- If itemized deductions are higher than the standard deduction, a taxpayer should get the benefit of the higher itemized amount.
- With the increase in the standard deduction under the Tax Cuts and Jobs Act, fewer individuals will see a tax benefit from their itemized deductions.
- Itemized deduction “bunching” is a strategy to either accelerate or delay the payment of deductible expenses into a different year to help exceed the standard deduction amount.
Clients often ask if they will be able to itemize deductions on their tax return to claim more deductions than the “standard deduction”. The standard deduction differs depending on your filing status, but it is a flat amount that the Internal Revenue Service (IRS) allows all qualified taxpayers to deduct from their income every year. In comparison, a taxpayer’s itemized deduction amount varies from year to year depending on actual expenses. As deductions reduce taxable income, no one wants expenses that could reduce their tax bill to go unused.
The answer to the question, “Will I benefit from itemizing deductions?”, has become more relevant with the increase in the standard deduction under the Tax Cuts and Jobs Act (TCJA). The TCJA increased the standard deduction to $12,000 for single filers and $24,000 for married filers¹. Along with this increase, the TCJA has reduced or eliminated the ability to itemize some deductions, including state income and property taxes, some mortgage interest and other miscellaneous deductions. These changes will make it harder for some to realize the benefit of their deductible expenses.
According to IRS Publication 17², there are six major categories of expenses that are used to calculate the itemized deduction amount, which are provided below. However, the application of these categories has changed significantly under the TCJA:
1. Medical expenses paid out of pocket that exceed 7.5% of your Adjusted Gross Income (AGI).
TCJA update: 10% of your AGI after 2018.
2. Taxes you paid, such as real estate taxes, personal property taxes, and the higher of:
a. State and local income taxes or
b. State and local sales taxes
TCJA update: Limited to $10,000 in total per year.
3. Interest you paid up to certain limits, such as mortgage interest, some home equity lines of credit and investment interest expense.
TCJA update: Mortgage interest now has limits of $750,000 for new mortgages, and home equity interest availability is more limited.
4. Charitable donations limited up to 50% of AGI.
TCJA update: The limit is increased to 60% of adjusted gross income.
5. Casualty and theft losses not covered by insurance that exceed 10% of your AGI, less $100.
TCJA update: Eliminated under the TCJA, unless incurred from federally declared disasters.
6. Miscellaneous itemized deductions, with some deductions limited to those exceeding 2% of your AGI.
TCJA update: Eliminated under the TCJA.
Each year it is important to review your itemized deductions. If the total estimated itemized deduction amount is less than the standard deduction, there may still be a chance you could increase your itemized deductions by doing some careful planning. By accelerating certain expenses planned for the following year into the current year, you can exceed the standard deduction amount and claim the higher itemized deduction amount in the current year. This technique is known as itemized deduction “bunching.” Another version of this technique is when you delay expenses planned for the current year and push them into the following year, to provide this same “bunching” benefit.
To provide some examples of how this may work, the following are four common itemized deduction bunching strategies that we look for when tax planning for our clients:
Adjusting the Timing of Charitable Donations
This is the simplest way to modify the amount of itemized deductions for a taxable year, as the taxpayer has complete control of when to make the payment. We sometimes suggest opening and contributing to a “donor advised fund” to accelerate multiple years’ worth of donations into one year, as the tax benefit is recognized at the time of contribution into the fund. With the limitations imposed on many itemized deductions under the new tax law, one of the easiest ways to benefit from a bunching strategy is through the timing of charitable contributions.
For example, assume Sarah and Jim, married filers, had the following for 2018: $10,000 of combined property and state income tax, $7,000 of qualified mortgage interest and their usual $5,000 of charitable contributions. The total of their deductions for 2018 would be $22,000, which is less than the new standard deduction of $24,000. Therefore, the standard deduction would apply. If instead they were to “bunch” an additional year of charitable contributions into 2018 by using a donor advised fund, their total deductions for 2018 would be $27,000. This would provide them the added deduction, without changing the tax affect for 2019, where we would assume they would again be using the standard deduction amount. Using this bunching example, the total deductions combined for the two years would be $51,000, rather than just $48,000 if bunching had not been utilized.
Pre-Paying Next Year’s Real Estate Tax Bill in Addition to the Current Year’s Bill
This can be another option for some people in certain tax situations. The actual process to do this, however may be complicated, depending on the specific county in which the property is located. After the passing of the TCJA, the IRS has also limited this strategy to pre-paying those taxes that are actually assessed at the time of payment.
Submitting a Fourth-Quarter State Estimated Tax Payment by December 31st
Normally, a fourth-quarter estimated tax payment would be due January 15th of the following year. Paying it earlier, before the end of the year, can be another way to increase the amount of itemized deductions for the year. Again, this strategy is now more limited under the TCJA, as the total deduction allowed for state income and property taxes is limited to $10,000.
Accelerating or Delaying Out of Pocket Medical Expenses
This could be hard to accomplish because individuals sometimes have limited control over when some medical procedures can be performed as well as the timing of billing for the service. Also, the taxpayer would typically need to have relatively low income for the year because medical expenses paid out of pocket would need to exceed 7.5% of AGI, and 10% of AGI after 2018.
In summary, it is possible to adjust itemized deductions within a year to arrive at a higher itemized deduction amount, providing a larger tax benefit over the standard deduction. Because of the TCJA, the tax benefit of bunching itemized deductions has been reduced and made harder to accomplish. However, with careful planning and guidance, some of the benefits lost under the TCJA can be found again. If you have any questions or would like further information, please feel free to contact us.