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Tax Reform and Your Bottom Line, Part 1: Bunching Deductions

September 08, 2021

In 2017, Congress signed a tax reform bill called the Tax Cuts and Jobs Act. This new law offers significant changes to taxes as we’ve known them, but these changes are only effective for a finite period of time (2018 – 2025). This is the first of a series of articles focused on how to use the current tax law changes to maximize your bottom line.

For starters, let’s identify the major changes that might affect you and your family:

Tax rates have been reduced across the board for all income brackets.
The standard deduction has increased for all filers.
Personal exemptions have been suspended.
Itemized deductions are no longer limited based on adjusted gross income, but caps have been put in place on how much you can deduct for certain items such as mortgage interest, and state and local taxes.
Child and dependent credits have increased, and the income phase out level allowing for eligibility has increased.
Since these changes are only in effect for 8 years, now might be the time to determine if any tax planning strategies can help you minimize your tax liability.

Effective for 2018 tax filers, the standard deduction has been increased to $12,000 for a single tax filer and to $24,000 if you are married filing jointly (or a qualified widow(er)). The tax code allows taxpayers to take the higher of: the newly increased standard deduction or their Schedule A itemized deductions. Before you rush your decision, remember that your Schedule A deductions might look different this year than they have in past years.

For Schedule A deductions, all deductions must be reported in the year they were incurred. Some of the changes to the major deductions allowed on your Schedule A include:

Mortgage interest on mortgages up to $750,000 that were acquired after December 15, 2017 is deductible; (mortgage interest on mortgages up to $1,000,000 acquired prior to this date is still deductible).
State and local taxes up to $10,000 are deductible.
Medical and dental expenses that are more than 7.5% of your adjusted gross income are deductible. Starting in January 2019, only medical and dental expenses that exceed 10% of your adjusted gross income are deductible.
Charitable contributions of cash up to 60% of your adjusted gross income are deductible.
Unreimbursed job-related expenses and other miscellaneous itemized deductions that were subject to the 2% of adjusted gross income floor are no longer deductible.
With these newly imposed limits in conjunction with the higher standard deduction is it even worth completing a Schedule A? It might be.

If you are just shy of taking the itemized deductions or if your itemized deductions give you a marginal advantage over the standard deduction, bunching your deductions might be a good tax planning strategy for you.

Bunching deductions is basically timing the payments of your tax-deductible expenses so that they are incurred in the same year. You may find yourself bunching deductions for one year and taking the standard deduction for the next. Of the tax-deductible items on your Schedule A, you would most likely bunch medical expenses, charitable contributions and tax payments.

Charitable contributions are the simplest deduction to bunch since the taxpayer has total control over when and how much to contribute. Essentially, you would “double up” your charitable giving for one year, pay nothing in the next year, “double up” in year 3, pay nothing in year 4, and so on. The years you “double up” would be the years that you use your Schedule A itemized deductions on your taxes. The years that you pay nothing are the years that you would take the standard deduction. Bunching deductions seems to be more powerful when your Schedule A deductions and your standard deduction are neck and neck.

Remember that the tax law changes are only effective for the next eight years then they revert to 2017 tax laws. Over this eight-year time frame, depending on the size of your charitable contributions, this strategy could provide even more tax savings than just using Schedule A deductions over the same period of time.

While just claiming the standard deduction might be the easiest and fastest way to file your taxes, bunching your deductions could provide you with a pop of tax savings that makes the extra effort and advanced planning worth it. In the world of personal finance, it’s not just how your investments perform, it’s how well you can manage your bottom line. These new tax law changes provide an opportunity to do just that.

Securities and Advisory Services offered through The Strategic Financial Alliance, Inc. (SFA) – Member FINRA, SIPC.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. The SFA does not provide tax or legal advice.