Writing a Check to Save Some Money

Given all our techie options for paying people these days, writing a check seems almost quaint doesn’t it?  Much like the hand-written “thank you” note (which I still appreciate), the process of getting out the checkbook, writing the check, recording it in the register (hopefully), putting it in the envelope and stamping it with postage seems to be an anachronistic practice found in some rejected Norman Rockwell painting and not for anyone today with a laptop and/or tablet.

But before the calendar flips to 2015, I believe doing some simple math and scratching out a check or two could save a family some cash when tax-filing rolls around this coming April.  How?  By employing a strategy called “bunching deductions” and legally taking advantage of deductions to your income this year, instead of next year.

How does it work?  In reality, it’s a two-year strategy and it works best for taxpayers who have total deductions that approximate the standard deduction every year on their tax returns (For 2014, the standard deduction is $12,400 for joint filers and $6,200 for individuals).

As a refresher, taxpayers have the choice every year to either itemize their deductions (a.k.a. add them up and subtract them from income) OR take the standard deduction against their income.  So if a family has $200,000 of AGI (adjusted gross income) and their deductions only add up to $11,000 they are obviously better off subtracting the larger standard deduction ($12,400) in order to minimize their taxable income.  Of course if they have deductions that total over $12,400 they are better off itemizing and reducing their tax burden.  But what if we could “pull ahead” some deductions for one year, itemize and take the higher deduction amount, then take the standard deduction the following year?  Well, we can and we should!

Let’s use an example to illustrate:  Let’s say every year, Joe & Mary Taxpayer have AGI of $200,000 file jointly and pay about $5,000 in real estate taxes, $3,000 in mortgage interest, $3,000 in state & local income taxes and contribute $1,000 to charity.  These are all deductible expenses and total $12,000.  Given the standard deduction is $12,400, they are better off taking the standard deduction.

But they could “pre-pay” a few of next year’s deductible expenses this year: namely real estate taxes and charitable deductions.  Instead of paying those same amounts every year, they contribute an extra $1,000 to the charity (doubling the 2014 contribution) and pre-pay the extra $5,000 in real estate taxes before the end of the calendar year and their deductions for 2014 now total $18,000.  So they are effectively benefiting from $5,600 of extra deductions ($18,000 – $12,400 standard deduction) which at a 28% marginal tax bracket saves them just over $1,500!  Then, fast forward to 2015: they don’t contribute to the charity (because they already did) and don’t have to pay the real estate taxes and their deductions are now only $6,000 (state and local taxes and mortgage interest) but they can take the standard deduction of $12,400!

Of course to accomplish this, the taxpayers must have enough cash in the bank to finance this extra payment- yet another example of why I recommended a solid base of liquidity to all clients.

As an added kicker, for a couple in that income tax bracket, they are starting to get phased out of other tax advantages (i.e. Roth IRAs, Traditional IRAs and various education deductions) so any time we can save some money on taxes, it’s a welcome break from Uncle Sam.

Bottom line:  Before starting your New Year Eve celebration (or barely making it to midnight, which is how I usually celebrate) it might be a good idea to do some quick math, dust off that checkbook and write an extra check or two. Ironically, writing those checks could save you some money.

Merry Christmas, Happy Holidays and Happy New Year!!

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