Savvy tax planning is about more than knowing what to write off. Just as essential is knowing when to take deductions. Choosing to stuff deductions into one tax year as opposed to another bears directly on how much winds up with the IRS. Advancing or postponing those payments by only a day at yearend can save plenty of moola.
Suppose that Scott and Jeanne Nugent determine they'll pay less tax for 2014 by using the standard deduction than by itemizing things like charitable contributions. OK. But instead of forfeiting those potential itemized deductions, the couple can postpone them and trim taxes for 2015. They could also do the reverse: Accelerate itemized deductions from next year into this year.
Simply put, the Nugents can bunch itemized deductibles into one of two years so they exceed their standard deduction. Then, for the other year, they use the standard deduction if that's more advantageous than itemizing.
Even if the Nugents are never likely to use the standard deduction—perhaps because their state income taxes and property taxes always easily exceed it—they might profit from bunching deductions like medical expenses and miscellaneous expenses from one year into another. This is because they're linked to limitations based on adjusted gross income. But bunching can prove inadvisable if the Nugents are subject to the alternative minimum tax. Under the AMT, they lose deductions for state and local taxes and miscellaneous expenses and some medical expenses.
Let's say the Nugents plan to claim the standard deduction for this year and next; they expect payments for itemized expenses to be just below the standard deduction for this year. If they pay no mind to the calendar, the cap on their total deductions for both years will be the standard deduction for each year.
But an extra $2,000 in payments by Dec. 31 would raise their itemized deductions to $2,000 more than the standard deduction for this year and still entitle them to claim the standard deduction next year. That bit of foresight would give them a two-year total of $2,000 more in deductions than if they had routinely taken the standard deduction for both years. Assuming the Nugents are in a total tax bracket (federal, state and, perhaps, city) of 30 percent, that would mean a savings of $600—not big bucks but more than enough to pay for a pleasant night on the town.
Suppose instead they expect that payments for itemized deductibles will be more than the standard deduction for this year and next. Or suppose they expect to be in a lower bracket next year because Scott's earnings decline or he retires. Under either assumption, their best strategy might then be to pay for as many deductibles by Dec. 31 as they can, instead of waiting until next year. For instance, they can make extra contributions or, if they're at or near the 10 percent floor for medical deductions (7.5 percent through 2016 for individuals age 65), take care of some elective items and pay for them now—like dental work and prescription refills. That way, the Nugents get more mileage out of their itemized deductions this year because they offset income taxed at a higher rate.
About the author:
Julian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator) and an attorney. More on this topic is available from "Julian Block's Year Round Tax Strategies", available at julianblocktaxexpert.com.
Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes...