Tripled Deduction Value: Bunching Strategy for $2M Gift

Tripled Deduction Value: Bunching Strategy for $2M Gift

Executive Summary

A high-net-worth client of Harrington Legacy Advisors desired to donate $2 million to their alma mater but faced concerns about exceeding annual charitable deduction limitations and potentially wasting a significant portion of the gift's tax benefits. To address this, Harrington Legacy Advisors implemented a "bunching" strategy, strategically concentrating donations into alternate years to exceed the standard deduction and maximize itemized deductions. This approach tripled the client's charitable deduction value, resulting in over $600,000 in estimated tax savings over a five-year period.

The Challenge

Our client, a successful entrepreneur in their late 60s, approached Harrington Legacy Advisors with a substantial charitable intention: a $2 million gift to their alma mater, a prestigious university with a strong endowment. While driven by philanthropic desires, they were also keenly aware of the potential tax implications and sought to maximize the benefit of their generosity. The challenge lay in effectively structuring the donation to minimize their tax burden while ensuring the full $2 million reached its intended recipient.

Specifically, the client's annual income averaged $800,000, placing them in a high federal income tax bracket. Their projected standard deduction for a married couple filing jointly was $27,700 (based on the 2023 standard deduction). Under normal circumstances, donating even a fraction of the $2 million in a single year would exceed the adjusted gross income (AGI) limitations for charitable deductions. The IRS generally limits cash contributions to public charities to 60% of AGI. Therefore, even if they donated the entire $2 million in one year, the deductible portion would be capped at $480,000 (60% of $800,000), leaving a significant $1.52 million potentially wasted from a tax perspective.

Furthermore, with other itemized deductions, such as state and local taxes (SALT), already nearing the $10,000 limit, simply donating smaller amounts annually would provide minimal tax relief due to falling below the standard deduction threshold in most years. The client also expressed concerns about potential future tax law changes that could further impact the deductibility of charitable contributions. The existing scenario, without proactive tax planning, would have resulted in a suboptimal tax outcome, effectively negating a large portion of the potential tax benefits associated with their generous donation. A simple, direct donation approach would have severely limited the impact of the gift on the client's overall tax liability.

The Approach

To overcome the challenges, Harrington Legacy Advisors recommended a "bunching" strategy, designed to concentrate charitable donations into specific years, allowing the client to significantly exceed the standard deduction and maximize their itemized deductions in those years.

The strategic thinking behind the bunching strategy involved several key steps:

1. Multi-Year Tax Projection: We created a detailed five-year tax projection, considering various income scenarios, investment performance, and anticipated expenses. This projection served as the foundation for modeling different donation scenarios and assessing their impact on the client's overall tax liability.
2. Deduction Optimization: We identified years where the client could realistically exceed the standard deduction with the $2 million donation. This involved strategically timing the donation and coordinating it with other potential itemized deductions, such as medical expenses or investment losses. We determined that donating $1 million in Year 1 and another $1 million in Year 3 would be the most advantageous schedule.
3. AGI Limitation Management: We meticulously ensured that the annual donation amounts did not exceed the IRS's AGI limitations for charitable deductions. By spreading the donation over two years, we kept the annual donation amounts manageable and within the allowable limits (60% of AGI).
4. Flexibility and Contingency Planning: We incorporated flexibility into the plan to account for unforeseen circumstances, such as changes in income or investment performance. The plan included built-in adjustments to ensure that the client could still maximize their tax benefits even if their financial situation changed.
5. Coordination with Other Advisors: We coordinated closely with the client's other advisors, including their accountant and estate planning attorney, to ensure that the bunching strategy aligned with their overall financial plan and estate planning goals. This collaboration ensured a holistic and integrated approach to managing the client's wealth.

The core of the bunching strategy rested on the principle that the client would only itemize deductions in the years they made substantial donations, while taking the standard deduction in the intervening years. This allowed them to effectively "front-load" the tax benefits of their charitable contributions and significantly reduce their overall tax burden.

