Reduce your 2010 taxes—it’s not too late!

Even though its 2011, there may still be ways to reduce 2010 taxes. Funding an IRA between now and April 15 is one of the few remaining methods to reduce 2010 taxable income. Let’s look at three popular IRAs to determine if a year-end contribution is appropriate for you.

If you are self-employed and have no other employees, a SEP IRA may be the best way to reduce your taxable income. If your company is an S or C Corporation, you can contribute up to 25 percent of your W-2 income to a SEP IRA. With a sole proprietorship or an LLC your maximum contribution is 20 percent of your net adjusted self employment income. Net adjusted self employment income is calculated by subtracting ½ of the self employment tax from net self employment income. The maximum annual contribution to a SEP IRA is $49,000.

If you cannot contribute to a SEP IRA, you may be eligible to contribute to a traditional, deductible IRA or to a Roth IRA. To determine if you qualify for an IRA contribution, you’ll need to understand the rules.

To contribute to a traditional IRA, you must be under 70½ years old and you (or your spouse) must have earned income. In 2010, the maximum IRA contribution is $5,000 ($6,000 if over age 50).
When covered by a company retirement plan, you may deduct the maximum contribution amount if your Adjusted Gross Income (AGI) is no more than $56,000 as a single tax payer or $89,000 as a joint filer. If your spouse is not covered by a retirement plan and you are, your spouse may contribute the maximum amounts to an IRA, as long as your joint AGI is under $167,000.
If neither you nor your spouse is covered by a retirement plan, you may each contribute the maximum contribution amounts, regardless of your income. The “spousal IRA” rules allow both spouses to contribute to an IRA, even when only one spouse has earned income.

If you expect to pay higher taxes in retirement than you pay now, contributions to a Roth IRA may be a better choice. To contribute to a Roth IRA, your Adjusted Gross Income (AGI) must be less than $105,000 as a single filer or $167,000 as a joint tax filer. As with a traditional IRA, your maximum Roth IRA contribution is $5,000 ($6,000 if you are over age 50). If you make any traditional IRA contributions, the maximum Roth contribution is reduced by the amount contributed to the traditional IRA.

Sometimes, the decision on whether to fund an IRA or a Roth IRA is made for you. If you are not covered by a company retirement plan and a single filer with an AGI over $105,000 or a joint filer with an AGI over $167,000, you may only fund a traditional IRA. If you are covered by a company retirement plan and your AGI is over $90,000 but less than $167,000, as a joint filer, or over $56,000 but less than $105,000 as a single filer, you may only fully fund a Roth IRA.

Your age can also be a factor. If you have earned income and are over age 70½, only a Roth IRA may be funded.

Funding a Roth IRA instead of a traditional IRA has other advantages. When you are buying your first house, all of your contributions to a Roth IRA plus $10,000 of growth and income can be withdrawn with no taxes or penalties. If funds are required for any purpose before age 59½, a Roth IRA usually allows contributions to be withdrawn, with no taxes or penalties. With a traditional IRA, withdrawals before age 59 ½ will always be taxed and will usually include a 10 percent early withdrawal penalty.

For people under age 40, the tax free growth and ease of withdrawing funds often make Roth IRA contributions a better choice. As an estate planning tool, Roth IRAs provide an excellent mechanism for passing tax free funds to your children.

Whether you chose a SEP IRA, a traditional IRA or a Roth, if you are eligible to fund an IRA in 2010, do it before April 15.
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Wayne Farlow is the founder of Financial Abundance, LLC, a Registered Investment Advisor, providing fee-only financial planning, asset management and retirement planning services. He is the author of “Financial Abundance Guide,” available free at www.finabguide.com . He can be reached by email at [email protected] or at 303-554-0309.