Millions of individuals can still pick up hundreds or thousands of dollars in extra deductions for their 1997 income tax returns by depositing money in an Individual Retirement Account or self-employed retirement plan.
The new tax law will make it possible for one-income married couples to contribute far more to IRAs this tax season than in the past.
And most taxpayers will find that they can use their 1997 return to sneak some extra money into the new Roth IRA, even though this new breed of IRA wasn't effective for 1997 returns.
Individuals also will find that Congress has expanded the itemized medical deduction and provided parents who adopted a child last year with a valuable new tax break.
Depositing money in an IRA or self-employed retirement plan remains the most lucrative way still left for most individuals to trim their 1997 tax bill.
Most middle- and lower-income workers are eligible for at least a partial IRA deduction on 1997 returns. And anyone with self-employment income, including employees with free-lance earnings or sideline businesses, can make tax-deductible contributions to a Keogh or Simplified Employee Pension (SEP) plan.
Contributions to an IRA can yield up to $2,000 in deductions per worker, or up to $4,000 for a married couple. Depending on the type of plan, most self-employed workers can make tax-deductible contributions of as much as 13 percent to 20 percent of their self-employment earnings, up to a maximum deposit of $24,000 or $30,000.
The tax benefits go beyond earning a tax deduction for your deposits. Contributing to a retirement plan can also increase other deductions on your return. That's because IRA, Keogh and SEP contributions reduce your adjusted gross income, which in turn will increase various tax benefits whose size is linked to adjusted gross income. Among them are deductions for medical and "miscellaneous" itemized expenses, and the child-care tax credit. The list is longer for upper-income taxpayers who face an automatic cutback in most itemized deductions and personal exemptions as their adjusted gross income rises.
Contributing to a retirement account can also help you dodge IRS penalties for failing to have enough tax withheld from last year's paychecks. Because deductible contributions reduce your tax liability, the amount you needed to have withheld or paid in estimated taxes last year is reduced. Thus, your underpayment penalty will be reduced or eliminated.
Using retirement accounts to escape underwithholding penalties could prove to be a salvation for many investors who cashed in large stock market gains last year but forgot to have extra tax withheld from their paychecks.
Married couples with adjusted gross incomes below $50,000 and single individuals with adjusted incomes under $35,000 are eligible for at least a partial IRA deduction. Even if your income is above those levels, a full IRA deduction is available if neither you nor your spouse was covered by a retirement plan at work last year.
IRA contribution limits
Each worker is allowed to contribute up to $2,000 in earnings to an IRA. And married couples can deposit a combined total of up to $4,000.
In the past, one-income couples were allowed to contribute no more than a total of $2,250. But Congress felt that discriminated against homemakers and included relief in 1996 tax legislation. As a result, one-income couples are now allowed to contribute up to $4,000 a year in job earnings to an IRA, the same limit that has long applied to two-earner couples.
The new law, however, doesn't make it any easier for a non-working spouse's IRA contributions to qualify for a deduction on 1997 returns. As before, if either spouse is covered by a retirement plan at work, then neither spouse's IRA contributions are deductible unless their combined adjusted gross income is below $50,000.
Starting on 1998 tax returns, which get filed next year, however, most non-working spouses will be eligible to deduct IRA contributions even if their spouse isn't eligible.
Non-deductible contributions
Workers who aren't eligible to make tax-deductible contributions to an IRA can make non-deductible IRA contributions. Few taxpayers have been enthusiastic about non-deductible IRAs because there is no upfront deduction for contributions and earnings are taxed at regular rates when withdrawn.
But non-deductible IRAs have special appeal this tax season, says Thomas Ochsenschlager, a Washington, D.C., tax partner at the accounting firm of Grant Thornton. The reason: Most taxpayers will be eligible to convert their non-deductible IRA into the new and more attractive Roth IRAs.
Roth IRAs didn't become effective until 1998, so they are not an IRA option for your 1997 return. But making a non-deductible IRA contribution for your 1997 return is a way to funnel extra money into a Roth IRA. The reason is that taxpayers with adjusted gross incomes under $100,000 in 1998 will be allowed to convert their conventional IRAs into Roth IRAs. The advantage to converting is that all your future earnings would be tax-free. Although contributions to a Roth IRA are not deductible, withdrawals are tax-free as long as the account has been open for more than five years and you're over age 59ï or are using up to $10,000 to buy a first home.
When converting to a Roth, however, money rolled over is subject to tax as if it had been withdrawn. How much, if any, tax you might have to pay for converting your non-deductible IRA will depend on what other IRAs you have. But any tax that would be due could be paid over four years.
The deadline for making IRA contributions for 1997 returns is April 15 - even if you get a filing extension.
Contributions to self-employed plans can be made up until the due date of your return, which can be later than April 15 with a filing extension.
To make a deductible contribution to a Keogh this tax season, you must have had a Keogh established at a financial institution by the close of the tax year, which was Dec. 31 for most self-employed individuals. Otherwise, you'll need to use a SEP, which can be set up and funded anytime up until your filing deadline.
Medical deduction eligibility
Most taxpayers haven't been able to write off any of their medical bills because the deductibility standards were raised a decade ago. Unreimbursed medical expenses are now deductible only to the extent that they exceed 7.5 percent of adjusted gross income. It used to take a serious illness to get past that threshold. But more taxpayers should be able to surpass the threshold on 1997 income tax returns because of a new tax-law provision and the general rise in out-of-pocket costs for health care.
Under the health insurance reform law enacted by Congress in 1996, payments for certain long-term care services provided to the chronically ill are now eligible for the medical deduction. So are premiums paid for long-term care insurance policies that meet certain standards.
In addition, many taxpayers have more out-of-pocket expenses eligible for the medical deduction these days. In recent years, employers have been requiring workers to shoulder more of the health-care tab through bigger co-payments and higher deductibles.
Adoption credit
Parents who adopted a child last year may be eligible to claim a new tax credit for up to $5,000 in related expenses. The credit can be up to $6,000 for adopting a child with "special needs."
Congress created the credit as a way to help middle-income parents with the often-substantial expense of adopting a child, including adoption fees, court costs and attorney fees.
The credit is reduced for parents with adjusted gross incomes in excess of $75,000 and isn't available for those with incomes above $115,000.
Whether eligible parents will be able to claim the credit on their 1997 return will depend on the status of the adoption.
Adoption expenses incurred last year can be claimed on 1997 returns only if the adoption became final in 1997. Otherwise, you won't be able to claim the credit until you file your 1998 tax return next year.
If the adoption effort were unsuccessful, your expenses are eligible for the adoption credit only if the child was a U.S. citizen or resident. Any such expenses incurred in 1997 can't be claimed until you file your 1998 return next year.
