If you read the popular press, you’ve probably read or seen headlines about the “bunching” strategy. This strategy has become increasingly popular as people adjust to the new standard deduction, which was doubled for tax years beginning with 2018. It’s a strategy that might be of particular interest if you are charitable and seek income tax minimization (don’t we all).
So what’s bunching, and can it reduce your income tax liability? This post offers a number of examples that hopefully will help you decide if it’s a valuable strategy for you.
The Basics of Bunching
To quickly define bunching: it is doubling your charitable giving in tax year one, and not making any charitable donations in tax year two (or vis-a-vis). By bunching your donations into one of two tax years, it’s possible to reduce your combined year one and two income tax liability by increasing available aggregate deductions. This discussion only makes sense if I spend a bit of time getting into the tax regime weeds.
In preparing your tax return, you have two choices: claim your itemized deductions or take the standard deduction. The standard deduction for married taxpayers filing jointly is $24,000 ($12,000 for individuals filing single). So, only if aggregate itemized deductions in a tax year exceed $24,000 (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 any average tax year. Taking the standard deduction decreases your taxable income by $1,000, since taking the standard deduction increases your deductions by $1,000 (standard deduction of $24,000 versus aggregate itemized deductions of $23,000). If you are in the 24% tax bracket, you save $240 each tax year by taking the standard deduction rather than itemizing deductions – or $480 in aggregate over tax years one and two.
The bunching strategy is all about maximizing the impact of your itemized deductions combined with the standard deduction 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, you bunch your charitable giving into one of two tax years – your overall tax liability decreases by $3,360 given the fact pattern in Example One. Here’s how:
Example Two: Same facts as in Example One, except you move all of your charitable giving to tax year one. Now, your itemized deductions in year one are $38,000. Your year two itemized deductions are $8,000. So? For year one, you claim $38,000 of itemized deductions. For year two, you claim the $24,000 standard deduction since your itemized deductions are only $8,000. What have you accomplished? Bunching your charitable giving into year one yields $62,000 of total deductions over tax years one and two, in contrast to deductions of $48,000 over tax years one and two absent bunching. Bunching increases your total deductions by $14,000, yielding tax savings of $3,360 for a taxpayer 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 tax year one, and nothing in tax year two you increase your total deductions over year one and two by $6,000. Why? In year one, you itemize deductions, claiming $30,000. In year two, you take the $24,000 standard deduction. Total deductions over year one and two are $54,000, as compared with $48,000 had you donated $15,000 in year one and $15,000 in year two – remember, in those years you would have claimed the $24,000 standard deduction each year for total deductions of $48,000, If you’re in the 24% tax bracket, bunching saves you $1,440 given these facts ($6,000 increased 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 $24,000. Why? In year one, you itemize deductions, claiming $60,000. In year two, you take the $24,000 standard deduction. Total deductions over year one and two are $84,000, 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 $5,760.
As you can see, bunching is a powerful strategy (in the case of a married, filing jointly taxpayer, the most bunching can ever reduce the federal income tax liability is $24,000 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. 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.
Take the fact pattern of Example Three. If you choose a bunching strategy with a donor-advised fund, you contribute $30,000 into your donor-advised fund in year one, saving you $1,440 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.
We would be more than happy to discuss with you how bunching and donor-advised fund accounts work hand-in-glove.
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.