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To Bunch or Not to Bunch?

13 Minute Read

To bunch or not to bunch? That is the question.

Over the past few years, mostly since the passage of the Tax Cuts and Jobs Act (TCJA) at the end of 2017, there have been significant conversations around whether you should utilize a bunching strategy as part of your tax planning – combining large gifts, expenses or tax-efficient transfers into one giving year versus spreading it out over multiple years. The goal is usually to reduce taxes by getting over or under different income or deduction thresholds.

Bunching can be used with charitable gifts, 529s, retirement accounts, medical expenses and even certain business expenses. Really, it’s about determining the most efficient time to make certain payments, transfers or contributions to maximize your financial planning goals.

For instance, the standard deduction for federal income taxes is $12,950 for a single filer and $25,900 for married filing jointly in 2022. In order to benefit from an itemized tax deduction, like a charitable gift, you will need to have deductions that total up to be more than the standard deduction amount. Another reason to bunch expenses or deductions into a year is because you might have higher taxes this year than in the near future. Perhaps you got a large bonus or sold a business, raising your income – and potentially your taxes – just for one year.

The interesting twist on this right now is that as we start to hear the conversation about the current administration potentially raising or lowering taxes, it could really shift your tax planning and bunching strategies. For instance, if you think tax rates might go down next year, it’s possible you’d want to bunch together charitable contributions into this year to reduce taxes at a higher rate. If you think tax rates might go up for you next year, there’s an argument that you shouldn’t give to charity this year and should instead wait until tax rates are higher to give, perhaps bunching a few years of charitable giving into one year.

But either way, you might want to consider a bunching strategy as part of your financial planning, gifting and tax planning.

Let’s take a deeper look into three strategies for bunching: outright gifts to charity, donor-advised funds and 529 plans.

More Outright Gifts to Charity

Giving to charities is a part of life for many Americans. In 2020, Americans gave $471 billion to charity, according to Giving USA. Fortune reports this was up 5.1% from 2019’s $448 billion.

Let’s look at charitable giving from a tax bunching planning realm. Maybe you usually give $10,000 per year to charity. If that’s the amount you’re giving and you have $10,000 in state and local taxes in an itemized deduction, you’re not going to get over the standard deduction. 

The 2017 Tax Cuts and Jobs Act raised the standard deduction for taxpayers. In 2022, the standard deduction was $12,950 for single filers (up from $6,500 pre-TCJA) and $25,900  for married filing jointly filers (up from $13,000 pre-TCJA).

Because of the changes in the TCJA, more Americans are now filing as standard filers versus itemized filers. Since the passage of the TCJA, the number of people itemizing was slightly more than 18 million in 2018, down from 46.5 million in 2017, according to the Tax Foundation. What this means is that many people are not getting a tax benefit for the amount of the gift to charity.

However, you could itemize and be able to give more money to charity if you decide to take the next five years of charitable contributions, bunch them together and make them all this year. That will give you a $50,000 itemized deduction, plus the $10,000 SALT deduction we discussed, which puts your total deductions at $60,000 versus $25,900 for a standard married filing jointly filer. This could end up saving you somewhere around $10,000 in taxes.

Remember, if you don’t pass over the standard deduction, you don’t get to deduct those items. So if you give $10,000 for each of the next five years but never pass over the standard deduction, you’re not going to get a tax benefit from donating to charities.

If that’s not a possibility before the end of the year, you can wait until next year and bunch this year’s and next year’s contributions together. While not everybody loves waiting to do their charitable donations, waiting a year could reduce your tax burden in a potentially higher income year while also providing more to your favorite charities.

The reality is that most people don’t give to charities for the tax benefits, but why not get the best deal you can possibly get? The government wants you to give to charities, encouraging you to do so by having itemized deductions for charitable contributions.

Donor-Advised Funds

Another way to bunch together charitable contributions is with a donor-advised fund (DAF). You can contribute to a DAF – a charitable giving vehicle that’s administered by a public charity – with an irrevocable, tax-deductible contribution. You, as the donor, can then recommend grants from those funds to charitable organizations, while the charitable sponsor retains legal control over the assets in the DAF.

If you choose a DAF, you can get the tax reduction now on the full amount of the charitable gift, while you let the investment returns grow tax-free inside the fund in order for you to make larger contributions to charities.

In 2019, contributions to DAFs totaled $38.81 billion, an 80% increase in contributions since 2015, according to the National Philanthropic Trust.

A donor-advised fund might be a good vehicle if you had a really high tax year. For example, say you sold (or plan to sell before the end of the year) a business and subsequently have $1 million in taxable income and most of your taxes are subject to the highest tax rate possible. While maybe you normally give around $10,000 a year to charity, you could bunch five years of gifting together into this year and give $50,000 to the DAF. You would get the full $50,000 deduction this year, then could suspend giving for a few years but still have money go from the DAF to your favorite charity in each of the next five years.

The benefit? By bunching these gifts today, you can offset taxes in this year but still make the payments you normally would to the charity in the future.

The downside is that you need to come up with the funds this year and can’t spread your gifts to the DAF over five years to get the full deduction today.

Bunching into 529 Plans

Charitable contributions are not the only way to bunch. In the realm of state income tax planning, look to bunching in a 529 plan if you’re utilizing one to stash away money for your children’s or grandchildren’s future education expenses.

About 30 states offer a state income tax deduction for 529 plans. You can find a list from SavingForCollege.com. Remember, you do not get a federal income tax deduction for contributions to a 529 plan, but the investment gains can come out tax-free if used correctly to fund college education expenses.

You could also bunch five years’ worth of contributions into the 529 plan in a high tax year, which is also known as “superfunding” in the 529 world. This has two benefits: It could save you taxes, and it gives your contributions a longer period to grow in the tax-advantaged 529 account.

Essentially, you can make a lump-sum contribution of up to $80,000 per spouse in 2022 – or five times the annual gift tax exclusion ($16,000) – to be distributed evenly over five years to avoid the federal gift tax. The stipulation here is that you can’t take the annual exclusion for other gifts to this particular beneficiary over that five-year period.

Keep in mind that with the passage of the TCJA, 529 plans can be used for more than just tuition now. In addition to tuition, qualified expenses now include housing costs, school fees, books and equipment (including computers) so long as they’re used for the beneficiary’s coursework.

While there are benefits to funding 529 plans earlier rather than later, bunching can also be a valuable tax planning strategy to reduce state income taxes while saving for college expenses. 

As you plan for the year and your future financial goals, consider utilizing these strategies so you don’t pay more taxes than you have to by bunching contributions, deductions, and gifts. This article does not represent all potential bunching strategies, as bunching can also be done with retirement plans, medical expenses and certain business expenses. Work with your financial professional to explore what your next five years of giving will look like and whether you should bunch in this year or next.

 

This article was written by Jamie Hopkins from Forbes and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to legal@industrydive.com.

 

The contents in this article are being provided for educational and informational purposes only. The information and comments are not the views or opinions of Union Bank, its subsidiaries or affiliates.

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