In this video, I discuss itemized deduction versus standard deduction as covered on the TCP CPA exam.
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"Bunching" itemized deductions is a tax strategy used to maximize the benefits of itemizing deductions on a taxpayer's federal income tax return. This approach involves timing expenses so that they are concentrated in a single tax year, rather than spread out over multiple years. Here's how it works:
Understanding the Standard Deduction: Each taxpayer has the choice between taking the standard deduction or itemizing deductions (deducting specific eligible expenses). If your itemized deductions exceed the standard deduction, itemizing can lower your taxable income more than the standard deduction would.
Timing Expenses: Bunching involves planning and timing certain deductible expenses to fall into a single tax year. This means accelerating or delaying payments for deductible expenses so they total more than the standard deduction in one year. Common deductible expenses include charitable contributions, medical expenses, state and local taxes (SALT), and mortgage interest.
Exceeding the Standard Deduction: By bunching expenses, you aim to have enough itemized deductions to exceed the standard deduction in one year. In the following year, when your expenses are lower, you would then take the standard deduction.
Example: Suppose the standard deduction is $12,000. In Year 1, you make charitable donations and pay medical expenses such that your itemized deductions total $18,000. You itemize and lower your taxable income more than the standard deduction would. In Year 2, you have fewer deductible expenses, so your itemized deductions might only total $6,000. Here, you take the standard deduction of $12,000.
Planning and Flexibility: This strategy requires planning and can be particularly effective for expenses that are somewhat within your control, like charitable giving. It also requires understanding the timing and limits on deductions (like the SALT deduction cap).
Benefits: Bunching can result in significant tax savings in the years when you itemize deductions. However, it requires careful planning and may not be suitable for everyone, depending on their financial situation and the predictability of their expenses.
Alternative Minimum Tax Considerations: For some taxpayers, the Alternative Minimum Tax (AMT) can affect the benefits of bunching strategies, as certain deductions are disallowed under the AMT.
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