If your tax deductions normally fall short of itemizing (or if you itemize, but only marginally) consider using the strategy of bunching deductions to provide bigger tax benefits.
The tax code allows most taxpayers to either utilize the standard deduction or itemize their deductions – whichever provides a greater benefit. As a rule, most taxpayers just wait until tax time to add up their eligible expenses and then use the higher of the standard deduction or their itemized deductions.
To be more proactive, you can time the payments of tax-deductible items to maximize your itemized deductions in one year. Then take the standard deduction in the next year.
Itemized Deductions
For the most part, itemized deductions include medical expenses, property taxes, state and local income (or sales) taxes, home mortgage and investment interest, charitable deductions, and casualty losses.
The “bunching strategy” is more commonly associated with medical expenses, tax payments and charitable deductions, although there are circumstances in which the other deductions might come into play.
Common Bunching Deductions
Medical Expenses
You contract with a dentist for your child’s braces. The dentist may offer you an up-front, lump sum payment or a payment plan. By making the lump sum payment, the entire cost is credited in the year paid, thereby dramatically increasing your medical expenses for that year. If you do not have the cash available for the up-front payment, then you can pay by credit card, which is treated as a lump-sum payment for tax purposes. However, if using a credit card, you must realize that the credit card interest is not deductible. This means you should determine if incurring the interest is worth the increased tax deduction.
Another important issue with medical deductions is that only the amount of the total medical expenses that exceeds 7.5% of your adjusted gross income (AGI) is actually deductible. So, there is no tax benefit in bunching medical deductions unless the expenses exceed this limitation.
If the current year is an abnormally high-income year, you may, where possible, wish to put off making medical expense payments until the following year when the 7.5% threshold is less.
Taxes
Property taxes on real estate are generally billed annually at mid-year. Most locales allow property owners to make semi-annual or quarterly payments. Thus, you have the option of paying it all at once or paying in installments. This provides the opportunity to bunch the tax payments. For example, you could pay one semi-annual installment or two quarterly installments and a full year’s tax liability in one year and only paying one semi-annual installment or two quarterly installments in the other year. In doing so, you are able to deduct 1-½ year’s taxes in one year and 50% of a year’s taxes in the other.
Late Payment of Property Taxes
Thinking of making your property tax payments late as a way to accomplish bunching? A word of caution… The late payment penalty will probably wipe out any potential tax savings. And this strategy won’t work if your mortgage payments include real property taxes held by the lender. This is because you can only deduct the tax payments that the lender makes on your behalf during the tax year.
State Income Tax Considerations
Reside in a state that has state income tax*? The state income tax paid or withheld during the year is deductible as a federal itemized deduction. So, for instance, if you are paying state estimated tax in quarterly installments, the fourth-quarter estimate is generally due in January of the subsequent year. This gives you the opportunity to either make that payment before December 3. Which allows you to be able to deduct the payment on the current year’s return. Or make the payment in January before the January due date. Then you can use it as a deduction in the subsequent year.
*We don’t have state income tax here in Washington state. However I have included the reference for my out of state clients.
A few words of caution about the itemized deduction for taxes
Taxes are only deductible for regular tax purposes. So, to the extent you are taxed by the AMT), you derive no benefits from the itemized deduction for taxes. Also, through 2025, the max amount per year that you can deduct on your federal return for state and local taxes is $10,000. ($5,000 if using the married separate filing status).
Charitable Contributions
Charitable contributions are a nice fit for “bunching” because they are entirely payable at the taxpayer’s discretion. For example, if you normally tithe at your church, you could make your normal contributions during the year. Then you could prepay the entire next year’s tithing in a lump sum in December of the current year. This would double up on the church contribution one year, leaving you with no charity deduction for church the second year.
Normally, charities are very active with their solicitations during the holiday season. This gives you the opportunity to make the contributions at the end of the current year or simply wait and make them after the end of the year. Be sure to get receipt or acknowledgment letter from the organization for documentation. The statement needs to clearly show in which year the contribution was made.
Think a “bunching” strategy might benefit you? Please call this office to discuss the issue and set up an appointment for some in-depth strategizing.
Mid-Year September Tax Planning Checklist
