28 April 2017

A Two-Year Plan to Lower Your Taxes

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You could lower your tax bill by making next year’s charitable donations before Dec. 31 and prepaying next year’s state and local taxes. By doing so, you could benefit from a simple tactic that takes advantage of a feature of the tax system: Each year, taxpayers get to decide how they want to take deductions from taxable income. The Internal Revenue Service offers two options. Taxpayers can take the standard deduction, which is $6,200 for a single filer and $12,400 for joint filers. Or they can itemize expenses such as mortgage interest, state and local income and property taxes, and charitable donations, which can add up to a larger deduction.

Unless you receive reasonably sophisticated tax advice, chances are that each year you make the choice that lowers your tax bill the most for that year. About 70% of U.S. taxpayers simply take the standard deduction, which is the easier route. But many people can boost overall deductions for every two-year period by alternating between the two approaches each year. In the years when you itemize expenses, you make two years’ worth of charitable donations and pay two years of property taxes. For a typical couple that owns a home, that could add up to well over $12,400.

The following year, you take the standard deduction, which could be much more than you would have qualified for otherwise, given that you would have relatively little to itemize for that tax year.

To be sure, the savings may be modest. Don Williamson, who heads the Kogod Tax Center at American University in Washington, said the maneuver is likely to be of marginal benefit to many taxpayers. Those savings may be welcome nonetheless, especially for those on middle-class incomes.

The technique frequently gets overlooked. Tax planners tend to focus most on taxpayers with higher incomes or more complex affairs, whose deductions are so large that it almost always makes sense for them to take itemized deductions each year. When they recommend paying some of next year’s expenses early, it is typically to help wealthier clients avoid the impact of the alternative minimum tax, the parallel tax code designed to close loopholes in the principal code. Yet even those who aren’t among the highest earners can benefit from multiyear planning.

The maneuver does have some drawbacks. By prepaying some of next year’s expenses, taxpayers miss out on the interest they could have earned on the money.

But inflation is low and so are short-term interest rates, so the cost is likely minuscule. Meanwhile, low interest rates have reduced the value of the deduction for mortgage interest, bringing many taxpayers’ total annual deductions down below the value of the standard deduction.

What’s more, some taxpayers may find it attractive to simplify their tax filing every other year by taking the standard deduction. The IRS calculates that the average nonbusiness taxpayer spends about eight hours a year on tax compliance.

Itemized deductions and standard deductions were designed as alternatives. But with a little careful planning you can get the best of both worlds.

 

Click here to access the full article on The Wall Street Journal. 

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