Unlucky 7: The Top Taxpayer Mistakes, Part 6

Here's part 6 of a piece from Money Central that details the top taxpayer mistakes:

Failing to bunch deductions

There are a number of deductions that are allowed only after you exceed a minimum amount. For example, only those medical expenses that exceed 7.5% of your adjusted gross income are allowed. Alternatively, miscellaneous deductions are allowed only to the extent that they exceed 2% of your adjusted gross income.

Your best planning strategy here is to bunch your deductions into a single year to exceed these minimum requirements. For example, if you have an adjusted gross income of $100,000, only those medical expenses in excess of $7,500 can be deducted. In order to exceed this "floor" amount, you might prepay your orthodontia bill or pay your Jan. 1 medical insurance on Dec. 31. With miscellaneous itemized deductions, and the same adjusted gross income, you need to exceed $2,000 in expenses. Prepay your tax preparer on Dec. 31 for that year’s taxes or bunch order your investment subscriptions and expenses to exceed that amount.

Here's another one where an accountant can save you a bunch of time and money.

Click here to read part 7 of this series.

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Comments

[Hal]

This is a great tip. I would also argue that if practical you should do it for your other deductions as well. For instance, my wife and I bunched deductions for 2003, took the standard deduction for 2004, and are bunching again for 2005.

For instance, say you would have $16,000 in deductions for each year. If you didn't bunch and had $16k in deductions for each year, assuming a 25% marginal rate, here would be the benefit over three years:

2003 - $4000 ($16,000 @ 25%)
2004 - $4000 ($16,000 @ 25%)
2005 - $4000 ($16,000 @ 25%)
Total tax benefit = $12,000

Now assume you took $8000 of that $16000 you had in 2004 and bunched it into 2003, and the other $8000 you bunched into 2005, and took the standard deduction for 2004:

2003: $6000 ($24,000 @ 25%)
2004: $2375 ($9500 standard deduction @ 25%)
2005: $6000 ($24,000 @ 25%)
Total tax benefit = $14,375

Of course you won't be able to control all your deductible expenses (i.e. mortgage interest), but you can easily control most other items such as charitable donations, and in many locales even your annual property tax bills.

Definitely study it closely and talk to an accountant, since this strategy may have other unintended effects such as AMT, but for many this is a winning strategy.