Contribution Timing and Tax Deductions

[Justin Bilyj]

I have a client who wants to start a deferred traditional ira. Her income is exactly 40k and she wants to max her deduction of 5k for 2012. Can she start an ira and deduct her contributions she makes tomorrow for the year 2012? She didn't file her taxes yet for 2012. Could she also contribute another 5k this year towards her 2013 tax season if she is able to still tag this on to 2012?

Also, she is on the income line for tax rate, $39,999. Would the tax deductability of her contributions reduce her magi to $35k, effectively lowering her income to the 15% tax bracket? If this were the case, dropping her down the next tax bracket would save her 5k in taxes, wouldn't that effectively pay for itself?

Just trying to wrap my head around this.
Thank you for the enlightenment!

 

[Norwayguy]

I have a client who wants to start a deferred traditional ira. Her income is exactly 40k and she wants to max her deduction of 5k for 2012. Can she start an ira and deduct her contributions she makes tomorrow for the year 2012? She didn't file her taxes yet for 2012. Could she also contribute another 5k this year towards her 2013 tax season if she is able to still tag this on to 2012?

Also, she is on the income line for tax rate, $39,999. Would the tax deductability of her contributions reduce her magi to $35k, effectively lowering her income to the 15% tax bracket? If this were the case, dropping her down the next tax bracket would save her 5k in taxes, wouldn't that effectively pay for itself?

Just trying to wrap my head around this.
Thank you for the enlightenment!

In a word...Yes she can still make 2012 traditional IRA contributions if she has not filed her taxes she has till April 15th though many carriers have an earlier response. She could also do 2013 contributions as well. In regards to the tax savings I leave that to the CPA.

 

[Justin Bilyj]

Thanks Peter,
I was hoping your and scagnt would respond!

 

[Tahoe Ray]

I have a client who wants to start a deferred traditional ira. Her income is exactly 40k and she wants to max her deduction of 5k for 2012. Can she start an ira and deduct her contributions she makes tomorrow for the year 2012? She didn't file her taxes yet for 2012. Could she also contribute another 5k this year towards her 2013 tax season if she is able to still tag this on to 2012?

Also, she is on the income line for tax rate, $39,999. Would the tax deductability of her contributions reduce her magi to $35k, effectively lowering her income to the 15% tax bracket? If this were the case, dropping her down the next tax bracket would save her 5k in taxes, wouldn't that effectively pay for itself?

Just trying to wrap my head around this.
Thank you for the enlightenment!

I am assuming that this is a single filer...

Maybe I am misunderstanding what you are saying above but it looks like you're confusing "marginal tax rates" with "effective tax rates".

A person making 40k in 2012 assuming no deductions, no exemptions and only looking at federal taxes (all for simplicity) would pay 10% on income from 0-$8,700, 15% on income from $8,701 to $35,350 and 25% on income from $35,351 to $85,650 (there are three additional, higher, brackets as well).

So...your client making 40k annually would owe (again with no deductions or exemptions) federal taxes of: $870+$3,997.35+$1,162.25=$6,029.60.

Reducing her income to 35k annually she would owe: $870+$3,944.85=$4,814.85...a tax savings of $1,214.75.

However, when you start factoring exemptions and deductions, she will likely only have $750 of tax savings (15% of $5,000) since her taxable income will likely be below $35,350 (but above $8,700) anyway.

This is a great opportunity to speak with whoever prepares her taxes (since I'm not an accountant and this post is subject to a lot of variables). Get their number, call them up and let them know that you have a client in common and would like to discuss a recommendation with them. Since they are working with someone with 40k in income, the preparer may not be someone who will be a constant source of referrals but then again, you never know.

Good luck.

 

[Norwayguy]

I see you edited your post to provide more info. The other way of looking at the tax savings is you think the 5K difference will save her 5K in taxes does not work that way assuming this 5K dropped her from the 25% marginal rate to 15% just multiply the 5K by 25% and that would really be the max savings in this case 1250 in savings at most.

 

[scagnt83]

Can she start an ira and deduct her contributions she makes tomorrow for the year 2012? She didn't file her taxes yet for 2012. Could she also contribute another 5k this year towards her 2013 tax season if she is able to still tag this on to 2012?

She has until April 15 2013 to contribute for 2012.

She has until April 15 2014 to contribute for 2013.

Yes, she can contribute to both 2012 & 2013 during 2013 (provided 2012 is before the 4/15 deadline).
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Her income is exactly 40k and she wants to max her deduction of 5k for 2012.

Also, she is on the income line for tax rate, $39,999. Would the tax deductability of her contributions reduce her magi to $35k, effectively lowering her income to the 15% tax bracket? If this were the case, dropping her down the next tax bracket would save her 5k in taxes, wouldn't that effectively pay for itself?

Just trying to wrap my head around this.
Thank you for the enlightenment!

The $5k IRA contribution will reduce Taxable Income by $5k.

That does not mean that she will save $5k on her taxes; it will not pay for itself.

As Ray pointed out, the tax brackets are progressive. So its not just 25% of $40k vs. 15% of $35k.

You can always use money chimps tax calculator for situations like this.


And if you do, you will find that Ray is correct that hypothetically it will be approximately $1200 in tax savings.

But it is seldom as cut and dry as that.

How Deductions, Credits, Allowances, etc effect your return are all dependent on income levels.

So changing income levels can change a lot, not just the tax rate.

That being said, it is seldom a bad thing to reduce your AGI!


The good news is that if you reach out to the cpa and have them run a hypothetical for her with the $5k IRA contribution, you will be fully informed. And with their software it shouldnt be hard for him to do.
Be sure to tell him that its a $5k IRA contribution, dont just ask them to run things at $35k income, because that would be different since sometimes you get credits for IRA contributions.

 

[padthaiforlunch]

She should ask about those savings when she gets her taxes done. empty don't be bugging her tax man until after 4/15. He won't have any time for you. There must be a ce class where op can learn the in and out this.