The strategy of lumping and clumping, often referred to as "bunching," emerged following the almost doubling of the standard deduction after the Tax Cuts and Jobs Act was enacted in December 2017. This method can lead to tax savings, but how does it work?

You might have come across references to this tax-saving approach in discussions about personal finance. So, what is it, and how does it help?

This "lumping and clumping" method gained traction due to the increased standard deduction of $12,000 for individuals and $24,000 for couples. To benefit from itemizing deductions, your total must exceed these amounts, which can be quite challenging. Thus, lumping and clumping involves strategically timing deductions to alternate between itemizing in certain years and using the standard deduction in others.

Breaking It Down Further

Understanding this strategy requires knowing exactly which expenses you can itemize. The main candidates include medical expenses, state taxes, mortgage interest, and charitable donations.

Itemizing medical expenses is particularly tricky since they must exceed 10% of your adjusted gross income (AGI). For example, with an AGI of $100,000, you'd need at least $10,000 in medical costs to qualify. Additionally, itemizing deductions is limited, with a cap of $10,000 on the combination of property and income taxes. This limitation has significantly impacted taxpayers, especially those in high-tax states.

The mortgage interest deduction is now capped at $750,000 of principal, reduced from $1 million. If your mortgage originated before December 15, 2017, or if you had a binding contract before that date, you won't face this cap. However, home equity lines of credit used for specific purposes are no longer deductible.

So, How Do You Meet the Every-Other-Year Requirement?

Here's where strategic planning comes into play: in the years you choose to itemize, you should shift deductible expenses to meet the threshold.

For instance, you could prepay your January mortgage in December to claim additional interest as a deduction. Additionally, timing medical procedures could be beneficial, though you'll need substantial medical expenses to itemize effectively. You could also consider increasing your charitable contributions in one year and dialing back in the next. Donor-advised funds can facilitate this without disrupting your favorite charities' funding.

Let's Consider an Example

Imagine a couple, Harry and Meghan, who file jointly in 2018 and claim the standard deduction of $24,000. The deduction rises to $24,400 in 2019 due to inflation.

In 2018, they paid $7,000 in state income taxes and $6,000 in property taxes.

Due to the cap, they can only claim $10,000 in taxes for 2019. They also incurred $6,400 in mortgage interest and expect their medical expenses to fall below the 10% AGI threshold. Their flexibility lies in charitable donations; to itemize, they need to contribute more than $8,000. Therefore, Meghan and Harry donate $15,000 to a donor-advised fund, bringing their itemized deductions to $31,400—$7,000 more than the standard deduction.

How does this affect their taxes? If their AGI is $120,000, the standard deduction of $24,400 leaves them with taxable income of $95,600, resulting in an IRS bill of $12,749. By itemizing, their taxable income drops to $88,600, reducing their tax liability to $11,209, a total savings of $1,540. You may wonder why they'd donate an extra $7,000 just to save $1,540. The intent is not merely to gain a larger deduction but to maintain their charitable giving strategy while optimizing tax benefits.

The pattern continues: in 2020 and possibly 2021, they might opt for the standard deduction again, then return to itemizing in 2022 with another significant donation to their donor-advised fund.

This approach embodies the essence of proactive financial management: planning ahead, and making informed decisions, one lump or clump at a time.