The end of the calendar year is a busy time for many reasons – holiday parties, shopping, open enrollment, utilization of flex spend dollars, and of course – tax strategizing!
I work closely with clients to review their year-to-date estimated taxes and see if there are some strategies they wish to employ before the end of the year to manage their tax liability.
One such strategy that came up this week concerned charitable contributions and is often referred to as “bunching.” I thought it was worth elaborating on this idea in this week’s column.
When did “bunching” become popular?
This strategy arose from the The Tax Cuts and Jobs Act (TCJA) which became law in December 2017. Most of the law’s changes were implemented in 2018 and are scheduled to sunset after 2025.
Under the TCJA, the standard deduction nearly doubled in size but a $10,000 cap was placed on the amount of state and local taxes (SALT) that could be itemized . For 2022 taxes, single filers may claim a $12,950 standard deduction, while married couples filing jointly can claim a $25,900 standard deduction.
Why did this impact charitable strategies?
With the substantial increase in the standard deduction, many taxpayers who historically itemized deductions likely found themselves taking only the standard deduction – especially since there was a cap on SALT taxes. For a married couple, assuming they met the $10,000 SALT maximum, they would need $15,900 in other itemized deductions (such as mortgage interest and charitable deductions) to benefit from itemization. Otherwise, they would take the standard deduction.
Where does “bunching” come into play?
Those who are charitably inclined can maximize their tax benefits by bunching two years of charitable contributions into one year pushing you above the standard deduction for that year and itemizing instead, allowing for a higher deduction. In the following year, you don’t make a charitable donation and you take the standard deduction instead. (A donor-advised fund can be an effective tool for this strategy as it allows you to still make the actual gifts to charity in both years – you can learn more on that topic here)
Can I see an example?
Sure! Here’s a case study of this concept, obtained from Schwab Charitable
Let’s say a married couple annually has $23,000 of itemized deductions, including $10,000 in donations to a donor-advised fund or other public charity. Because that amount is below the $25,100 standard deduction in 2021 and $25,900 standard deduction in 2022, they could take the standard deduction each year, and over two years they would claim a total of $51,000 in standard deductions.
However, the couple instead takes a more tax-smart approach. Rather than donating $10,000 to charity each year, the couple concentrates or bunches two years of charitable contributions into a single year. The bunched giving creates a total of $33,000 in itemized deductions in 2021, and they take the $25,900 standard deduction in 2022. With this option, the couple has $7,900 of additional tax deductions over the two years. In addition, if these contributions were made to a donor-advised fund account, the couple could recommend grants to charity in both of the years.
Are there other strategies related to charitable donations?
Charitable donations are eligible for itemization, which reduce your taxable income (to the extent itemized total > standard deduction). As a result, you can also use them to offset a high-income year (caused by a capital gain, Roth conversion, job promotion, option exercise, etc.) and allow yourself to move back down to a lower tax bracket.
Should taxes drive my charitable gifting?
People donate for may reasons that go far beyond quantitative and tax motivations. However, it is simply a fact that there is a benefit in the tax code to making such gifts. If you wish to use the strategies available to you, they are at your disposal.
Hope this information helps you strategize your year-end gifting!
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