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Reduce your 2007 taxes

March 24th, 2008 at 04:29 pm

While many opportunities to reduce your 2007 taxes ended on December 31, there may still be some last minute steps for lowering your taxes. If you qualify, taking the following actions by April 15 can reduce your current or future taxes.

1. Fund your IRA – If you are under 70 ½ years of age, have earned income and are not covered by a company retirement plan, you may contribute to a traditional IRA the lesser of your earned income amount or $4,000 ($5,000 if you are at least age 50). The IRA contribution is deducted from total income, which lowers your Adjusted Gross Income (AGI).

If you are in the 25% federal income tax bracket, your income tax savings (combining federal and state taxes) for a $4,000 contribution is almost $1,200. Since the after tax cost for this investment is approximately $2,800, you receive an immediate investment return of 42% on the $4,000 contribution.

Even with a company sponsored retirement plan, if Modified Adjusted Gross Income is under $52,000 ($83,000 for a joint tax filer), your IRA contribution is fully deductible.

2. Fund a Spousal IRA - Are you aware that if your spouse has no earned income, he/she can still contribute up to $4,000 ($5,000 if at least age 50) to an IRA for 2007?

With a Spousal IRA, if either spouse has earned income, both spouses may be able to fully fund a tax deductible IRA. Even if the income earner has a company sponsored retirement plan, the spouse may contribute to an IRA.

If the Modified Adjusted Gross Income (MAGI) on your joint tax return is less than $156,000, the Spousal IRA contribution is fully deductible. If you or your spouse has little or no income, be sure to fund a Spousal IRA.

All IRA contributions grow tax-free until your required withdrawals begin at age 70 ½. If you qualify, fund a traditional IRA by April 15.

3. Fund a Roth IRA – You may contribute $4,000 ($5,000 if at least age 50) to a Roth IRA for 2007, if your AGI is under $99,000 ($156,000 for a joint tax filer). However, the maximum contribution is reduced by any contribution that you make to a traditional IRA.

While funds contributed to a Roth IRA do not immediately reduce your taxes, the contributions will grow tax free and are not taxed when they are withdrawn.

If you hope to leave any assets for your kids, Roth IRAs are perfect. Your children can roll them into an inherited Roth IRA and make withdrawals based on their life expectancy. With this approach, Roth IRAs can provide decades of tax free growth.

If you are over age 70½ or you are covered by a company retirement plan and your MAGI is over $52,000 ($83,000 for a joint tax filer), you may only contribute to a Roth IRA. If you cannot fund a traditional IRA, but qualify for a Roth IRA, be sure to fund it by April 15.

4. Fund a Health Savings Account (HSA) – If you had a qualified High Deductible Health Plan (HDHP) throughout 2007, you can contribute $2,850 to an HSA for an individual health plan or $5,650 for a family plan. You may contribute an addition $800, if you are age 55 or over. For tax payers in the 25% tax bracket, the $5,650 HSA contribution costs only $3,975 after federal and state taxes, providing an immediate 42% investment return.

With an HSA, you may use funds to pay current medical bills or you can invest the funds for long-term, tax-free growth. By investing the HSA funds until retirement, you will have years of tax free growth and can withdraw all of the funds tax-free for medical expenses. The HSA funds could pay for most, if not all of your medical expenses during retirement.

Other savings plans that can be funded between now and April 15 include a SEP IRA, if you are self employed, and a Coverdell ESA for you children’s educational expenses. If you qualify for any of these plans, contributions by April 15 can save on taxes, either now or in the future.

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