No one likes paying taxes. Since the Tax Cut and Jobs Act (TCFA) of 2017, many of you have seen your Federal tax bill decline. But there is still more you can do to lower your total income taxes through a technique called bunching.
Many of you previously were able to itemize your deductions before the TCJA of 2017. For married couples filing jointly, this act changed the standard deduction from $12,600 to $24,000. For singles, the standard deduction went from $6,300 to $12,000. In 2020 the standard deduction will be $24,800. This act helped make filing taxes simpler for millions of Americans. The Joint Committee on Taxation estimates that 94% of households can claim the standard deduction. The downside, if there is one, is that you can no longer claim a tax benefit for your charitable giving. There is a method that you can use to get a tax benefit. The strategy is often referred to as bunching because you "bunch" items that are deductions into one year, instead of over two years. For example, you could pay all of your property taxes in December every other year. If your property taxes are 3,000, then every other year, pay the full amount in December instead of half in December and half in May. Every other year, the property taxes you could deduct are $4,500 ($3,000 + $1,500). A side-note on this tax deduction, the most you can deduct for state and local taxes is $10,000.
Another deduction that you can bunch is your charitable giving. For example, if you give $10,000 a year to your church, you can instead give $20,000 every other year. Then in the years you give, you can itemize your deductions, and in the other years, you can use the standard deduction. The problem is that giving is something that we want to do consistently and not every two years. The solution to this problem is the donor-advised fund. A donor-advised fund, often referred to as a giving fund, is essentially a conduit for your giving. When you contribute money into the donor-advised fund, you get a tax deduction.
Think of it as an account that you fund with your money. You don't own this account, but you are both the donor and the adviser for this fund. As the donor, you receive a tax deduction when you contribute to the account. As the adviser, you are the one who decides which charities will benefit. A charitable foundation (for example, the MB Foundation) is the owner of the account. That is why you receive a tax deduction when you donate your money to the fund and not when the foundation gives the money to the charity. As long as your recommendation is a 501(c)(3) charity, your request is generally accepted. Your charity contributions are called grants, and you get credit for the grant unless you choose to remain anonymous.
The tax benefit to "bunching" is that you will be able to itemize every other year. (For you math nerds) Here is an example. Let's say you have the following itemized deductions.
Charitable giving = $14,000
Mortgage interest = $3,500
Property tax = $3,300
State tax = $4,000
They add up to $24,800, which is no more than the amount of the married filing jointly, standard deduction for 2020. So there is no additional tax benefit from your giving. If instead, you bunch your charitable giving into every other year by putting it into a Donor Advised Fund (and change the way you pay property tax and your mortgage), then the total the first year is:
Charitable giving = $28,000
Mortgage interest = $3,778
Property tax = $4,950
State tax = $4,000
Your itemized deductions add up to $40,728. If you are in the 22% tax bracket, this incremental amount over the standard deduction of $24,800 equals a savings of $3,080 every other year.
22% * ($40,728 - $24,800) = $3,080
So you will pay $3,080 less in Federal income tax. The total tax savings after six years is $8,920*.
I have a spreadsheet prepared for calculating the amount that you will save over the next six years*.
The requirement for doing this is you must have the money available to pay your taxes early and also put money into the Donor Advised Fund. The first year is the most difficult because (for this example), you will need an additional $14,000 for giving and $1,650 to pay your property taxes early.
*The amount is only an estimate and makes several assumptions, including, you are not subject to AMT.