tax deductions during a two-year period by “bunching” charitable giving into one tax year, then taking a break from direct charitable giving the following year.
Bunching your donations into one of two tax years allows you to reduce your combined year one and two income-tax liability by increasing your year one and two aggregate deductions.
Bunching helps maximize your deductions, thereby reducing your income-tax liability over a two-year period. This article explains charitable bunching using examples that will hopefully help you decide if it’s an appropriate strategy for you.
How It Works
In preparing your tax return, you have two choices: claim your itemized deductions or take the standard deduction. For 2022, the standard deduction for married taxpayers filing jointly is $25,900 ($12,950 for individuals filing single). So, only if your aggregate itemized deductions exceed $25,900 (for married taxpayers) will you take itemized deductions.
Example One: You are a married taxpayer and, on average, make charitable donations totaling $15,000 each and every tax year. Your other itemized deductions average $8,000 each year. So, on average, your aggregate itemized deductions are $23,000 each tax year. You will take the standard deduction for 2022. Taking the standard deduction decreases your taxable income by $2,900, since taking the standard deduction increases your deductions by $2,900 (standard deduction of $25,900 versus aggregate itemized deductions of $23,000). If you are in the 24% tax bracket, you save $696 in federal income taxes by taking the standard deduction rather than itemizing deductions – or $1,392 in aggregate over tax years one and two (ignoring any increase in the itemized deduction for year two).
The bunching strategy is all about maximizing the impact of your itemized deductions over a two-year tax horizon. Here’s how it works. Using the facts from Example One, if you move all your charitable giving to either tax year one or two—in other words, bunching your charitable giving into one of two tax years—you maximize the impact of your itemized deductions and decrease your overall tax liability over the two-year period.
Example Two: Same facts as in Example One, except you move all of your charitable giving to 2022. Now, your itemized deductions in 2022 are $38,000. Your 2023 itemized deductions are $8,000 since you skip direct charitable gifts in 2023. For 2022 you claim $38,000 of itemized deductions. For 2023, you claim the $25,900 standard deduction (likely, the 2023 standard deduction will be higher as the result of indexing) since your itemized deductions are only $8,000. What have you accomplished? Bunching charitable giving into 2022 yields $63,900 of total deductions over 2022 and 2023 ($38,000 plus $25,900), in contrast to deductions of $51,800 over tax years 2022 and 2023 ($25,900 plus $25,900) without bunching. Bunching increases your total deductions by $12,100, yielding federal tax savings of $2,904 for a taxpayer filing as married who is in the 24% tax bracket.
Who Should Bunch?
Who does bunching work for? Anyone whose aggregate itemized deductions excluding the charitable deduction are usually below their standard deduction can benefit from bunching (provided the total bunched donations together with other itemized deductions in the donation year exceed the available standard deduction). If that’s you, bunching is worth a look.
Example Three: You are married filing a joint return, but have no itemized deductions other than the $15,000 you give to charity every year. If you donate $30,000 in 2022 and nothing in 2023, you increase your total deductions over 2023 by $4,100 (again, assuming no change in the amount of the itemized deduction between 2022 and 2023). Why? In 2022, you itemize deductions, claiming $30,000. In 2023, you take the $25,900 standard deduction. Total deductions over year one and two are $55,900, as compared with $51,800 had you donated $15,000 both 2022 and 2023 – remember, in those years you would have claimed the $25,900 standard deduction each year for total deductions of $51,800. If you’re in the 24% tax bracket, bunching saves you $984 given these facts ($4,100 increase in deductions times 24%).
Of course, the tax savings are more significant if you generally give more.
Example Four: You are married filing a joint return, but have no itemized deductions other than the $30,000 you give to charity every year. If you donate $60,000 in tax year one, and nothing in tax year two you increase your aggregate year one and two deductions by $25,900. Why? In year one, you itemize deductions, claiming $60,000. In year two, you take the $25,900 standard deduction. Total deductions over year one and two are $85,900, as compared with $60,000 had you donated $30,000 in year one and $30,000 in year two. If you’re in the 24% tax bracket, bunching saves you $6,216 over a two-year period.
As you can see, bunching is a powerful strategy. Note that the maximum amount bunching can reduce the federal income tax liability by is the amount of the applicable standard deduction times the applicable marginal tax bracket – but that’s a discussion for another time.
Protecting The Charities You Love
One concern you may have is that you don’t want to double up on what you are providing particular charities in one year, and then provide nothing the following tax year. There is a simple solution to this, and it’s why this article has used the term “direct charitable giving.”
By combining bunching with a donor-advised fund account, you can smooth the amount received by your favorite charitable organizations on an annual basis, and keep their funding from you consistent with your previous year’s giving, while maximizing your income tax deductions.
A donor-advised fund account, offered by charitable organization’s such as DonorsTrust (where I work) or offered by financial institutions and community foundations, works similarly to a charitable savings account. This one-minute video describes the basics. Donor-advised funds are the fastest growing charitable tool in the country, and bunching is a part of the reason why.
If your bunched contribution is to a donor-advised fund account, from which you advise grants over a period of years, you can continue to provide the same dollar level of support to your favorite organizations on an annual basis so the use of the bunching strategy won’t impact your giving pattern.
Take the facts of Example Three. If you choose a bunching strategy with a donor-advised fund account, you contribute $30,000 into your donor-advised fund in year one, saving you $984 in taxes over the two years. You can then recommend gifts of $15,000 in both year one and year two to your favorite charities.
Coupling a bunching strategy with a donor-advised fund account allows you to maintain the charitable impact you want, and, with the tax monies you’ll save, perhaps increase it further.
Keep in mind, the above discussion is illustrative and educational in nature, only. We are not a law or accounting firm, and we cannot offer tax advice specific to your situation. This discussion is presented for educational purposes, only. Before making any decision impacting your taxes, you should consult your specific fact pattern with your tax advisor.
Jeff Zysik is COO and CFO at DonorsTrust. He is an attorney and accountant with fifteen years of tax planning experience, focusing primarily on sophisticated estate and income tax concepts. Before joining DonorsTrust, he was managing-director and co-founder of Charitable Entity Administration, LLC (CEA).