Proactive Tax Planning Strategies

When tax time rolls around and the question of whether to use the standard deduction or itemizing and getting a bigger benefit, many taxpayers find themselves unable to itemize their deductions because the totals fall short of the level needed to qualify. If you find yourself in this position, and you are only falling short by a small amount each year, then you may be able to take advantage of a strategy known as bunching.

Bunching is a proactive way of approaching taxes. It requires a bit of planning ahead and timing expenditures rather than looking back at the previous tax year and calculating what was spent, but it can be well worth the effort if it is done right.

When you bunch your tax-deductible items, it means that you strategically choose to alternate years in which you incur the majority of your tax-deductible expenses so that you qualify to itemize, and then use the standard deduction in the other years when there are fewer of them.

It is most commonly used for taxes, medical expenses and charitable contributions, though expenses that can be used as itemized deductions can also include home mortgage and investment interest, unreimbursed job-related expenses, casualty losses and others. 

Here are some examples of ways that you can bunch your expenses in order to get a bigger tax benefit:

Charitable Contributions 

Choosing whether to make contributions to a charity is an entirely voluntary act that many people participate in, and in most cases people have a specific sum or portion of their income in mind for what they want to give each year.

If you make contributions throughout the course of a single year equivalent to what you want to give during that tax year, and then make your contribution for the following year as a lump sum in December, you have effectively doubled the amount that you’ve given during the single year while still providing the same gift to the charity.

As long as you have a receipt of acknowledgement letter showing that the second year’s contribution was made during the first tax year, you will be able to bump up your tax-deductible amount.

Medical Expenses 

Nobody wants to have big medical expenses, but if you have multiple procedures coming up that you are able to schedule rather than an emergency whose timing is out of your control, it makes a lot of sense to schedule all of them in the same year.

Likewise, if you are about to embark on an expensive medical or dental investment that might typically be paid via a payment plan (such as a child’s orthodontia), if you pay in one lump sum rather than over time you will greatly increase your medical expenses for that year, and boost yourself up towards the level where you will be able to take the itemized tax deduction.

It is important to keep in mind that if you choose to make a big lump sum payment via your credit card and you end up having to pay interest on the card, you are not able to deduct that interest, so think carefully and make sure that the deduction you are seeking is worth the cost of the interest you’re likely to pay. It is also important to remember that there are certain levels that must be achieved in order to take the medical deduction.

Expenses must be more than 10 percent of your adjusted gross income (AGI) in order to be deductible, though through 2016 that number is 7.5 percent if you are over 65. If you qualify for the Alternative Minimum Tax, then the 10 percent figure applies. Make sure that your expenses are going to exceed these levels before putting yourself into a high expense position – or putting yourself through a lot of medical procedures all at once.

Property Taxes

Property taxes and state income taxes can both be bunched in order to increase your chances of being able to itemize. Property tax bills usually arrive in the middle of the year, and they can generally be paid in installments or you can pay them all at once.

As a result, you can time your payments so that you only make half the year’s payments in one year, then in the next year pay the balance of the first and half of the second year’s taxes. This effectively means that you’re paying 1.5 times the amount in one year and half on the other, boosting your tax payments and chances of itemizing. Make sure that when you’re planning your timing you don’t end up paying any of the taxes late – a late fee may quickly eliminate the benefit that the itemization provides.

State Income Taxes

In states where taxpayers are required to pay state income tax, the federal government allows the state tax that has been withheld over the course of a tax year to be used as an itemized deduction. Those who estimate their state taxes and pay them quarterly have the opportunity to choose whether to pay the last quarter’s estimated payment during the tax year or to hold it over into the next.

By alternating what is done each year, you have a greater tax payment on alternating years, and a greater ability to use the itemized deduction. Again, it is important to remember how the AMT comes into play in these scenarios – If you are subject to the alternative minimum tax, you won’t be able to itemize tax payments.

If this type of proactive tax strategy sounds like something that would work for you, we’d be happy to create a plan to help you maximize your benefit. Contact our office today at (801) 613-0900.