THE TAX CUTS AND JOBS ACT - THE NEW STANDARD DEDUCTION

The new tax bill passed last December includes many provisions that affect the “average” taxpayer.  The increased standard deduction will affect the vast majority of Americans.  Here’s how it works.  A taxpayer is entitled to deduct the larger of their standard deduction or their itemized deductions.  In 2017 a couple filing jointly was entitled to a standard deduction of $12,700.  So, if their itemized deductions exceeded $12,700, then they would deduct their itemized deductions.  Itemized deductions include such items as mortgage interest, real estate tax, state and local income tax or sales tax, charitable contributions, and medical expenses.  In 2018 that same married couple is entitled to a standard deduction of $24,000.  So what does this mean for that married couple?  If their itemized deductions are below $24,000, then they will deduct the standard deduction of $24,000 regardless of the amount of itemized deductions they paid.  So those who make purchase decisions based upon tax savings may no longer benefit from those tax savings and they need to be aware of this. 

 But this also presents a planning opportunity.  Consider the following information:

                                                                                         2018                                       2019

                -Deductible medical expenses                   $  3,000                                 $  3,000

                -State income tax (or sales tax)                 $  2,000                                 $  2,000

-Real estate tax                                           $  4,500                                 $  4,700

                -Mortgage interest                                      $10,000                  $10,000

                -Charitable contributions                           $  3,000                                $  3,000

                Total Itemized Deductions                          $ 22,500                 $ 22,700

 Under the above scenario, this couple would deduct the standard deduction in both 2018 and 2019.  (The 2019 standard deduction will increase slightly due to the inflation adjustment but for this purpose, we will disregard that adjustment.)  So their total deduction for 2018 and 2019 would be $48,000 ($24,000 + $24,000).  Now suppose we change the timing of some of these deductions.  Let’s pay the 2018 real estate tax in early 2019, let’s pay our charitable contributions in 2019, and let’s defer payment of our medical expenses until 2019.  See below:

    2018                         2019

                 -Deductible medical expenses                   $           0                 $  6,000

                -State income tax (or sales tax)                 $ 2,000                 $  2,000

-Real estate tax                                           $          0                 $  9,200

                -Mortgage interest                                       $ 10,000                $ 10,000

                -Charitable contributions                             $          0                 $  6,000

                Total Itemized Deductions                           $ 12,000                 $ 33,200

 Under this scenario this couple would deduct $24,000 in 2018 (because the standard deduction is higher than the itemized deductions) and they would deduct $33,200 in 2019 for a two year total of $57,200.  By controlling the timing of some of their deductible payments, they increased their total deduction over the two year period by $9,200.  This is referred to as “Bunching Deductions” and it can save a taxpayer a lot of money.