As year-end tax planning commences, donors should be aware of two charitable giving strategies to reduce taxable income: bunching and Qualified Charitable Distributions (QCD).
Bunching and the standard deduction vs itemized deductions
The passage of the Tax Cuts and Jobs Act expanded the standard deduction up through the end of 2025. It also lowered tax rates, limited deductions for state and local taxes (SALT) and mortgage interest, and caused close to ninety percent of taxpayers to choose the standard deduction over itemized deductions during this period.
Even high net worth taxpayers might find adding enough itemized deductions to exceed the standard deduction difficult. The tax deduction as an incentive for charitable giving decreased. To make use of itemized deductions during this period, bunching charitable contributions is a good strategy to maximize itemized deductions.
A donor bunches major charitable donations in one year with the intent to exceed the standard deduction for that year. The strategy is useful in a year when a financial windfall is expected.
Standard deductions for 2023
| Filing status 2023 | Standard deduction 2023 |
|---|---|
| Married Filing Jointly | $27,700 |
| Head of Household | $20,800 |
| Single or Married Filing Separately | $13,850 |
| 65 or Older or Blind (MFJ) | $ 1,500 per person |
| 65 or Older or Blind (Single) | $ 1,850 per person |
Source: IRS provides tax inflation adjustments for tax year 2023, IRS, October 2022
Qualified Charitable Distribution (QCD) from traditional IRA
Each taxpayer is allowed an annual $100,000 QCD from his traditional IRA tax-free. Taxpayers must be at least 70.5 years of age and transfer the funds directly to a qualified charity. Most public charities qualify, however, donor-advised funds, private foundations, and supporting organizations do not.
Recent legislation allows a one-time $50,000 QCD per taxpayer to establish a charitable remainder trust (Note: The $50,000 counts toward the $100,000 limit). QCDs satisfy the Required Minimum Distribution (RMD) requirement for qualified retirement plans, and they do not raise the taxpayer’s adjusted gross income (AGI).
Case study
Reuben and Cherise are 73 years old and married. Their marginal tax rate is 32%. Since Reuben retired several years ago, the couple live comfortably with Reuben’s pension, Social Security, and investment income. Each one owns a 401(k) and Traditional IRA worth six figures and they both must take Required Minimum Distributions (RMD) of $37,000 beginning this year.
Not needing the extra income, neither wishes to withdraw the RMD. Cherise will also be vested in her company’s stock options and plans to exercise them on her last workday to fund their dream vacation. The options will add $350,000 to her income and put her in the highest income bracket at 37% which starts when taxable income reaches $693,750.
The couple’s average itemized deductions consist of SALT (capped at $10,000), $3,000 mortgage interest, and $2,500 deductible medical expenses, totaling $15,500. Their standard deduction for 2023 is $30,700.
They’ve been less charitable the past several years due to the use of the standard deduction for taxes and been feeling more charitable lately.
Rueben and Cherise decide to do $72,000 of QCDs for their RMDs for 2023 and bunch $100,000 of the options proceeds to their five favorite charities 2023.
This strategy offers multiple benefits:
- Reduces 2023 taxable income by $172,000
- Puts them into a lower tax bracket
- Gives them the fulfillment of sharing their life’s blessings
This strategy will serve them well if the standard deduction and tax rate changes when the Tax Cuts and Jobs Act expires in 2025. Reuben and Cherise could use QCDs each year to satisfy their RMDs and lower their AGI. Lowering AGI could benefit certain deductions limited by AGI, the taxability of Social Security, or lower state income tax. In addition, they would be giving substantial gifts to charity every year.
Conclusion
Qualified Charitable Distributions and charitable bunching are two strategies a donor can use to reduce taxable income. Annual QCDs will establish an annual legacy of giving while bunching can offset the tax consequences of windfall events. Find more tax-smart giving strategies in this blog by Kyle Christopherson, MBA, CFP® – SVP, Client Growth.
Consult with your financial advisor or one of Ren’s charitable giving experts today to discuss your charitable giving options for 2023.
