tax question
I did my taxes last night. I used Free File, which is on the IRS homepage, to link to H&R Block’s TaxCut program - I’m eligible to file my federal taxes for free, because last year I earned less than their free file eligibility limit. I’ve been doing this for years with no problems. Last year, for the first time ever, I went into a tax prep company’s office to file there, because I had an interstate move and three W-2’s. Do you know I wound up having to remind the tax preparer what to do? She was looking up stuff and everything, and I was mad, because I could have done as good a job as she did. This year, partly because of that experience, and partly because my tax situation is more simple again, I went back to Free File. However, I didn’t actually file the return yet. First of all, I’m still waiting on a form. I know how it affects my taxes, but I need the name of the institution and I won’t know it until I receive the form. The other reason I’m waiting to actually file is because I have a question I need answered.
At this point, I owe about $500. I got what I wanted - I didn’t overpay in taxes. However, I made a few thousand dollars more than I thought I would last year (because of my severance pay). So, when I used the tax withholding calculator, I wound up not withholding enough. I’m not shocked to owe money, and I can easily pay what I owe by April. (This is why I wanted to calculate my taxes as quickly as possible - I have a few months to save for a payment if I need to.) That said, if I can get out of paying the government, I will.
The contribution period for my traditional IRA is not over until the taxes are due in April. I was wondering if it would help for me to contribute about $500 to my IRA for tax year 2007. My thinking is that I can use the IRA deduction to reduce my tax liability and come out even with the government. I can start contributing for tax year 2008 after I contribute that first $500. I did what I usually do when I have a tax question - I visited the IRS website. From what I’ve read, it seems that this might actually work. Even though I was covered by an employee sponsored 401K plan in 2007 (which would affect whether I can deduct the full amount of my contribution), it seems that my income was low enough to allow me to deduct the whole contribution. Does that mean dollar for dollar? I actually received a contribution form in the mail with the year-end statement of my IRA, that has a box you can check if you want your contribution to apply to 2007 instead of 2008. Does anyone reading this know if this is something people with IRAs routinely do?
I am probably going to call an accountant and find out if my little plan will work. I’d hate to send $500 to my IRA just to find out that I have to come up with another $500 for a tax payment, ‘cause the IRA contribution didn’t reduce my tax liability.
Update: It wouldn’t be a dollar-for-dollar deduction. I went into the tax program and changed my 2007 contribution to $500 to see what would happen. It made my tax liability go down, but only by about $100. I would still have to pay almost $400. That would mean paying $900 out of pocket to save $100 on taxes, instead of just paying the government the $500 I owe and making the regular contributions to the IRA that I was going to make anyway. I think I’d rather do the latter.
So I calculated how much I expect to contribute between now and April 1st (10% of my pay for the next eight weeks). It’s actually more than $500, which surprised me. It would result in saving about $170 dollars from my tax liability. And I can come up with less than $350 to pay the government by then, too. I also realized that I can tell the government how much I expect to contribute and just pay them when I’m ready, even if it’s before April 1st. I guess as long as I actually contribute what I say I will, it doesn’t matter.
