President Trump's tax reform has bumped the standard deduction but cut many miscellaneous deductions, which may send wealthy clients scrambling for ways to reduce taxable income. One strategy involves bunching years’ worth of charitable deductions into a single year.
This tactic can help clients accumulate enough itemized deductions to exceed the standard deduction ($12,000 for single taxpayers and $24,000 for married couples filing jointly) for one year and then claim the standard deduction in the years when the donations are dispersed to charities.
Bunching deductions is a decades-old tax concept, said Daniel Morris, a CPA and senior partner at Morris + D’Angelo CPAs in San Jose, Calif. “Bunching works over the long term when people can arrange their affairs to maximize their combined standard and itemized deductions between and among the years,” he said.
“Before 2018, bunching deductions was a strategy most recommended for taxpayers older than 65 because the standard deduction for seniors filing a joint return was relatively high and they typically didn’t have mortgage interest and income tax deductions as high as younger taxpayers,” said Mary Kay Foss, a CPA in Walnut Creek, Calif.
Gail Rosen, a CPA with Wilkin & Guttenplan in Martinsville, N.J., offered the example of a high-net-worth client who can realize an extra five figures in deductions over three years. Let’s say your wealthy client gave $15,000 to charity each year and accumulated $19,000 in other deductions to make $34,000 annually. Over three years, that client realizes $102,000 in deductions.
Using a donor-advised fund (DAF) and bunching all three years’ $15,000 deductions into the first year, however, produces $64,000 in deductions for that year. This of course is followed in each of the next two years by only $19,000 annually in remaining deductions—but the new, increased standard deduction allows for $24,000 in each of the next two years.
Your wealthy client’s net total in three years’ deductions hits $112,000—$10,000 more due to the first-year bunching. In the 37-percent tax bracket, Rosen pointed out, the savings using DAF and bunching is $3,700.
“If an individual is going to have a liquidity event or another one-time spike in taxable income, a charitable contribution is a great way to even out the tax," added Foss. "The DAF will handle all of the details, like obtaining receipts and vetting the charity for IRS approval.”
“Disbursements from your DAF to the charities can be made ratably (annually or monthly), and you can stop it or change the donations at any time,” said John Mezzanotte, managing partner at Marcum in Greenwich, Conn.
Congress may soon propose restrictions on DAFs, say some experts, restricting payouts over multiple years. “Some HNW individuals may want to consider a private foundation instead of a DAF,” Foss said, “but that decision depends on a lot of factors. The private foundation typically will handle much greater contributions than a DAF.”