Technical Implementation

The technical implementation of the bunching strategy involved several key tools and calculations:

1. Tax Planning Software: We utilized sophisticated tax planning software to model various donation scenarios and assess their impact on the client's federal and state income tax liabilities. This software allowed us to accurately calculate the deductible portion of the donation in each year, considering AGI limitations and other relevant factors.
2. AGI Calculation: We meticulously calculated the client's adjusted gross income (AGI) for each year of the five-year projection. This involved factoring in all sources of income, including salary, investment income, and retirement distributions, as well as any applicable deductions, such as IRA contributions or student loan interest.
3. Charitable Deduction Calculation: We applied the IRS guidelines for charitable deductions, specifically focusing on the limitations for cash contributions to public charities (60% of AGI). We carefully monitored the client's AGI to ensure that the donation amounts remained within the allowable limits. The software automatically calculated the deductible amount, taking into account these limitations.
4. Itemized Deduction Optimization: We optimized the client's itemized deductions in the donation years by strategically timing other deductible expenses, such as medical expenses or investment losses. This ensured that the client fully utilized their itemized deductions and maximized their tax savings.
5. Tax Bracket Analysis: We analyzed the client's tax bracket in each year of the projection to determine the potential tax savings associated with the charitable deductions. This analysis helped us to quantify the financial impact of the bunching strategy and demonstrate its value to the client.

Specifically, in Year 1, the $1 million donation, capped by the AGI limitation, resulted in a deductible amount of $480,000. Combined with the SALT deduction of $10,000, total itemized deductions reached $490,000, far exceeding the standard deduction of $27,700. In Year 2, the client claimed the standard deduction. In Year 3, the process repeated with the second $1 million donation, also subject to the AGI limitation.

The tax planning software also allowed us to project the long-term impact of the bunching strategy on the client's overall wealth. By reducing their tax burden, the client was able to retain more of their investment gains and accelerate their wealth accumulation.

Results & ROI

The implementation of the bunching strategy yielded significant financial benefits for the client:

• Tripled Charitable Deduction Value: By concentrating the donations into alternate years, the client effectively tripled the value of their charitable deduction compared to donating smaller amounts annually and taking the standard deduction in most years.
• Over $600,000 in Estimated Tax Savings: Based on our five-year tax projection, the bunching strategy resulted in an estimated tax savings of over $600,000 compared to simply donating smaller amounts annually. This represents a substantial return on investment for the client.
• Significant Reduction in Tax Burden: The client experienced a significant reduction in their overall tax burden, freeing up more capital for investment and other financial goals.
• Increased Charitable Impact: By maximizing the tax benefits of their donation, the client was able to make a more significant impact on their alma mater, supporting its mission and programs.

Before Bunching (Estimated):

• Annual Donation: $400,000 (over 5 years)
• Deductible Amount (capped at AGI limits): Approximately $240,000 per year
• Total Deductible Amount (over 5 years): $1,200,000
• Estimated Tax Savings (assuming 37% tax bracket): $444,000

After Bunching:

• Donation Schedule: $1,000,000 in Year 1, $1,000,000 in Year 3
• Deductible Amount (capped at AGI limits): Approximately $480,000 in Year 1 and Year 3
• Total Deductible Amount (over 5 years): $1,440,000 (2 x $480,000 + 3 years of standard deduction ($0 after itemizing in bunching years)
• Estimated Tax Savings (assuming 37% tax bracket): Approximately $610,000.

Net Tax Savings: $166,000, approximately 37% improvement, over simply distributing donations annually

This translates to an effective rate of 37% for the bunching donation and 37% less than that for the simple approach.

Key Takeaways

For other advisors considering implementing a bunching strategy for their clients, here are some key takeaways:

1. Comprehensive Tax Planning is Essential: Before implementing any bunching strategy, conduct a comprehensive tax planning analysis to assess the client's financial situation, income projections, and potential tax liabilities.
2. AGI Limitations Must Be Carefully Considered: Always be mindful of the IRS's AGI limitations for charitable deductions and ensure that donation amounts remain within the allowable limits.
3. Flexibility is Crucial: Incorporate flexibility into the plan to account for unforeseen circumstances, such as changes in income or investment performance.
4. Collaboration is Key: Coordinate closely with the client's other advisors, including their accountant and estate planning attorney, to ensure that the bunching strategy aligns with their overall financial plan.
5. Communicate the Value Proposition: Clearly communicate the value proposition of the bunching strategy to the client, highlighting the potential tax savings and increased charitable impact.

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