Who said tax planning can’t be a bunch of fun? Buckle up, as we unravel the gift that keeps on giving: the savvy strategy of Charitable Bunching.
Some Tax Basics
Under U.S. tax law, taxpayers have two options: take the flat, no-questions-asked standard deduction (IRC § 63(c)), or go through the process of itemizing deductions (IRC § 63(d)). The standard deduction is a specified amount that reduces your taxable income, no receipts required. On the other hand, itemized deductions allow taxpayers to list eligible expenses (like home mortgage interest, state and local taxes, and charitable contributions), which can provide a larger tax break if their total exceeds the standard deduction.
The charitable bunching strategy is a tax planning tactic that takes advantage of the standard deduction and itemized deductions system in U.S. tax law. Under normal circumstances, taxpayers might spread out their charitable contributions evenly across multiple years. This often aligns with how people choose to make their charitable donations. However, with a charitable bunching strategy, taxpayers “bunch” multiple years of charitable contributions into a single tax year. This results in a larger itemized deduction for that year. In the following years, without the bunched charitable contributions, the taxpayer’s itemized deductions might be less than the standard deduction. In these years, the taxpayer can opt for the standard deduction, which will provide a larger tax benefit than their remaining itemized deductions otherwise would.
By alternating between years of itemizing deductions and years of taking the standard deduction, taxpayers can maximize their total deductions over time. This strategy is especially effective for taxpayers who have itemized deductions that are close to the standard deduction.
Sample Scenario
Consider a married couple filing jointly, and have a taxable income of $240,000. Their state and local taxes amount to $12,000, and they pay a total of $13,000 in mortgage interest. They also give $5,000 annually to charity. The standard deduction for 2023 for most married couples filing jointly is $27,700.
In a normal tax year, without any special tax planning, their itemized deductions would total $28,000 ($10,000 in state and local taxes [subject to the “SALT Cap”] + $13,000 in mortgage interest + $5,000 in charitable contributions). Since this is higher than the standard deduction, the couple will likely elect to itemize deductions.
Incorporating Charitable Bunching:
Charitable bunching could allow the couple to increase their tax deductions over a period of years. Instead of making the usual annual contribution of $5,000 to charity, they would bunch several years of contributions into one year. For example, they could contribute three years’ worth of donations, or $15,000, in 2023.
This would increase their itemized deductions to $38,000 ($10,000 in state and local taxes + $13,000 in mortgage interest + $15,000 in bunched charitable contributions) for the year 2023.
In 2024 and 2025, without the charitable contributions, their itemized deductions would be $23,000 ($10,000 in state and local taxes + $13,000 in mortgage interest). However, they could take the standard deduction of $27,700 instead, which is $4,700 more than their itemized deductions. In fact the standard deduction in 2024 and 2025 will be higher as it is adjusted for inflation. At their marginal tax rate of 24%, this additional deduction could save them approximately $2,256 on their taxes over the 3 year period!.
Bunching in Practice:
One of the biggest issues around the charitable bunching strategy is timing between the best time to deduct charity for tax purposes and when you want the charitable organization to receive the contribution. This is where a Donor Advised Fund (DAF) comes into play. A DAF allows taxpayers to make tax deductible contributions of both cash and appreciated investments (which has its own tax benefit) to an account that itself qualifies as a charitable organization. You then “advise” the account, hence the name Donor Advised Fund, on where and when to direct your already deducted charitable contributions to the charity of your choice. Let’s say you intend to donate $5,000 to a local food bank annually. Your awesome CPA at Northbrook Financial has recommended a charitable bunching strategy to save taxes, but you don’t want the food bank to receive $15,000 this year, you want them to receive the same even $5,000 contribution per year. A DAF will allow you to maintain both the maximum tax deduction, by bunching up $15,000 this year, and preserve the personal intent by directing $5,000 distributions to the food bank annually.
Brokerages such as Fidelity, Vanguard, and Schwab all offer DAFs and many local community organizations and federations offer them as well. Review the requirements before opening – there are sometimes minimum contributions that are important to consider.
As with all tax planning strategies, the practical application will vary by person based on your circumstances. There are other technical tax considerations beyond the scope of this article, so be sure to consult with your tax advisor.
Interested in more real life tax planning tips? Email your comments and questions to planner@northbrookfinancial.com.
The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
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