Is it Best to Maximize or Minimize Deductions?

As the end of the year approaches, it's a good time to review your potential tax deductions and develop a strategy that maximizes the benefits. Most taxpayers may deduct the higher of two amounts from adjusted gross income when figuring their taxable income. These amounts are either a fixed amount set by law (the "standard deduction") or a listing of the expenses the taxpayer paid during the year that the government allows (known as "itemized deductions").

The basic federal standard deductions for 2010 are: $11,400 for joint filers, $8,400 for head of household, and $5,700 for others. Add-ons to the standard deduction are allowed for taxpayers (and their spouses, if filing jointly) who are blind and/or age 65 or older. In some years, other add-ons—such as a limited amount of real property tax—are also allowed.

It would seem to be a simple choice—use the larger of the standard or itemized deductions. However, strategies may be used to maximize the benefits that add complexity. For example:

• Bunching Strategy – If your itemized deductions and your standard deduction are about the same, it may be possible to maximize your itemized deductions every other year and take the standard deduction in alternate years. Methods of doing this are discussed below.

• The Alternative Minimum Tax (AMT) Effect - If you are subject to the AMT, the standard deduction is not allowed at all, but some itemized deductions are. Therefore, if you are subject to the AMT, you should always itemize your deductions.
  

Here are some tips on maximizing your itemized deductions:

• Medical – Medical deductions for regular tax purposes are deductible only to the extent that they exceed 7.5% of your Adjusted Gross Income (AGI). That percentage increases to 10% for the AMT. Where possible, consider prepaying or deferring medical expenses to match your deduction strategy. In addition to the normal medical deductions, don't overlook the costs of fertility procedures, learning disability expenses, nursing home expenses, pregnancy tests, certain special education, prescribed smoking-cessation programs, certain weight-loss program expenses, and certain impairment-related expenses.
  
  A child's medical expenses paid for by divorced parents are generally deductible by the parent who pays the expense. You can also deduct medical expenses for an adult "medical dependent." Generally, one who would qualify as your dependent except for gross income limitations.

• Taxes – Deductible taxes include real and personal property taxes as well as state and local income taxes. Generally, real property taxes are paid in two or more installments during the year. This gives you the opportunity to "bunch" tax payments by paying an entire year's tax bill plus one or more installments from the prior year all in one tax year.
  
  If you are paying state estimated taxes, the fourth quarter's payment is due by January 18, 2011 in most states. However, you have the option to pay it before the end of the year and move the deduction into 2010. Keep in mind that taxes are not deductible for AMT purposes.
  

• Charitable Contributions – Charitable contributions are deductible for both the regular tax and the AMT. Because they are discretionary, a taxpayer can choose when to make a payment. For example, you could prepay your 2011 tithes in 2010, thereby doubling up deductions in 2010.
  
  Don't overlook year-end non-cash contributions of items lying around the house that are never used. As long as they are in good or better condition and are contributed to a charity before the close of the year, the contribution will count as a deduction for 2010 (provided you have proper documentation).

• Miscellaneous Deductions – This is a catch-all category that generally includes investment and employee business expenses. These deductions are only allowed to the extent that they exceed 2% of your AGI—but not at all for AMT purposes. Don't overlook potential losses from IRA and variable annuity accounts that have declined in value during the recession. However, utilizing these losses requires special action, so please call for details.
  
  Because of the 2% of AGI limitation, certain otherwise-deductible expenses might be handled differently, such as working out a reimbursement plan from your employer for employee business expenses. Doing so may mean reducing your salary, but you will be converting taxable income to non-taxable reimbursement—always a desirable outcome. If your miscellaneous deductions are less than 2% of your AGI, consider paying IRA fees from the IRA account instead of making a separate payment.
  

If you believe you are a candidate for deduction planning, please call our office for an appointment.