If you are like many of my charitably minded clients, you probably got a surprise when you filed your tax return and found that you no longer itemize your deductions and, therefore, will likely not receive a tax deduction for future contributions. However, with some careful tax planning you might be able to structure your future donations in a way that generates a tax break once again. First, let’s set the stage with an example for a married couple showing Schedule A of their tax return prior to and following the passing of the Tax Cuts and Jobs Act (TCJA).
As you can see, prior to the TCJA, this couple’s itemized deductions were significantly higher than the standard deduction, primarily due to their annual donations. However, when the TCJA significantly increased the standard deduction (but eliminated the personal exemption deductions), their itemized deductions came up just short of the standard deduction amount.
One way this couple could reduce their lifetime taxes is to effectively bunch their donations in a way that allows them to itemize every other year. Logistically, this means they will attempt to double up donations in one calendar year and then not make any donations in the following calendar year. Here is a two-year example showing what would happen if they were to accelerate most of their planned year two donations into year one by making a large lump-sum donation of $10,000 in late December of year one, instead of spreading the donations over year two.
Even though the total itemized deductions for the two-year period does not change, by bunching $10,000 of their donations they effectively increased their total two-year deduction total from $48,800 ($24,400 x 2 years) to $57,400. If this couple is in the 22% tax bracket, they will save $1,892 of tax over two years:
$57,400 – $48,800 = $8,600 x 22% = $1,892
There are two significant disadvantages to donation bunching: 1) It requires having excess cash or other investments available to fund a lump-sum contribution, and 2) it may be more difficult for the receiving not-for-profit organization(s) to match the lumpy contribution pattern with their financial needs. While the first disadvantage can’t be fixed, the second one can be through use of a Donor Advised Fund (DAF)…but I’ll cover that in my next posting.
Paul Hansen, CPA, CFP®