When you donate to charity, have a lot of medical expenses or own your own home, you may not feel like you're getting the most bang for your tax buck if the total amount you are allowed to deduct is less than or barely over the amount of your standard deduction amount. To make use of the deductions you would have claimed, while claiming the standard deduction this year, you can employ a strategy of waiting to make payments on tax deductible items or charity donations until the next calendar year.
How the Strategy Works
In this strategy, you move around tax deductible payments and charity deductions to the following year in order to optimize deductions. One bill you could do this with is your property tax bill.
Let's say your property tax is $4,000 and is due by January 31, 2013. You see you don't have enough deductions to itemize them in 2013, so you pay your taxes on January 3, 2014. Because your property tax is paid in the next calendar year, it counts as a deduction for the 2014 tax year instead of the 2013 tax year. The property tax bill for 2014 ends up being $5,000 and you pay it in December. Now, you have $9,000 worth of property tax to deduct in addition to your other itemized deductions.
You could also use this strategy with mortgage payments due in January, or for charitable donations by donating to charity right after the first of the year instead of in the current one. In the meantime, you can still declare the standard deduction this year. (A few tax credits can greatly increase the amount of money you get back on your return. Don't miss Give Your Taxes Some Credit.)
How Itemizing Could Save You Money
No matter what deductions you are able to claim, everyone has the option of claiming a standard deduction based on their marital or head of household status. For example, Sally, a single person filing for the 2013 tax year qualifies for a standard deduction of $6,100. This amount is deducted from her taxable income which she paid income tax on in 2013 if she chooses to take the standard deduction instead of itemizing deductions.
Let's see if Sally would be better off itemizing deductions.
Sally owns half of a duplex with a mortgage of $500 per month. In 2013, about $375 of each $500 payment was mortgage interest. Over a year's time, she paid $3,600 in mortgage interest alone. She pays her property tax annually in December - it's due by January 31, 2014. Her property tax bill is $1,600. She doesn't have any other itemized deductions available, so her total deductions are $6,100. She's $100 over the amount she's guaranteed by having a standard deduction.
Sally's taxable income was $45,000 for the 2013 tax year. Her marginal tax rate is 25%. The extra $100 from itemizing increases her tax refund or decreases the amount of tax she owes.
However, she could pay her property tax and homeowners insurance in January, then pay next year's in December of 2014. If her mortgage interest, property tax, and income are the same in 2014 as they are in 2013, the extra $2,200 boost would give her a total of $8,000 in deductions - $1,900 hundred over the standard deduction. She would increase her tax refund or decrease her tax owed by between $500 and $550.
Complications with Itemizing Your Deductions
Moving payments to maximum tax benefits has a few potential complications:
- Tax law changes fast - A deduction you are counting on for next year may no longer exist. For instance, according to IRS publication 17, the deduction for state and local sales taxes was set to expire in 2010.
- Your tax bracket could change - Let's say your taxable income is $40,000. Next year, your income drops to $30,000. In this case, it's possible that you could benefit more from itemizing this year because your tax bracket is higher.
- Potential for late pays - While a paying an annual bill a month early works well for this strategy, don't delay any payment until after their dates.
Alternatives to Itemizing Deductions
There are other ways increase your tax refund or decrease taxes owed.
- Use tax software to optimize your deductions - When you use tax software, don't take any shortcuts. Answer all questions and you may find you're eligible for a tax deduction or credit you never thought about.
- Look for deductions that you can deduct on top of standard deductions - For instance, student loan interest deductions are available regardless of whether you itemize. In the 2009 tax year, deducting tax and registration paid on a vehicle did not require itemizing. (Not taking the standard deduction this year could save you hundreds of dollars. Check out An Overview Of Itemized Deductions.)
- Tax credits - Tax credits aren't dependent upon deductions.
Carefully picking payment dates is one way of optimizing deductions, but it's not the only way. Evaluate this option after you've considered all factors including complications and alternatives. With a studious review of your situation, you may find free money in the form of tax credits and deductions you may have initially missed.
To get the most money back this year, check out 10 Most Overlooked Tax Deductions.