It’s that time of year again — time to start planning to cut your taxes. Our next few articles will feature ideas we have to try and reduce your tax hit at tax time. Today we will discuss bunching your deductions in a particular year in order to save tax.
To understand how bunching works, let’s start with the basic idea that you can take either the standard deduction or your itemized deductions, whichever amount is greater. Let’s say your standard deduction is $24,000 and your itemized deductions add up to $20,000 (I’m using the married filing joint standard deduction amount to illustrate). In that case, you will use your standard deduction while your itemized deductions go to waste — every year!
Now suppose there were a way to shift some or all of your $20,000 of itemized deductions from Year 1 to Year 2. In that case, you’d still get a standard deduction of $24,000 in Year 1, but in Year 2 your itemized deductions could be greater than the $24,000. If you keep doing this each year, you get a tax break every other year.
The key is to decide which deductible items should be paid before the end of the year and which should be paid in January.
Some deductible expenses can’t be shifted, of course, but here are some that can:
Charitable contributions: You have complete control over the timing of charitable contributions. Many people like to give large contributions to their place of worship during the holiday season. So, in Year 1 wait a week and make the contribution just after December 31 to push the deduction to Year 2. In Year 2, make the contribution in December. As such, both contributions are made in Year 2. In Year 3, wait until January of Year 4 and so on.
Medical expenses: You have no control over when you get sick, but you have a lot of control over when you pay for services. You also have control over when you get your annual checkups. Schedule checkups near the end of the year and vary between December and January. And here’s a big one: Call your insurance company and schedule your annual premium billing to arrive in December with a January due date.
Property taxes: Many jurisdictions allow for semi-annual payments with the two payments crossing into different calendar years. So, in one year break up the payments into two. In the other year, make a full year’s payment on the initial due date.
State taxes: This area can get a little tricky but if you make quarterly estimated state tax payments, you can control whether you make your fourth quarter payment in December or January. There are other ways to control your state tax payments but there are penalties if you don’t follow certain rules. The major tax reform bill that went into effect in 2018 limits property taxes and state taxes to an aggregate of $10,000 per year, but some viability remains for the bunching strategy.
These are just a few general ideas and there are other considerations at work. Call us and let’s discuss. Perhaps a bunching plan will work for you and, if so, let’s draw one up.