One way for taxpayers to save money on their tax bill is via a strategy called “bunching deductions.”
This technique, in which taxpayers accelerate or defer income in order to exceed the standard deduction in a given tax year, took on renewed importance after the 2017 Republican tax overhaul.
That tax reform essentially doubled the standard deduction, making it less likely that taxpayers would benefit from itemizing.
But for savvy taxpayers, bunching deductions is a strategy that can work around this increased standard deduction.
It allows filers to itemize in “on” years, when itemized expenses are high, and take the standard deduction in “off” years, when itemized expenses are low. Nearly 10% of financial advisors identify bunching deductions as a top 3 year-end tax strategy, according to a survey of more than 200 financial advisors who are part of SmartAsset’s SmartAdvisor matching platform.
So, how does deduction-bunching work? SmartAsset crunched the numbers to illustrate how this strategy functions – and how it can shave hundreds or thousands of dollars off your tax bill.
A financial advisor may be able to help identify tax-savvy investment strategies. Find a financial advisor today.
Our Analysis
To run our deduction-bunching scenarios, we considered the finances of a sample married couple earning $200,000 in adjusted gross income (AGI) and paying an effective tax rate of 18%. They file taxes jointly.
Here are their potential itemized deductions:
Charity. This high-income couple wants to give $20,000 to charity each year.
State and local taxes. They also pay the $10,000 max per year in state and local taxes (SALT).
Mortgage interest. This couple deducts $8,000 in mortgage interest from their income every year.
Miscellaneous. We don’t include every possible deduction in this analysis. Some taxpayers may be able to write off medical expenses above 7.5% of adjusted gross income and casualty or theft losses.
The standard deduction for married joint filers in 2022 is $25,900. For 2023, it is $27,700. If the first three itemized expenses don’t top this amount in a given tax year, these taxpayers opt to take the standard deduction.
Running the Numbers
SmartAsset analyzed two different approaches to the 2022 and 2023 tax years.
Scenario 1. In this scenario, the married couple doesn’t bunch deductions. They donate $20,000 to charity, pay $10,000 in SALT taxes and shell out $8,000 in mortgage interest. That totals $38,000 in a single tax year, which takes them above the standard deduction and means it is best to itemize.
They itemize the same expenses in 2023.
Their tax bill for each year is $29,160, or $58,320 over two years. Remember: They pay an 18% effective tax rate on income less the amount itemized.
Scenario 2. In this scenario, the couple bunches their charitable donations. They make sure to donate two years’ worth of funds to a public charity or a donor-advised fund, within a single year.
In the first year, they itemize and pay $25,560 in taxes.
In year two, they take the standard deduction and pay $31,014 in taxes. Their total tax bill is $56,574. They save $1,746 by bunching deductions.
More Tips About Bunching Deductions
Charity. For the charitably inclined, a donor-advised fund (DAF) can be a tax-smart vehicle through which they bunch deductions. It allows for tax-deductible charitable contributions, potential investment growth and the ability to direct grants toward charities, even in years in which the charitable donation isn’t made for tax purposes.
Medical expenses. For taxpayers with relatively high medical expenses, bundling them into a single year to itemize deductions is an option. We chose not to show a medical expense deduction in this analysis, because deducting medical expenses requires having significant unreimbursed expenses above 7.5% of AGI. That's above $15,000 for a married couple earning $200,000.
Additionally, if you’re bunching deductions, it requires having some flexibility in when those expenses are accrued. Many medical expenses such as hospital visits are accrued as needed, not on a tax-savvy schedule.
Business owners. Small-business owners may have more flexibility in what they can choose to write off their taxes. If you own a business and are considering the impacts of deducting, for example, home office expenses, consider working with a tax professional.
Bottom Line
Bunching deductions can reduce your overall tax bill over several years. But for help identifying and claiming deductions, consider working with a financial advisor and a tax professional.
Tips for Tax Planning
- Work with an expert. While a tax professional or tax software can help you file your annual taxes, a financial advisor could help you optimize a tax strategy for your entire financial plan. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Estimate your tax burden. If you just want to estimate how much you’ll pay in taxes, consider checking out our tax calculator to see how federal and state taxes may impact you.
Questions about our study? Contact us at press@smartasset.com
Photo credit: ©iStock.com/Drazen Zigic