An old technique has new value after the Tax Reform bill, Part I

Bunching expenses, particularly charitable gifts, in one year rather than over multiple can provide added tax benefits, especially after the latest tax law changes. And combining that plan with a donor-advised fund can compound the tax savings.

The latest round of tax reform resulted in the limitation, or even outright repeal, of many of the itemized deductions previously claimed by individual taxpayers. In addition, the standard deduction, the base deduction amount that is available to all taxpayers, was nearly doubled. As a result, the number of taxpayers who will simply use the standard deduction rather than itemizing is expected to grow from about 70% to over 90%. While this will certainly simplify the tax filing process for many, it also means that certain expenses are less likely to provide a tax benefit going forward.

However, for taxpayers who have the ability to control the timing of these expenses, there may still be a way to maximize their tax benefit through a technique known as “bunching.” And while the concept of bunching deductions into a tax year when they provide the most benefit has been around as long as there have been income tax deductions, it’s taken on new significance as a result of the tax law changes.

ITEMIZED DEDUCTIONS VS. THE STANDARD DEDUCTION

Taxpayers are able to reduce the amount of their income subject to tax through the use of deductions. The tax code offers all taxpayers two methods for doing this – using the standard deduction or itemizing your deductions. The standard deduction is a flat amount based on your filing status, and under the tax reform bill this amount was increased dramatically.

Rather than using the standard deduction, taxpayers can instead itemize if it results in a larger total deduction. This means deducting specific expenses incurred during the year in order to reduce taxable income. Among the many types of expenses considered deductible are state income taxes (or sales taxes if they are more), property taxes, mortgage interest, charitable contributions, medical expenses, investment expenses, tax preparation fees, unreimbursed business expenses and casualty losses. Beginning in 2018, however, the treatment of many of those expenses has changed.

The combination of fewer expenses that qualify as itemized deductions plus a larger standard deduction means many fewer taxpayers will itemize their deductions going forward. As a result, the tax benefit of those previously deductible expenses will go away, effectively making those items more expensive.

Read the conclusion in Part II next month

Article provided by Rebecca Ross, Vice President and Financial Advisor at Robert W. Baird & Co., member SIPC. She has 34 years of financial services industry experience and can be reached at 239-541-9090 or rross@rwbaird.com. Baird does not offer tax or legal advice.