The 2019 Tax Season (to file returns for the 2018 tax year) is now full swing, but that doesn’t mean it’s too late to evaluate some last-minute tax strategies that may lower your tax bill for 2018.
That’s likely good news for many, as early reports from the IRS show that the average refund is down compared to last year (though overall tax bills are lower). Not surprisingly, many Americans have been left with a bit of sticker shock, seeing tax bills far higher than expected, or refunds far lower than expected.
If that sounds like you, here are four ways you may be able to utilize tax-favored accounts to lower your 2018 tax bill:
1. Get A Deduction For Contributing To A Traditional IRA
The most obvious – and the most likely way – that you might be able to lower your tax liability for 2018 in early 2019 is to make a 2018 deductible contribution to a traditional IRA. Although 2018 has long since ended, contributions to a traditional (or Roth) IRA for 2018 can still be made up through April 15, 2019. The maximum amount that you can contribute to an IRA for 2018 (and potentially deduct) is $5,500. If you were 50 or older by December 31, 2018, you can contribute up an additional $1,000, known as a “catch-up contribution.”
Be careful though! Not everyone can make such contributions! For starters, you need to make sure you meet the following two requirements:
- You (or your spouse) must have “compensation” for 2018. The term “compensation” generally means earnings, such as W-2 wages or self-employment income, though some other income (such as taxable alimony payments) counts as “compensation” as well. It does not include income from interest, dividends, capital gains, Social Security benefits, pensions, or distributions from retirement accounts.
- Your date of birth must be on or after July 1, 1948, as those 70 ½ or older by the end of 2018 are not allowed to make a traditional IRA contribution for the year (even if that contribution was made before you actually turned 70 ½).
Being able to make a traditional IRA contribution is only half the battle though. You must still make sure that you can receive a tax deduction for that contribution.
In general, an “above-the-line” deduction is allowed for contributions to an IRA. However, if you and/or your spouse are an “active participant” in an employer-sponsored retirement plan, such as a 401(k), 403(b), SEP IRA, or pension plan, and your income exceeds certain thresholds, the ability to deduct your contribution is lost (though you can still make a nondeductible IRA contribution).
2. Get A Deduction For Making A Contribution To An HSA
Another way that you may be able to lower your 2018 tax liability now is by making a 2018 HSA contribution. Like the deadline for IRA contributions, the deadline to make a 2018 HSA contribution is April 15, 2019.
HSAs are often considered the “best” tax-favored account, because they offer triple-tax benefits; tax-deductible contributions, tax-deferred growth, and tax-free distributions (when used for qualified medical expenses). You can only contribute to an HSA if you were enrolled in an HSA-eligible High Deductible Health Plan (HDHP), but the total amount you contribute will depend on what type of an HDHP you have.
Contributions to your HSA for 2018 are limited to $3,450 if you were enrolled in an Individual HDHP for the full year. Alternatively, if you were enrolled in a Family HDHP for the full year, the maximum contribution is, $6,900… double the amount for those with an Individual HDHP plan.
Note: If you were only enrolled in an HSA for a portion of the year, the maximum amount that you can contribute to an HSA will be reduced.
Similar to IRAs, HSAs have catch-up contributions, but unlike IRAs, HSA catch-up contributions can only be made by those who were 55 or older as of December 31, 2018 (as opposed to 50 or older by the same date for IRA catch-up contributions). The maximum HSA catch-up contribution is limited to 1,000 for 2018. However, if both you and your spouse were enrolled in a Family HDHP and were both 50 or older by the end of 2018, your catch-up contributions must be made to separate HSA accounts.
3. Get A Deduction For Making A Contribution To A SEP IRA
If you are a business owner, you may have yet another option at your disposal to secure a deduction and lower your 2018 tax liability; a SEP IRA contribution. Many employer plans, such as a 401(k) or a SIMPLE IRA, need to be set up (and in some cases, funded), before the end of the year. A SEP IRA, however, can be established and funded up to the tax filing deadline, including extensions, of the business sponsoring the plan.
As such, calendar-year partnerships and S corporations may generally establish and/or fund SEP IRAs for 2018 up through March 15, 2019. If those companies file for an extension, that deadline is pushed out until September 15, 2019. Alternatively, sole proprietors may generally establish and/or fund SEP IRAs for 2018 up through April 15, 2019, or October 15, 2019 if on extension.
Note that while filing an extension does not extend the deadline to make a traditional IRA contribution, it does extend the deadline to make a SEP IRA contribution. Thus, for business owners short on cash now, but who may be able to save enough to contribute to a SEP later in the year, the SEP IRA offers a distinct advantage.
However, because the SEP is an employer plan, if a business has employees (other than the owner), those employees may be entitled to a SEP contribution if one is made for the owner. This may reduce (or eliminate) any tax benefits that might be received for making those contributions.
4. Get A Credit For Making A Roth (Or Traditional) IRA Contribution
In general, there are two ways that you can lower your tax liability. You can use deductions to lower the amount of income that you pay tax on, or you can use credits to lower your actual tax bill. So far, we’ve only talked about deductions, but naturally, credits are more valuable since they reduce your tax liability dollar-for-dollar, whereas a deduction will only reduce your tax liability by some fraction of dollar.
Incredibly, in certain circumstances, Uncle Sam will actually subsidize your efforts to accumulate tax-favored retirement savings! It’s technically called the “Retirement Savings Contributions Credit,” but most people simply refer to it as the “Saver’s Credit.”
In order to qualify for the Saver’s Credit, you must pass a 4-part test. Specifically, you must:
- Be 18 or older
- NOT be a full-time student
- NOT be claimed as a dependent on someone else’s return
- Have adjusted gross income (AGI) within the applicable limits for your filing status
If you meet these requirements and did not already contribute at least $2,000 to some sort of retirement account for 2018 (including salary deferrals to a 401(k) and similar retirement accounts), contributing to an IRA now, for last year, will give you a tax credit. As the chart above shows, the maximum Saver’s Credit you’re entitled to varies based on your filing status and income, but an IRA contribution today, made for 2018, could net you up to a $1,000 credit to use towards your 2018 tax liability!
That contribution can be made to a traditional IRA, in which case you’d be entitled to a deduction (see #2 above) in addition to your credit. However, if your income is modest enough to qualify for the Saver’s Credit, there’s probably not all that much value in your deduction. So, in such situations, a better idea is often to make your contribution to a Roth IRA! That’s right, in certain situations, Uncle Sam will actually give you up to a $1,000 credit for building your own income tax-free retirement nest egg!
The Saver’s Credit doesn’t get nearly as much attention as other credits, such as the Child Tax Credit or the Earned Income Credit, but unlike it’s more popular “cousins,” it’s a credit you can still qualify for now with action in early 2019.
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