What is Bunching?

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Since we are now officially in tax season, I thought it would be a good time to focus on some tax topics. Today we are going to look at the standard deduction versus itemized deductions. In 2018, the standard deduction amount drastically increased following the 2017 Tax Cuts and Jobs Act. This increase greatly helped people that did not itemize before. However, many people that did itemize before now find the standard deduction to be more beneficial so they are no longer filing itemized deductions.

We are going to take a look at the difference in the two, some things that are eligible for itemized deductions, and ways to maximize your deductions and minimize your tax liability!

When you are filing your taxes, your form 1040, you basically add up all of your income whether it is from W2 wages, dividends, self employment, etc for your total income. Then you subtract either the standard deduction or your itemized deductions to arrive at your taxable income. The bigger that deduction, the lower your taxable income and thus the lower your actual tax liability.

For the 2022 filing year, the standard deduction is $12,950 for single or married filing separately and it is $25,900 for married filing jointly. For 2023 those figures increase to $13,850 and $27,700 respectively.

The thing is most people do not have enough itemized deductions for them to total more than the standard deduction. Therefore, the standard deduction is more advantageous. But you want to make sure you aren’t leaving any itemized deductions on the table. What are some expenses that are eligible to claim as an itemized deduction?

Medical and dental expenses can be a big one. If you pay for your health insurance yourself out of pocket then you can claim your premium payments. If you have a high deductible health insurance plan then you may be spending a lot out of pocket. Or maybe you have a high co-pay. A lot of people don’t have dental insurance and pay all of that out of pocket. These expenses qualify for an itemized deduction.

State and local income taxes, real estate taxes, and personal property taxes can be itemized.

Mortgage interest is a common one people know about. Home equity loans and lines of credit can be an itemized deduction as long as the funds were used for home improvement. You can’t take out a home equity line of credit and use the funds for a vacation and also be able to claim the interest as an itemized deduction.

Charitable contributions are also another common one. These can include gifts by cash or check but they can also include other contributions such as donating a car or appliances. This is why you always want to get a receipt when you donate items and have the receipt state the value of the item.

If you have suffered a loss due to a federally declared disaster, your loss can be claimed as an itemized deduction. Hurricane Ian this past year is an example of the type of disaster that would create the kind of loss to be claimed here.

I do want to note that many of the itemized deductions are subject to things like income limits so if you are planning to itemize, you want to make sure your deductions are allowed.

So, what should you do if your itemized deductions are almost as much as the standard deduction? You are incurring all of these expenses like mortgage interest, property taxes, etc and you feel like you aren’t able to take full advantage of those expenses because they don’t add up to as much as the standard deduction.

For example, say you have

$8,000 of mortgage interest,

$4,000 in property taxes,

$5,000 in state and local income taxes, and

$7,500 in charitable donations.

A total of $24,500. Just a bit under the standard deduction of $25,900. In this case you would take the standard deduction because it gives you more benefit.

But is there a way to use those qualifying expenses?

Bunching your itemized deductions may be a strategy that can work for you. You basically itemize every other year and take the standard deduction in the years you don’t itemize. Let me show you how this works.

Charitable contributions, property taxes, and medical expenses are the most common to bunch but if you pay estimated state and local taxes then you can use that too! Basically, what you are doing is paying two years worth of expenses in one year.

In our example just a minute ago, the couple was giving $7,500 in charitable contributions. Say they did that every year on December 31. If they wanted to bunch their itemized deductions then this is what they would do: for the year 2022, instead of making that $7,500 donation on December 31, 2022, they make it on January 1, 2023 and then they make it again on December 31, 2023. So, in 2022 they don’t have charitable contributions but in 2023 they have $15,000. By making the donation on January 1, 2023 you are not effecting your personal cash flow nor that of the receiving charity but you are effecting your total itemized deductions.

Most municipalities give a grace period until January 31 for paying property taxes. Using our same couple, say they pay their 2022 property taxes of $4,000 in January of 2023 and then pay their 2023 property taxes in December 2023. They now have $8,000 in property taxes to itemize.

What about medical expenses? If you know you are going to have a large expense and you have the flexibility to time it, then plan accordingly! For example, I have a high deductible health insurance plan. A few years ago I needed surgery and I knew it would get kicked to deductible first and we would have a roughly $7500 expense. Scheduling that surgery in a bunching year would help take advantage of that expense.

Let’s take a look at how the numbers shake out. Assume the couple we mentioned above are married filing jointly and have $100,000 in total income. In 2022, their itemized deductions totaled $24,500 so they took the standard deduction of $25,900 which creates a tax liability of $8,481. In 2023, they again have $100,000 in total income and their itemized deductions are slightly less than the standard deduction of $27,700 so they again take the standard deduction. Their tax liability is $8,236. For a total two year tax liability of $16,717.

Now, let’s say they decide to take the standard deduction in 2022 and bunch their itemized deductions into 2023. The 2022 tax liability would still be $8,481. Their itemized deductions would be:

$8,000 of mortgage interest,

$8,000 in property taxes because they paid the $4,000 for 2022 in January 2023 and 2023 in December 2023

$5,000 in state and local income taxes, and

$15,000 in charitable donations because they made their payments in January 2023 for their 2022 giving and again in December 2023 for the 2023 giving.

Total itemized deductions of $36,000.

Their 2023 tax liability would be $7,240 giving a two year tax liability of $15,721. They would save $1,000 just by changing the date of their property tax and charitable contribution payments!

It’s now February 2023 so we can’t go back and change 2022 at this point but if you have been taking the standard deduction because your itemized deductions were slightly less then you may want to look at holding your 2023 payments into January 2024 on eligible expenses and take the standard deduction in 2023 and bunch your itemized deductions in 2024. I don’t know about you but I am always game for saving $1,000! Especially in taxes!

Be sure to consult your own tax advisor if you have any questions about your own personal situation.