In recent years, charitable giving strategies have evolved to adapt to changing tax laws and financial circumstances. One such strategy that is popular among philanthropists is charitable bunching. When combined with a Donor-Advised Fund (DAF), this approach offers donors a tax-efficient and flexible way to manage their charitable contributions. In this post, we will explore how charitable bunching works and how a DAF can be a powerful tool for implementing this strategy.
What is Charitable Bunching?
Charitable bunching is a tax strategy designed to maximize deductions for charitable giving in response to changes in tax laws, particularly the Tax Cuts and Jobs Act of 2017 (TCJA). Under TCJA, the standard deduction nearly doubled, making it harder for many taxpayers to itemize deductions. As a result, fewer people could benefit from the tax incentives associated with charitable donations.
However, charitable bunching allows donors to "bunch" multiple years' worth of charitable contributions into a single tax year, increasing the chances of surpassing the standard deduction and qualifying for itemization. In the years when donors bunch their contributions, they can enjoy a significant tax break, and in other years, they can simply take the standard deduction.
How Does a Donor-Advised Fund Work?
A Donor-Advised Fund (DAF) is a charitable giving account designed for the sole purpose of supporting philanthropic causes. Donors can contribute cash, securities, or other assets to their DAF and receive an immediate tax deduction. However, they do not have to distribute the funds to charities right away. The funds can be invested and grow tax-free over time, and donors can recommend grants to their chosen charities whenever they are ready.
This flexibility makes DAFs an ideal vehicle for charitable bunching, allowing donors to separate the timing of their charitable tax deduction from the timing of their charitable distributions.
Combining Charitable Bunching with a DAF
Using a Donor-Advised Fund for charitable bunching offers several benefits:
Maximizing Tax Deductions: By making a large contribution to a DAF in a single year, donors can potentially exceed the standard deduction threshold, enabling them to itemize and claim a larger tax deduction. This is especially useful if the donor's income is high or if they expect a large windfall in a particular year.
Spreading Out Donations: After bunching contributions into the DAF, donors can decide when and where to distribute the funds. This means they can continue to support their favorite causes over time without needing to make additional donations in those years. It provides more control and flexibility in giving, making it easier to support long-term charitable commitments.
Tax-Free Growth: While the funds are in the DAF, they can be invested and grow tax-free. This allows the donor to potentially increase the total amount they can eventually give to charities.
Simplicity and Convenience: DAFs simplify record-keeping and administration by consolidating charitable donations into a single account. Instead of tracking multiple donations throughout the year, the donor only needs to keep track of their DAF contributions. Additionally, DAF providers handle much of the administrative work, including ensuring that the recipient organizations are qualified entities.
Example of Charitable Bunching with a DAF
Let us consider an example to illustrate how charitable bunching and a DAF work together.
Scenario: A donor typically gives $10,000 to charity every year. However, the standard deduction for a married couple filing jointly is $27,700 (as of 2024), which exceeds their annual charitable giving. This means they would likely take the standard deduction each year without benefiting from itemizing their charitable contributions.
To maximize their tax benefits, the donor decides to bunch five years' worth of donations into a single year by contributing $50,000 to a DAF. In that year, they can claim the full $50,000 donation as an itemized deduction, along with any other eligible deductions. Over the next five years, they continue supporting their favorite charities by recommending grants from their DAF, but they take the standard deduction on their tax return in those years.
In this scenario, the donor gets the best of both worlds: a larger tax deduction in the year of the contribution, while maintaining the ability to support their favorite causes consistently over time.
Key Considerations
While charitable bunching with a DAF can be a highly effective strategy, there are a few important considerations to keep in mind:
Timing: Donors need to plan their bunching contributions carefully, especially if they have fluctuating income or expect significant changes in their tax situation.
Contribution Limits: The IRS limits the deductibility of charitable contributions. For cash donations to a DAF, donors can typically deduct up to 60% of their adjusted gross income (AGI), while donations of appreciated assets may have lower limits.
Conclusion
Charitable bunching, when paired with a Donor-Advised Fund, is a powerful way to enhance the tax efficiency of your philanthropy. By making a larger contribution in one year and spreading out donations over time, donors can maximize their tax savings while continuing to support the causes they care about. Whether the donor is seeking to optimize their giving for tax purposes or simply wants more flexibility in managing their charitable donations, a DAF offers a valuable tool for turning your philanthropic vision into reality.
