Tax Deductibility of IRA Contributions

Tax deductibility of Individual Retirement Accounts (IRA's) is one of the primary features of these types of investments. These benefits can not only save a person and/or organization money, but also lead to greater income potential.

There are several types of IRA's and the tax benefits of each is unique. For individuals the benefits can mean added financial security in older age and for organizations/employers contributing to IRA's , the tax relief can lower payroll tax i.e. money paid to the Government. A brief description of various types of IRA's and the associated tax benefits are as follows:

• Traditional IRA: Contributions to traditional IRA's are tax deductible so long as the amount put into the account complies with federal tax regulations. This tax deduction lowers overall adjusted gross income allowing one to pay less taxes in a tax year or receive a larger tax return. Tax is applied to the contributions and earnings in this type of account at the time of withdrawal. Example: If monthly paychecks are $4,000/month, Monthly contribution from paycheck is $166.676therefore annual taxable income is reduced by $2000 saving $200 at the 10% income tax level.

• Roth IRA: Contributions are made from taxable income, however the withdrawals made after age 59.5 years of age are not taxed and neither are the earnings generated through the Roth IRA. Example: An individual contributes $4000/year to a Roth IRA, that contribution is not deductible, but over 10 years the 4K per year earns 10% each year. Compounded, the 10% tax free earnings yield ($74,124.67-$44,000)=$30,124.67. The $30K in tax free earnings saves one $4500.00 in taxes.

• Employer IRA: Corporations that don't utilize a pension fund may elect to use an employer IRA. These IRA's are established by an employer therefore are tax deductible for them and reduce taxable income for the employee. The affect is generally the same for the employee as taxable income declines in both instances. The contributions and earnings acquired through this type of IRA are tax deferred i.e. taxable upon withdrawal.

• Spousal IRA: Similar to traditional IRA's if contributions are made before the annual IRS mandated deadlines, the contribution is tax deductible. To benefit from a spousal IRA, the filer's tax status should be married filing jointly.

• Keogh: Keogh plans are similar to IRA's but slightly different in the sense they are for the self employed, certain types of small businesses and employees of those businesses. This money can be rolled over into an IRA and contributions are tax deferred until time of withdrawal. Unlike IRA's, Keogh's are not tax deductible because the funds are taken from gross earnings rather than net earnings i.e. pre-taxable income.

IRA contributions vary in terms of maximum amount allowed. Generally the contributions range between $4-6000 per year with contributions in the upper end being reserved for older retirement planners. This contribution amount can have a marginal influence on final tax calculations, but can be all that is needed to lower one's tax bracket from 20% to 15%.

What's more, not all contributions are deductible depending on one's income range. For Roth IRA's and Spousal IRA's incomes over 160K are either non-existent in the former, and not allowed in the latter. While an individual may own more than one IRA there are tax limits on the amount that is deductible i.e. $2000.00/year if filing singly and $4000.00 if married filing jointly.

Common Tax Deductions for Individuals

Tax deductions save taxpayers money by allowing them to list certain expenses, losses and cash out-flow as reductions to total taxable income. The lower the taxable income, the less tax a tax filer must pay. Deductions can be separated into three types, deductions to gross income, standard deductions and itemized deductions. In the United States, most individual tax deductions can be listed on either the Internal Revenue Service form 1040 or the IRS schedule A.

Deductions to gross income

After reporting total income with any losses subtracted on the IRS form 1040, tax filers have a chance to lower their taxable income using reductions in the adjusted gross income section. These reductions can be thought of as deductions to gross income and include items such as alimony, individual retirement account contributions, student loan interest, employee moving expenses and certain self-employment deductions such as health insurance, and self-employment tax reductions. If applicable, these deductions can be entered on the tax form regardless of whether the standard deduction or itemized deductions are utilized.

The standard deduction

If a single taxpayer, head of household or married couple file a form 1040 with the Internal Revenue Service and elect not to itemize deductions, a standard deduction can be used instead. The highest standard deduction is over $10,0000.00 for married couples filing jointly. Depending on whether a tax filer is single or head of a household, the married filing jointly amount is either reduced to half or three quarters for former and latter status' respectfully.

When deciding whether a standard deduction is the right course of action, an important question to ask is would itemized deduction's total be higher than the standard deduction? If itemized deductions don't add up to more, the standard deduction is the better choice for lower taxes because it will add up to less taxable income.

Itemized deductions

Itemized deductions are listed on the IRS Schedule A, which is filed along with a form 1040. On the schedule A, one will find deductions such as mortgage interest, charitable donations, sole proprietorship expenses, state, local, real estate, property and other taxes paid out. As mentioned, if these deductions add up to more than the standard deduction for an individual's tax filing status, it is advantageous to file itemized deductions for the purpose of reducing taxable income, lowering taxes or increasing tax return.

Tips for filing taxes

Tax season is often feared, loathed and avoided by many tax payers but it doesn't have to be such a terrible experience. There are ways to not only improve the tax filing experience, but also potentially benefit from it. The following paragraphs illustrate a few tips that may be useful to tax filers.

• Organize: Keeping important paperwork which will be needed by the April tax filing deadline is an important step in simplifying the taxation process. The easier it is to locate files with bills, expenses and taxes paid out, the better prepared one should be for the tax filing process.

• Maximize: If something is deductible, find out at the beginning of the tax year and not the end. The earlier one knows what is deductible, the more possible it is to stay on the look out for, and document tax filing deductions.

• Calculate: If single, the chances may be higher that filing itemized deductions may yield greater reductions especially if one runs a sole proprietorship out of home and pays mortgage interest and utilities on that home. If a charitable contribution places one in a lower tax bracket, and that contribution is less than 2-10% in additional taxes, it might be worth it in terms of lowering taxes and keeping income.

• Consult: Sometimes tax situations can be complicated by a divorce, estate settlement or complex finances related to business operations. In such instances it may be prudent to consult a tax attorney, accounting professional, the IRS, or any combination thereof. This can help make a potentially stressful situation easier, save valuable time, and give tax filers more peace of mind.

Tax deductions quite possibly are one of the best features of tax preparation because they assist tax filer's retained income to grow, not shrink. Additionally, if the deductions do lead to a tax return at the beginning of the following tax year, those returns, if not claimed, can be applied to the following year's tax filings as either a reduction to taxes owed, or an increase to tax returned.