As the end of the year draws to a close, there’s always that nagging question in the back of your mind: Is there anything I should be doing right now that will help put me in a better position come tax season?
That question becomes even more complex this year because the new tax law that took effect nearly doubled the standard deduction to $12,000 for individuals and $24,000 for married couples filing jointly. Not only that, but a lot of common deductions people used to itemize have been capped significantly. The amount of total deductions you can take in state and local taxes, for instance, is now capped at $10,000 — it used to be unlimited.
The change means fewer people than before are likely to itemize deductions. But what if the amount you would have itemized and the standard deduction come close? That’s when a strategy known as “bunching” itemized deductions can come into play.
WHAT DOES IT MEAN TO BUNCH YOUR DEDUCTIONS?
Essentially, bunching your deductions means you pay two year's worth of deductible costs before the end of 2018, so that you can itemize them on your 2018 tax returns. Then in 2019, you can take the standard deduction. This strategy requires you to think about your taxes two years at a time, but the idea is that you’d be less likely to miss out on the tax breaks that could come with itemizing.
WHAT TYPES OF DEDUCTIONS CAN I BUNCH?
Some examples of tax deductions you could prepay include:
- Property Taxes. You could pay next year’s property taxes in advance before the end of the year so that you can claim the property tax deduction this year, but you can only take a deduction on taxes that have been assessed — meaning that you have your property tax bill in hand. You can’t deduct anticipated taxes. The deduction you can take is also now capped at $10,000.
Medical Expenses. If you’ve been putting off an elective medical procedure or need to make an expensive prescription drug purchase, you may want to consider footing those medical expenses in 2018, especially if you already have had a lot of medical expenses. Bonus: This year, you can deduct medical expenses that exceed 7.5 percent of your adjusted gross income (AGI). In 2019, that AGI floor climbs to 10 percent.
Charitable Contributions. If you've got a charitable cause you know you want to support next year, then consider donating what you would have given the organization next year before the end of this year. If you still want to donate but are not sure yet who you want to support, you could put those contributions in a donor-advised fund (DAF). A DAF lets you invest money that will eventually be distributed to a nonprofit, based on recommendations you make to the fund manager. But you can take the tax deduction in the year that you actually put your money in the DAF. (Just note that DAFs have minimum contribution limits.)
There's likely more than what’s on this list that could apply to you, so talk to a tax advisor about what other deductions you could potentially qualify for.
HOW DOES BUNCHING WORK IN REAL LIFE?
Let’s say you and your spouse typically pay $8,000 in mortgage interest each year, and normally get a $9,000 property tax bill each year in December with a due date in January. Rather than wait until January to pay like you normally do, you decide to pay that bill before December 31. (Even though you paid $18,000 in property tax in 2018, you can only deduct $10,000 of it.)
Then let’s assume you normally donate $5,000 a year to your local arts organization. Before the end of the year, you decide to cut them another $2,000 check, which means you've given $7,000 in charitable contributions this year. Add up all these deductible costs (mortgage interest, property tax and charitable donations), and that’s $25,000 you can potentially take in itemized deductions for the year.
The following year, that would leave you with just $8,000 in mortgage interest and a remaining $3,000 in charitable contributions as far as deductible costs go — but that’s OK, because you can take the $24,000 standard deduction and still come out ahead.
Of course, this is a simple example, and your situation could be much more complex. So it’s always important to talk to your tax and financial advisors to get the full picture. But with some advanced planning, bunching your itemized deductions could be a good way to potentially maximize tax breaks.
This article is not intended as legal or tax advice. Northwestern Mutual and its financial representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting or tax adviser.