Charitable bunching, AKA charitable clumping, may provide a more tax-efficient way for charitable-minded folks to donate to their favorite charities, but it’s not for everyone.
Since we file taxes annually, we often think about our finances in annual terms – our income, our deductions, our charitable giving, etc. The problem is that if we completely silo individual years, we miss out on potential strategies to limit our tax burden, especially when it comes to charitable giving. One such strategy is charitable bunching.
What is Charitable Bunching?
Charitable bunching is when you make several years’ worth of charitable gifts in one year to get the full itemized deductions and then just take the standard deduction in the other years.
Why would you want to use a charitable bunching strategy?
Each year, when you prepare your tax return, you choose to either itemize or take the standard deduction. Itemizing only makes sense if your itemized deductions exceed the standard deduction. For married taxpayers filing jointly, the standard deduction is ~$25,000, while for those filing individually, the standard deduction is ~$12,500.
By “bunching” your charitable donations into one year, you can increase your itemized deductions for that year, which can then allow you to exceed the standard deduction. Then in the other years, you can have little to no charitable giving and simply take the standard deduction. Essentially, you donate the same amount but do so in a more tax-efficient manner.
Charitable bunching is a potentially useful strategy, but it’s not for everyone; it is often best for those whose itemized deductions come close to but do not exceed the standard deduction, and who make fairly significant charitable donations.
For example, let’s say you’re married filing jointly and you donate $4,000, on an annual basis, and have about $5,000 in other itemized deductions a year. Even if you bunch three years of charitable giving, you’re still better off taking the standard deduction since your itemized deductions in the bunching year only total $17,000 ($4,000 times three, plus $5,000 of other itemized deductions). In this case, there is no tax benefit to charitable bunching.
How to Implement a Charitable Bunching Strategy
You could implement a charitable bunching strategy by simply making multiple years’ worth of donations in a single year, but one of the downsides to this approach is that you’re not supporting the charity of your choosing in the years you don’t make donations. Keeping track of which years you have and have not donated may also prove a bit difficult. If you’re interested in implementing a charitable bunching approach but wish to avoid these potential concerns, one potential solution is running your giving through a donor-advised fund (DAF).
A DAF is an account specifically created for charitable giving. With regard to taxes, a DAF is sponsored by a charitable organization, so when you contribute to a DAF you get the full charitable deduction of your contribution, but you’re not required to distribute the money from the DAF in that same year and can instead spread out the charitable donations.
Therefore, a DAF simplifies charitable bunching because you can make your multi-year gifts into the DAF (and get the full upfront tax deduction for the entire multi-year gift), and then distribute the cash to the charity or charities of your choosing over the ensuing years.
An Example of Charitable Bunching
Let’s look at an example to see how a charitable bunching strategy could work. Before we do so though, I would like to point out that this is a purely hypothetical scenario and is not intended as personal tax advice. Before you implement any tax strategies, you should always consult with a tax professional.
Let’s say you’re married filing jointly. You donate $12,000 a year to charitable organizations and have about $10,000 in other itemized deductions each year. This means in a single year, your itemized deductions total $22,000. Since the standard deduction for married couples filing jointly is $25,000, you’re better off taking the standard deduction.
Now, let’s say that instead of donating $12,000 in a single year, you contribute three years’ worth of charitable giving ($36,000) to a DAF. As soon as you make the contribution, you can receive a charitable deduction for the full amount ($36,000), but you can still distribute the money in the same manner – $12,000 each year. So, in one year, your itemized deduction total is $46,000 ($36,000 in charitable deductions plus $10,000 in other itemized deductions). Then, in the next two years, you claim no charitable deduction, meaning your itemized deductions total only $10,000, and you can instead claim the standard deduction of $25,000 each year.
If you took the original approach of donating $12,000 each year and took the standard deduction for those three years, you have a total deduction of $75,000 for the three years, while if you bunch your charitable giving, your deductions over the three years total $96,000 ($46,000 in the first year when you claim the charitable deduction, and the standard deduction of $24,000 in the second and third years).
The Impact of the 2017 Tax Reform Bill on Charitable Giving
The charitable bunching strategy has existed for years, but the increase to the standard deduction in 2017 has meant those who prioritize charitable giving may find more benefit in it.
The 2017 tax reform bill, called the Tax Cuts and Jobs Act, significantly increased the standard deduction, dropping the number of tax returns with itemized deductions from ~31% before the tax reform to 13.7% in 2019.
While great for the majority of filers who don’t itemize, this has effectively diluted the potency of charitable deductions for those folks who regularly make charitable gifts. However, charitable bunching is one way to restore the power of charitable deductions, by providing the opportunity for itemized deductions to exceed the standard deduction in a given year.
With a new administration in Washington D.C. making a push for further changes to the tax code, charitable bunching may become less attractive, and we could see new tax minimization strategies develop (and The Legacy Builder blog will be right there bringing those strategies to your attention). But for now, charitable bunching is a compelling option.
Charitable Bunching in 2020 and 2021
There is one interesting corollary to the charitable bunching strategy. The CARES Act and follow-on Covid pandemic stimulus legislation created a unique, limited-time opportunity to deduct 100% of AGI for cash charitable donations in 2020 and 2021, with the limit currently set to revert to the previous limit of 60% of AGI starting in 2022.
This means if you’re thinking about implementing a charitable bunching strategy, 2020 and 2021 are great years to do your giving.
Having said that, it may not be advisable to use charitable deductions against all your gross income in one year, because then you’re offsetting income that will be taxed at much lower rates anyway. Instead, it may be better to spread your charitable contributions across multiple years, providing yourself the benefit of a charitable deduction in future years.
While it may seem like the opposite of charitable bunching, spreading your charitable contributions across multiple years instead of taking advantage of the temporary deduction of 100% of AGI, it’s ultimately adopting the same multi-tax year perspective. Which approach is right for you will depend on your personal financial situation and the tax implications across multiple years.
Comprehensive charitable legacy planning requires looking beyond a single year and considering the tax implications and opportunities that exist throughout your lifetime. At Charis Legacy Partners, taking the long view and planning accordingly is what we do. If you need further assistance with implementing any of these strategies, feel free to schedule a free consultation with us using the button in the navigation menu.