The Simple Trick to Make Your Tax Deductions Work Harder
Standard vs. Itemized Deductions
The IRS gives nearly everyone two ways to take deductions from their gross income before calculating their tax bill. Typically, you have a choice: You can take the appropriate standard deduction for your particular filing status, or you can itemize your deductions. Obviously, it makes sense to use whichever one produces the larger deduction.
Yet for many taxpayers, there's not a huge difference between itemizing deductions or taking the standard deduction. This makes sense, as the general idea of providing a standard deduction isn't to give taxpayers a windfall but rather to approximate a typical amount of deductions that you would otherwise have to itemize in order to claim. That also explains why standard deductions are higher for those who are 65 and older or are blind, as those groups of taxpayers tend to have higher levels of itemizable deductions that would warrant a corresponding increase in the standard deduction amount.
If the deductions you could itemize are within a small amount of your standard deduction, then you might figure that you should go ahead and save yourself the time and trouble of extra calculations and just take the standard deduction. But for many people, there's a better way to get the best of both worlds.
Bundling Your Deductible Expenses
The best solution to the standard vs. itemized deduction dilemma is to alternate back and forth from year to year. How it works is simple. In one year, aim to maximize your itemized deductions. In the next year, reduce your itemized deductions and take what will therefore be a much larger standard deduction. When you look at the sum of the two years, you'll find that your total deductions can sometimes be thousands of dollars higher using this method.
This strategy might seem too good to be true, but all it involves is the timing of when you pay bills that you'd eventually owe anyway. For instance, in order to maximize your itemized deductions, look at doing the following:
- Prepay your state and local property taxes before Dec. 31, even if they're not due until later in the following year.
- Make estimated tax payments on state and local income taxes before the end of the year that you can use to reduce your tax liability the following year.
- Try to group predictable medical expenses into the same year.
- Bundle two years' worth of charitable giving into a single year. For instance, you can make one year's gifts in January and then give again in December, and then go the entire following year without making annual gifts at all, instead waiting until January two years from now and repeating the pattern.
For example, say that your standard deduction for 2015 will be $6,300 and you typically have $6,000 worth of itemized deductions. Ordinarily, you'd just take the standard deduction and end up $300 ahead. But if you can take $5,000 of those $6,000 in itemized deductions and bundle them into a single year, then you'll be able to take an $11,000 deduction by itemizing, while then only paying $1,000 the following year and still getting to claim the $6,300 standard deduction. That boosts your total deductions for the two years from $12,600 to $17,300 -- a 37 percent increase that could put anywhere from $470 to more than $1,860 in tax savings back in your pocket.
Itemizing your deductions can seem like a pain in the neck. But by taking some simple steps to make the most of your ability to itemize, you could end up with huge tax savings you'd never before dreamed possible. That's an April gift everyone deserves.
Motley Fool contributor Dan Caplinger never met a deduction he didn't like. You can follow him on Twitter @DanCaplinger or on Google Plus. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.