Decoding the Tax Law: Bunching Your Charitable Gifts Could Save You on Taxes
By Chris Hostetler
Under the new tax code, fewer people will likely claim charitable gifts as itemized deductions. This is because the standard deduction has been raised and will automatically cover more taxpayers. It remains to be seen whether this will have a noticeable impact on the total amount that Americans give to charity – I hope that Americans will continue to be as generous as they have been historically, regardless of the tax code.
But at the very least, the new tax code may mean you need a new strategy for giving. Depending on your personal tax situation, you might want to consider “bunching”: making two years’ worth of gifts in one year. This strategy could work if you make substantial gifts but still land just below your standard deduction threshold.
To understand why this could make sense now, it’s important to first understand one of the basic principles of tax planning in the US. You can reduce your taxable income using the higher of: a. your standard deduction -or- b. the total of your itemized deductions, which could include charitable gifts, state and local income taxes, mortgage and home equity interest and certain other items.
All this was true before 2018, and it’s still true. But what has changed is that the standard deduction is now higher.
In 2017, if you were married and filed taxes jointly, your standard deduction was $12,700.
Jumping forward to today and assuming you are still filing married filing jointly, your standard deduction is now $24,000 – about double what it used to be. This sets the floor for what you will deduct. (There are also some new limitations on what you can itemize, but I’ll ignore those today to simplify this discussion.) Follow this link for more detailed information on the 2018 deduction rules, including standard deductions for various household types.
So how does the interplay between standard and itemized deductions work in real life? Let’s take a look at the Brady family’s situation – note that I'm simplifying this for illustration purposes:
The Bradys plan to gift $18,000 to the Society of Mid-Century Modern Architecture, a 501(c)3 organization (a fake charity – I totally made it up). Their other itemized deductions total $6,000. Total itemized deductions = $24,000, which exactly matches their standard deduction.
How can the Bradys reduce their taxable income? The Bradys want to continue giving to their charity, so they decide to make the gift again this year, even if it means they will not receive any additional tax break. But the good news is that, with a little planning, they can still claim a charitable deduction.
The Bradys’ financial planner and tax advisor work together and recommend that they use a “bunching” strategy. They will make two years’ worth of charitable gifts immediately, giving $36,000 in 2018 and none in 2019. The result will be:
2018 itemized deduction is $42,000 = $18,000 gift + $18,000 gift + $6,000 other deductions
2019 standard deduction is $24,000
The Bradys are still giving the same total amount to charity over the next two years. But by doing it all in 2018, they gain an additional $18,000 deduction.
Assuming they are in the 24% marginal tax bracket, the additional $18,000 deduction saves them $4,320 in federal taxes.
THE BRADYS' DEDUCTIONS - YEARLY CHARITABLE GIFTS VS. BUNCHING
Illustration created by Hilltop Wealth Advisors
How can the Bradys ensure that their charity continues receiving a steady flow of donations?
There is an additional, related strategy to consider. What if the Bradys want the Society for Mid-Century Modern Architecture to continue receiving a steady amount every year, even though they are making bunched gifts every other year? They can use a tool called a Donor Advised Fund (DAF). DAFs have been around for a while, but they may become more popular under the new tax code, so people like the Bradys can facilitate a bunching strategy. A DAF allows you to make a charitable contribution this year, hold the money in an account, and then decide in future years which charity will receive those funds and how much. You can open a DAF with a relatively low cost.
In the past, you would typically set up a DAF if you had an extremely high-income year, such as when selling a business or exercising employer equity awards; it will still be an especially useful tool in such cases. But I expect DAFs will become somewhat more common as some taxpayers begin bunching gifts every other year, as in the Bradys’ case.
Since we’re talking about taxes, let’s wrap up with a couple of important caveats:
As always, gifts still must be made to a qualified charity, approved by the IRS
My scenarios are greatly simplified and modified to illustrate the topic at hand. Consult with your tax advisor to see how the new tax code will affect you. And please talk with your financial planner if you would like to explore how charitable gifting strategies might fit into your financial plan.
Bunching charitable gifts will NOT benefit everybody. As with most tax strategies, this depends on your personal situation.
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
Hilltop Wealth Advisors does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation.
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