Slim Your 2021 Tax Bill By Fattening Your IRA
If you didn’t get around to contributing to an IRA in 2021 and you’re looking for ways to lower your tax bill, you may still have an option. Qualified taxpayers can make deductible contributions to traditional IRAs until the tax filing date of April 18, 2022, and claim the benefit on their 2021 returns.
Who is eligible?
You can make a deductible contribution to a traditional IRA if:
You (and your spouse) aren’t active participants in an employer-sponsored retirement plan, or
You (or your spouse) are active participants in an employer plan, but your modified adjusted gross income (MAGI) doesn’t exceed certain levels that vary from year to year by filing status.
For 2021, joint tax return filers who are covered by an employer plan have a deductible IRA contribution phaseout range of $105,000 to $125,000 of MAGI. For taxpayers who are single or a head of household, the phaseout range is $66,000 to $76,000. For married filing separately, the phaseout range is $0 to $10,000. For 2021, if you’re not an active participant in an employer-sponsored retirement plan, but your spouse is, the deductible IRA contribution phaseout range is $198,000 to $208,000 of MAGI.
Deductible IRA contributions reduce your current tax bill, and earnings within the IRA are tax deferred. However, every dollar you take out is taxed in full (and subject to a 10% penalty before age 59½, unless an exception applies).
IRAs are often referred to as “traditional” IRAs to distinguish them from “Roth” IRAs. You also have until April 18 to make a Roth IRA contribution, though, unlike traditional IRA contributions, Roth IRA contributions aren’t deductible. Withdrawals from a Roth IRA are tax-free if the account has been open at least five years and you’re age 59½ or older. (Contributions to a Roth IRA are subject to income limits.)
What’s the contribution limit?
For 2021, if you’re eligible, you can make deductible traditional IRA contributions of up to $6,000. If you were age 50 or older on Dec. 31, 2021, you also may be eligible to make a “catch-up” contribution of up to $1,000.
Alternatively, small business owners can set up and contribute to a Simplified Employee Pension (SEP) IRA up until the due date for their returns, including extensions. For 2021, the maximum SEP contribution is $58,000.
2 alternate IRA strategies
Here are a couple of other ways you may be able to save tax with an IRA:
1. Turn a nondeductible Roth IRA contribution into a deductible IRA contribution. Did you make a Roth IRA contribution in 2021? That’s helpful in the future when you take tax-free payouts from the account, but the contribution isn’t deductible. If a deduction is important now, you can convert a Roth IRA contribution into a traditional IRA contribution using a “recharacterization” mechanism. Assuming you meet the requirements, you may then take a traditional IRA deduction.
2. Make a deductible IRA contribution, even if you don’t work. Generally, you must have wages or other earned income to make a deductible traditional IRA contribution. An exception applies if your spouse is the breadwinner and you’re a homemaker. If so, you may be able to take advantage of a spousal IRA.
For more information about how IRAs or SEPs can help you save the maximum tax-advantaged amount for retirement, contact us.
Hiring? You May Be Eligible For A Valuable Credit
If you’re a business owner who needs to hire, be aware that a law enacted at the end of 2020 extended through 2025 a tax credit for employers that hire individuals from one or more targeted groups. The Work Opportunity Tax Credit (WOTC) is generally worth $2,400 for each eligible employee but can be worth more, in some cases much more.
Targeted groups
Generally, an employer is eligible for the credit only for qualified wages paid to members of a targeted group. These groups are:
1. Qualified members of families that receive assistance under the Temporary Assistance for Needy Families program,
2. Qualified veterans,
3. Qualified ex-felons,
4. Designated community residents,
5. Vocational rehabilitation referrals,
6. Qualified summer youth employees,
7. Qualified members of families in the Supplemental Nutritional Assistance Program (SNAP),
8. Qualified Supplemental Security Income recipients,
9. Long-term family assistance recipients, and
10. Long-term unemployed individuals.
Employer eligibility and requirements
Employers of all sizes are eligible to claim the WOTC. This includes both taxable and certain tax-exempt employers located in the United States and in some U.S. territories. Taxable employers can claim the WOTC against income taxes. However, eligible tax-exempt employers can only claim the WOTC against payroll taxes and only for wages paid to members of the qualified veteran targeted group.
Many additional conditions must be fulfilled before employers can qualify for the credit. Each employee must have completed a minimum of 120 hours of service for the employer. Also, the credit isn’t available for employees who are related to the employer or who previously worked for the employer.
Credit amounts
The credit amounts differ for specific employees. The maximum credit available for the first year’s wages is $2,400 for each employee, or $4,000 for a recipient of long-term family assistance. In addition, for those receiving long-term family assistance, there’s a 50% credit for up to $10,000 of second-year wages. The maximum credit available over two years for these employees is $9,000 ($4,000 for Year 1 and $5,000 for Year 2).
For some veterans, the limits are $4,800, $5,600 or $9,600. For summer youth employees, the wages must be paid for services performed during any 90-day period between May 1 and September 15. The maximum WOTC credit available for summer youth workers is $1,200 per employee.
Worth pursuing
Additional rules and requirements apply. And in limited circumstances, the rules may prohibit the credit or require an allocation of it. However, for most employers that hire from targeted groups, the credit can be valuable. Contact us with questions or for more information about your situation.