The Art of Bunching Deductions for Charitable-Minded Taxpayers by Joanie B. Stein, CPA
Posted on April 19, 2019 by Joanie Stein
Many individuals filing their first federal income tax returns since the enactment of the new tax law are surprised to learn that they were not able to write off the donations they made to non-profit organizations in 2018. While few people give to charity solely for a tax break, much ink has been spilled over whether the potential loss of the charitable deduction will cause taxpayers to cut back on their generosity or stop giving to charity altogether. The fact is the Tax Cuts and Jobs Act provides some philanthropic-minded taxpayers with an opportunity to change their giving strategies for greater tax efficiency and charitable impact.
The New Tax Law
Under tax reform, the charitable deduction is available only to those taxpayers who itemize their deductible expenses. With a near doubling of the standard deductions to $12,200 for individuals and $24,400 for married couples filing jointly in 2019, it is estimated that the number of households clearing this threshold and itemizing deductions for charitable contributions in 2018 is approximately half of what it was in 2017, before the passage of the TCJA.
On the other hand, the law provides taxpayers whose deductible expenses exceed the cutoff and are able to itemize their deductions greater tax savings for their charitable contributions. For tax years 2018 through 2025, the amount of the deduction itemizing taxpayers may claim for charitable cash gifts increases to 60 percent of adjusted gross income (AGI) while keeping the current deduction for gifts of appreciated assets at 30 percent of AGI. Moreover, the TCJA’s repeal of the Pease limitations means that high-income households can deduct significantly more of their qualifying itemized expenses through 2025.
Unfortunately, many taxpayers do not have a well-though-out giving strategy; they merely write checks to non-profit organizations here and there. The new law provides an opportunity for families to create a giving plan that allows them to make a greater impact on their favorite charities while at the same time improving their own tax circumstances.
The Solution: Bunching Charitable Gifts
One tactic families can employ to ensure they receive the full tax benefit of their philanthropic efforts is to bundle together two or more years of charitable donations into a single year. This strategy of “bunching” several years of charitable gifts into one year can push taxpayers above the threshold for itemizing deductions in that year and provide them with a deduction for the full value of their donation. In alternate years, taxpayers could give less and simply claim the standard deduction.
As simple as this may sounds, bunching deductions requires careful planning and timing of expenses. After all, philanthropy involves far more than making donations to non-profit organizations in exchange for tax savings. Rather, philanthropy is a state of mind and long-term commitment of time, money and resources to effectuate a positive change in communities around the world and the lives of the people who live there. It is a code of ethics and guiding principle that families share and pass down from one generation to the next. Therefore, philanthropic-minded families want their charitable giving to make a measurable impact on the organizations and people who receive their gifts. To best accomplish this goal, taxpayers may want to consider directing their bunched charitable gifts to donor-advised funds (DAF) that support the specific charities that matter most to them.
More about Donor Advised Funds
DAFs are savings accounts controlled by sponsoring organizations, such as financial services firms or community foundations, that accept and invest taxpayers’ irrevocable charitable donations and later distribute those funds via grants to designated charities. The funds themselves are 501(c)(3) charities that act as turnkey solutions to help taxpayers manage and maximize their charitable giving and tax efficiency. Because DAFs invest donations for tax-free growth, a gift to a DAF in one year can result in a larger grant to a recipient charity in future years.
In return for their multi-year, bunched gifts to DAFs, taxpayers receive an immediate tax deduction for the full amount of their gift in the year of contribution. For cash gifts, the annual deduction can be as much as 60 percent of the taxpayers’ annual AGI in tax years 2018 through 2025, or 30 percent of AGI for gifts of appreciated assets, such as securities, real estate or interest in a family business held for more than one year. By comparison, taxpayers who make charitable contributions to a private foundation can deduct up to 30 percent of AGI for cash gifts and only 20 percent of AGI for appreciated assets. These types of non-cash donations to DAFs or private charitable foundations also provide taxpayers with the ability to reduce or eliminate their exposure to capital gains tax on the appreciation of those assets while also giving a much larger gift to charity. When DAF contributions surpass the IRS limits, taxpayers may carry the deduction forward five years.
For example, a taxpayer who gives $6,000 to charity every year may not receive the benefit of a full tax deduction in each of those years. However, if the taxpayer gives $12,000 to a DAF every two or three years, he or she is more likely to clear the standard deduction ceiling and qualify to write off the full value of his/her bunched charitable gifts in those years. Moreover, because the DAF invests the taxpayer’s $12,000 gift, the recipient non-profit entity will receive the appreciated value of that gift.
The requirements for participating in donor advised funds varies from one sponsor to the next. Even though there is no law governing when or how often a DAF must grant assets to qualifying charities, most have policies in place requiring account owners to grant minimum gifts to nonprofits every few years to ensure that funds are put to work for charitable causes. However, DAF participants should note that while they will receive a tax deduction in the year of their contribution, their donations may not reach the intended charities in the same year. As a result, donors should investigate DAFs before making contributions to ensure that the selected fund squares with the donor’s unique philanthropic goals and philosophies.
Another Solution for Older Taxpayers
Charitable-minded taxpayers over the age of 70½ who are financially comfortable and do not need their individual retirement account (IRA) savings to fund their later years have another giving strategy available to them. More specifically, these taxpayers may make qualified charitable distributions (QCDs) from their traditional IRAs directly to certain non-profit organizations to satisfy their annual IRA required minimum distribution (RMD) obligations. While taxpayers will avoid income tax on the transferred amounts to non-profit entities, their QCDs will not qualify for a charitable deduction. Moreover, taxpayers should be aware that are specific rules prohibiting them from making QCDs to donor advised funds or private foundations or from SEP IRAs, SIMPLE IRAs or 401(k) plans.
Despite the changes that the new tax law brings to charitable deductions, most people will continue to give generously to those in need and carry on their philanthropic traditions. Yet, it behooves taxpayers to examine their existing giving strategies in light of tax reform and consider employing different methods to improve the charitable impact of their gifts and their potential tax savings.
About the Author: Joanie B. Stein, CPA, is a senior manager with Berkowitz Pollack Brant’s Tax Services practice, where she works with individuals and closely held businesses to implement sound strategies that are intended to preserve wealth and improve tax-efficiency. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.