As the tax year draws to an end, you may start to ask yourself the question, “should I itemize or take the standard deduction?” Because of the recent changes to the Tax Law, more and more people are choosing to take the standard deduction. However, itemizing can have large benefits, so the decision can be complex.
For many, deciding whether or not to itemize comes down to adding up their deductible expenses, looking at the newly raised standard deduction ($24,000 for married couples filing jointly), and choosing the higher of the two. If these two numbers are close, though, you may have a third option that could greatly benefit you financially.
It is possible to both itemize and take the standard deduction when you use a strategy called “bunching.”
“Bunching” refers to when you pay two years’ worth of a Schedule A deductible expense in one year. For example, if you annually give $4,000 to charity, you can pre-pay your $4000 contribution for next year in December. That way, you can “bunch” two years’ worth of deductions onto the same year.
This works best with predictable charitable giving, but in some situations can also be accomplished by prepaying property taxes and/or by electing to incur nonessential medical expenses during strategic years (subject to 7.5% floor).
To properly “bunch,” you would typically alternate between itemizing in the year you make your 2 years of charitable contributions and taking the standard deduction in off years. While alternating every other year is most common, it can sometimes make sense to bunch 3 or even more years into one single year.
Take note that this strategy requires you to plan your taxes two or more years in advance. As you do so, work with an expert financial planner and a good accountant to ensure that you are maximizing your return.
Here is a real-life example. Let’s say that, one year, a married couple deducts $10,000 in state and property taxes (the maximum amount) and pays $9,000 in mortgage interest. If they typically give $3000 to charity, they are still $2,000 below the standard deduction.
So, that year they would take the standard deduction unless they employed a bunching strategy.
Instead, they could pay their normal charitable contribution and also prepay their contribution for the next year, allowing them to deduct $6,000 for charitable giving rather than just $3,000. Their total deductions then add up to $25,000, giving them an extra deduction of $1000.
This strategy can also be the best move if you already itemize every year. Say that a married couple takes $10,000 in deductions for state and local income taxes, deducts $5,000 of mortgage interest, and regularly make charitable contributions of $10,000. Instead of taking itemized deductions over 2 years totaling $50,000 ($25k/yr), they could bunch those charitable contributions into the same year. The two years together would result in total deductions of $59,000 ($35k in bunched year plus $24k in standard deduction year) for a net of $9,000 in extra deductions.
Remember, your situation may be more complex than these simple examples. Thus, it is essential to consult with an expert as you plan your taxes. At TrueNorth Wealth, we are fee-only financial planners and retirement benefit advisors who will ensure you are pursuing an optimized tax strategy.
Contact us today for all your financial planning needs. Whether you’re looking into selling business assets or learning more about 401(k) solutions, TrueNorth Wealth is the financial company you can trust to find the best solution for you.