Understanding the “Bunching” Strategy for Itemized Deductions

Previously as part of a year-end tax tip, we introduced the concept of "bunching" deductions as part of year-end tax planning strategies. This post will take a closer look at how the bunching strategy works, who it benefits most, and any potential drawbacks to consider.

Standard Deduction vs. Itemized Deductions: A Quick Overview

To understand bunching, it’s essential first to know the difference between the standard deduction and itemized deductions.

Standard Deduction: This is a fixed dollar amount that reduces your taxable income. It’s automatically available to all taxpayers and varies based on filing status. For 2024, the standard deduction is $14,600 for single filers, $21,900 for heads of household, and $29,200 for married couples filing jointly. Most taxpayers benefit from taking the standard deduction, as it’s simpler and often larger than itemizing.

Itemized Deductions: This option allows you to deduct specific eligible expenses like mortgage interest, property taxes, state and local taxes (SALT), charitable contributions, and medical expenses (above a certain threshold). When the total of these deductions exceeds the standard deduction, itemizing can result in greater tax savings. However, itemizing requires more detailed record-keeping and only benefits taxpayers whose deductible expenses add up to a significant amount.

Many taxpayers find that their deductible expenses fall short of the standard deduction, making it more advantageous to stick with the standard deduction. However, that’s where the bunching strategy can make a difference.

How the Bunching Strategy Works

Bunching works by “clustering” certain deductible expenses in one year to exceed the standard deduction and allow you to itemize, while in alternate years, you revert to taking the standard deduction.  For example, instead of making regular annual charitable donations, a taxpayer might decide to “bunch” two years’ worth of contributions into a single year. By doing so, they could potentially push their itemized deductions above the standard deduction threshold, allowing them to itemize that year. In the following year, they would then take the standard deduction.

The bunching strategy is generally most effective for taxpayers who have expenses that are close to, but slightly below, the standard deduction limit. The taxpayer will regularly incur deductible expenses, such as mortgage interest or charitable donations, that can be flexible in timing. This also benefits taxpayers who are looking to increase their tax savings without incurring additional costs—simply by adjusting the timing of expenses.

This strategy is especially beneficial for high-income earners or those with fluctuating income, as they may be able to leverage larger deductions in high-income years.

Types of Expenses to Consider Bunching

Some common deductible expenses that are ideal for bunching include:

Charitable Contributions: If you regularly donate, consider combining donations from two or more years into one tax year.

Medical Expenses: Medical expenses are only deductible to the extent that they exceed 7.5% of your adjusted gross income (AGI). By timing elective procedures or high-cost medical treatments within the same tax year, you may be able to exceed this threshold.

State and Local Taxes (SALT): The SALT deduction is capped at $10,000, but if your state and local taxes vary by year, it may be beneficial to time some payments within a single year to maximize deductions.

Drawbacks of the Bunching Strategy

While bunching can create substantial tax savings, there are some considerations to keep in mind:

Cash Flow Impact: Bunching may require paying larger expenses in a single year, which can strain cash flow if not planned carefully.

Potential for Diminishing Returns: The Tax Cuts and Jobs Act of 2017 placed limits on certain deductions, like the SALT deduction cap of $10,000. For high earners in high-tax states, even bunching might not push itemized deductions above the standard deduction, limiting the benefits.

Less Flexibility in Donation Timing: If you’re bunching charitable donations, you’ll lose the flexibility to spread contributions over multiple years, which may affect your planned giving goals.

Is Bunching Right for You?

The bunching strategy is not a one-size-fits-all solution. If your itemized deductions are significantly below the standard deduction, or if you have limited flexibility in timing your expenses, bunching might offer limited tax benefits. However, for taxpayers close to or slightly above the threshold, bunching can be a smart way to maximize deductions and reduce overall tax liability.

The best approach is to evaluate your past deductions, consider any anticipated expenses, and determine if this strategy aligns with your financial goals. For many taxpayers, bunching can offer a practical way to optimize tax savings without changing overall spending, just by adjusting timing. Consult with a tax professional to assess if bunching is right for your situation and to map out an approach that maximizes your deductions while maintaining financial flexibility or reach out to us at info@mkhstaxgroup.com.