Everyone likes to save on taxes. Making the most of deductions is one avenue available to taxpayers to reduce their tax bill. All taxpayers have the option to either itemize deductions or take the standard deduction, which is currently $12,700 for a married couple under age 65. If a couple’s standard and itemized deductions are close to being the same amount each year, there is an opportunity to plan these expenses in a way that may reduce the overall tax bill.
Common itemized deductions include property taxes, charitable contributions, mortgage interest and certain medical and investment-related expenses. Because of the standard deduction, a married couple may realize no tax benefit for deducting these expenses unless they exceed $12,700. One way to avoid missing out on this tax advantage is to delay some deductions in one year and accelerate them in the next. This strategy, sometimes referred to as “bunching” or “doubling up” deductions, results in itemizing deductions every other year and taking the standard deduction in the alternate years.
Some itemized deductions must be paid in the year that they are due. However, others offer more flexibility and are good candidates for this strategy. For example, in Travis County a taxpayer can choose to pay the current year’s property taxes in December of the current year, or wait one month and pay in January of the following year. This flexibility lets you pay, and deduct, two years’ worth of property taxes in one calendar year.
Here is an example of how bunching or doubling-up on itemizing deductions might work. We will assume the following:
- A married couple, both age 60, with a paid-off home mortgage and grown children.
- Adjusted gross income is $120,000 per year for 2016 and 2017.
- Property tax on their home is $8,000 per year for 2016 and 2017. They have earmarked $4,000 per year for charitable deductions and no other expenses that would qualify as itemized deductions.
- For this example, we will assume tax rates remain constant in 2016 and 2017.
If the couple pays property taxes and charitable contributions each year, they will owe $16,278 in taxes each year for 2016 and 2017. However, if they pay two years of property tax ($16,000) and charitable deductions ($8,000) in 2016, and then do not pay any in 2017, their 2016 tax bill is reduced to $13,453. In 2017 their taxes remain the same at $16,278.
While total out-of-pocket expenses did not change at all, proper planning allowed the couple to save $2,825 in taxes for 2016.
This strategy may not work if you have large deductions, such as mortgage interest, medical and investment-related expenses that don’t allow you the flexibility to choose when they are paid. In addition, some mortgages require you to pay property tax as part of your monthly payment. There are other factors to consider. First, you must consider your income and the changing tax laws. If the tax rates or your income are going to change significantly in a coming year, those changes must be taken into account when implementing this strategy. Second, if you are subject to the Alternative Minimum Tax there are several itemized deductions that will not help you if you accelerate their payments because they are removed in the calculation of the AMT.
By Jim Kerr
Austin Asset does not practice law or accountancy; please consult your attorney and tax advisor in these areas. Moreover, you should not assume that any information or any corresponding discussions serves as the receipt of, or as a substitute for, personalized investment advice from Austin Asset licensed employees. The opinions expressed are those of Austin Asset and are subject to change at any time due to the changes in market, economic conditions, or tax regulations.