Consider these last-minute ideas to reduce your tax bill.
Fund a deductible individual retirement account (IRA)
You may be able to contribute up to $4,000 (or $4,000 each if you are married) to an IRA and deduct that amount from your income. You can contribute $500 more if you are 50 or older. If you are in the 28 percent federal tax bracket, a $4,000 IRA contribution will reduce your federal taxes by $1,120, plus whatever you save on state taxes. It can be a bit tricky, however, to determine whether you qualify.
If you earned taxable compensation during 2005, you are eligible to fund a deductible IRA if:
- Your compensation came from wages or salary, self-employment income or taxable alimony, and
- You were not covered by an employer retirement plan (such as a 401(k), 403(b), SIMPLE IRA, SEP-IRA, Keogh or pension plan), or
- You were an active participant in a retirement plan and your adjusted gross income (AGI) was less than $50,000 to $60,000 (single or head of household), $75,000 to $85,000 (married filing jointly or qualifying widow or widower), or $0 to $10,000 (married filing separately). The ranges indicate phase-outs. For example, if you are married and your AGI was $80,000 -- halfway through the phase-out range -- you can deduct half an IRA or $2,000.
- Your spouse worked, and
- Your joint AGI was less than $150,000 to $160,000.
The deadline for funding a 2005 IRA is April 17, 2006. You can open an IRA with a bank, mutual fund company or brokerage firm. Call the toll-free number of a mutual fund company such as Vanguard, Fidelity or T. Rowe Price, and the company will send you an application and instructions. Or, visit the fund company's Website.
Fund a Roth IRA
Not eligible for a deductible IRA? If you are covered by a retirement plan and make too much money to contribute to a deductible IRA, you can fund a Roth IRA if your AGI is less than $95,000 to $110,000 (single or head of household) or $150,000 to $160,000 (married filing jointly). A nonworking spouse can also fund a Roth IRA if the income limits are met.
Although you don't receive any immediate tax savings from a Roth IRA because your contribution is not deducted from your taxable income, the money can be withdrawn tax free in retirement. For many people, that makes the Roth the best saving option in the long term. So even if you are eligible for a deductible IRA, you may want to consider a Roth IRA instead.
If you're completely out of luck and had earned income but are not eligible for a deductible or Roth IRA, you can fund a non-deductible IRA. You don't get an immediate tax break, and your earnings are taxed when you withdraw them in retirement, but the IRA grows tax-deferred. A nondeductible IRA is the "last resort" IRA.
Tip: You can file your tax return before you have made your IRA contribution as long as you meet the April 17, 2006 deadline for funding the IRA. Some taxpayers file early and use their refund to fund their IRA.
If you are self-employed, you can still make tax-deductible contributions to a SEP-IRA, as long as you didn't fund another type of retirement plan (like a SIMPLE IRA or Keogh) for the 2005 tax year. For 2005, your contribution is limited to 25 percent of your net self-employment earnings up to a maximum of $42,000.
The beauty of a SEP-IRA is that you can make the contributions as late as your return date plus extensions, although you must request an extension and pay your taxes by April 17. SEP-IRAs are offered by mutual fund companies, brokerages and banks; require minimal paperwork; and cost nothing or very little to set up. NOTE: If you have employees, you must generally fund SEP-IRAs for them in the same percentage as your own.
Tip: Even if you contribute to a SEP-IRA, you can still fund a Roth IRA or a deductible IRA as long as you meet the eligibility requirements listed above.
If you're married, do your taxes twice
If you are married, calculate your taxes both as joint filers and separate filers. In some high-tax states such as Ohio, married couples in which both partners work can save several hundred dollars by filing separately. But be careful: Some tax benefits are not available or phase out more quickly for separate filers. And remember if you file separately on your state return, you must also do so on your federal return.
The Hope and Lifetime Learning credits ($1,100 to $1,650 in 2006) phase out if your income is higher than $45,000 to $55,000 for singles and $90,000 to $110,000 for married couples. If you paid tuition for a child last year and you are no longer eligible to take the credit, maybe your child can. This only works if your child earned enough money to take the full credit (typically $15,000 or more). There's an additional pitfall: If you were eligible to take an exemption for your child and decide to forgo it so your child can claim an education credit, your child cannot take the exemption either.
If you took courses to acquire or improve job skills, you can take a Lifetime Learning credit for 20 percent of the tuition costs up to $1,100 as long as your income is below the limits above. The courses do not have to lead to a degree; a computer course at a community college can qualify.
Take credit for donations to charity
If you hauled a few bags of used clothing to a charitable thrift shop such as Goodwill, it pays to take a few minutes to figure your deduction. Make a list of all the items donated and then add up the fair market value. The Salvation Army will give you a list of values for used clothing and household goods that pass muster with the IRS.
Finally, the best way to save on taxes is to make sure you take every deduction to which you are entitled. Go through your records (including check stubs and credit card statements) one more time.