If you knew how to potentially save a couple thousand dollars a year, would you do it? If yes, then I would recommend looking in to bunching your expenses.
The concept of bunching your expenses has been around for a long time, but I believe has become more applicable with the new tax law.
One of the biggest changes to individual tax returns going forward will have to do with the standard deduction. Personal exemptions have been eliminated and the standard deduction has increased to $24,000 for married filing jointly ($12,000 for single filers). For reference, taxpayers will choose to itemize their tax deductions or take the standard deduction, whichever is greater.
To make matters even worse, the SALT deductions have been capped at $10,000. SALT stands for state and local taxes. Two of the biggest SALT deductions include state income taxes and real estate taxes. If you live in the state of Illinois and live in a house appraised at $300,000 or more, you will likely have real estate taxes of at least $7,000 a year. After you add on your state income taxes paid you can easily reach the cap of $10,000.
To put it really simply, the new tax law makes it much more difficult to for couples to itemize their deductions. Limiting SALT deductions can cost families (especially in high income states) significant tax savings.
Two other popular deductions are mortgage interest and charitable giving. Mortgage interest can easily amount to 5-10k a year and many families will give anywhere from 3-10% of their income to charities annually.
Let’s look at a practical example of a middle-class family.
Joe and Jane are in the 22% tax bracket (combined income of $77,500 - $165,000) with 5% state taxes. They have the following tax deductions in 2018:
- SALT - $10,000
- Mortgage interest - $7,000
- Charitable giving - $8,000
This gives them a total of $25,000 in deductions for the year, just above the 24k threshold. But could they do something different to save money that they would otherwise pay in taxes?
If Joe and Jane could bunch their expenses, that could save quite a bit in taxes this year and in the future. Here is an example of a bunching strategy.
Joe and Jane decided to give money to their favorite charities in December of 2018 that they planned to give in 2019. The only thing that changed is their charitable giving went up to $16,000. This makes their total deductions go up to $34,000 for the year 2018 and drop to $18,000 for tax year 2019.
How much will they save in taxes? The chart below shows the difference between if they kept doing what they are currently versus bunching.
|Year||Deductions||Tax Rate||Savings ($)|
|Total tax savings||13,500|
|Total tax savings||15,390|
Bunching their taxes saves them $1,890 over a two-year time span. If they were to implement this strategy over the next ten years if could save them $9,450 with their current deductions.
Another way to bunch your deductions is to look into paying your real estate taxes ahead of time if you aren’t maxing out your SALT deductions. Many municipalities will allow you to prepay.
Donor advised funds (DAFs) are another option that can help with bunching. A DAF allows you to contribute large sums to a fund with a designated charity as the beneficiary and control when the funds are disbursed to the charity, but you get an immediate tax deduction for contributions.
If your financial plan doesn’t include any tax planning, you are missing out. Understanding tax law gives you a good opportunity to save money in taxes each year. If you would like to have a conversation about how we can help you are welcome to schedule an introductory call.
Always consult your CPA prior to implementing any tax advice.
Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.