In light of the 2017 Tax Cuts and Jobs Act (TCJA) which substantially increased the standard deduction and limited certain itemized deductions, the bunching strategy offers a practical approach to maximize tax benefits. This strategy is particularly relevant from 2018 through 2025, providing tax preparers a valuable tool to suggest to their clients for optimizing their itemized deductions.
Understanding Bunching
Bunching involves strategically timing deductible expenses to alternate between taking the standard deduction in one year and itemizing deductions the next year. This method is beneficial when a client’s itemized deductions hover around the standard deduction threshold. Here, tax preparers can discuss and assist clients in planning deductible payments, such as medical expenses, taxes, and charitable contributions, to maximize deductions in alternating years.
Practical Applications
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Medical Expenses: Encourage clients to consolidate expenses, such as large medical payments, into a single year. This can involve paying for significant medical procedures upfront to exceed the 7.5% of AGI threshold for deductibility.
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Property Taxes: Advise clients to pay property taxes in a manner that allows them to bunch payments in a single year, ensuring they don't exceed the $10,000 deduction cap for state and local taxes under TCJA. Make sure to avoid penalties that might negate tax savings.
- Charitable Contributions: Guide clients to bunch their charitable donations by prepaying the next year’s contributions in December.
Cautions and Considerations
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Tax Cap on Deductions: Remember that the $10,000 SALT limitation on itemized tax deductions means there's little benefit in prepaying taxes beyond this threshold.
- Alternative Minimum Tax (AMT) Impacts: Be cautious for clients under AMT, as they may derive no benefit from itemized deductions due to differing rules.