You may have heard on the podcast about the tax-reducing strategy with the odd name: lumping and clumping. What is it and how can it reduce your taxes?
The “lumping and clumping” strategy, also known as “bunching,” gained steam when the standard deduction almost doubled when the Tax Cuts and Jobs Act was passed in December 2017. Why? In order to itemize—which generally saves you money if you qualify to do it—your total deductions need to be above the increased standard deduction, which is now $12,000 for singles and $24,000 for couples. That’s become a harder bar to clear, so lumping and clumping involves trying to push deductions into every other year, itemizing and then and not itemizing in the off years.
More Details, Please
Wrapping your head around this means knowing what you can—and can’t—itemize. On the “can” list: Medical expenses, state taxes, mortgage interest and charitable contributions—that’s about it.
It’s even harder to itemize medical expenses, because they have to be more than 10% of your adjusted gross income (AGI). Say you have AGI of $100,000, that means you need at least $10,000 in medical expenses to itemize. Plus, you don’t get a lot of leeway with itemizing taxes, because there is now a cap of $10,000 for both property taxes and income taxes. This cap has really limited taxpayers’ ability to itemize, especially those taxpayers who live in high-income-tax and high-property-tax states.
The mortgage interest deduction has been capped at $750,000 of principal, down from a cool million (you’re not affected if you had a mortgage before Dec. 15, 2017, or a binding contract before Dec. 15, 2017, with a closing by April 1, 2018). And those home equity lines of credit that you used to pay down credit card debt or for college tuition? No longer deductible.
I Get It, So How Do I Clear The Every-Other-Year Bar?
Here’s where you get strategic: In the years that you want to itemize, you want to move deductible expenses around so that they qualify.
For instance, you can make your January mortgage payment in December of the year before, so that additional mortgage interest can be deducted. It may mean carefully timing medical procedures if possible. (Note: You still need a LOT of medical expenses in order to itemize, so don’t bank too much on this one). You can even consider beefing up your contributions to charity in one year and tailing off in the next. (There’s even a way to do this so that your favorite charities won’t feel the difference using donor-advised funds.)
How About An Example?
A married couple—let’s call them Harry and Meghan—files a joint tax return in 2018 and takes the standard deduction of $24,000. In 2019, it increases to $24,400 (thanks inflation!).
Looking at their 2018 tax information, their state income taxes were $7,000, and their real estate taxes were $6,000.
Using these numbers as close estimates for 2019, they can only claim $10,000 in taxes due to the cap. They also had paid $6,400 in mortgage interest. They don’t anticipate that their medical expenses in 2019 will be greater than 10% of their AGI, so where they have flexibility is making charitable contributions. To itemize, they need to contribute more than $8,000 to charity. Ideally, you don’t want your itemized deductions to just equal the standard deduction, because why not just take the standard deduction then? So, Meghan and Harry make a charitable contribution of $15,000 to a donor-advised fund. Their itemized deductions equal $31,400, which is $7,000 more than if they took the standard deduction.
What does this mean for their bottom line? Say their AGI is $120,000. If they were to take the standard deduction of $24,400, that leaves them with taxable income of $95,600, and they owe the IRS $12,749. If they itemize their deductions of $31,400, that gives them taxable income of $88,600, and they’ll owe $11,209, which is a tax SAVINGS of $1,540. You may say, why give another $7,000 in order to only save $1,540? You’re not doing this just to get a larger deduction; you knew that you wanted to continue to give to charity, so you’re timing it so that you still receive some bang for your buck.
The timing continues: For example, in 2020 and perhaps 2021, they take the standard deduction. Then in 2022, they decide they want to make another large charitable contribution to their donor-advised fund, and again they are able to itemize.
It all boils down to what HerMoney goal-getters are all about: taking control of our finances by planning ahead, and we can all do that, one lump or clump at a time.
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