Many investors, especially those who run small businesses, don't have a clear picture of their income tax liability before the end of a tax year.
Prior to filing their income taxes, there are some moves investors can make to improve their tax situation and retirement planning.
"To minimize your taxable income contribute the annual maximum limit," says Eric Nelson, financial advisor at Woloshin Investment Management in Medford, New Jersey. "If you have a non-working spouse you can also make a contribution on their behalf which can double the amount of contributions for your family. Spousal contributions can be made as long as you file a joint tax return and have income greater than both IRA contributions."
Even if you already contribute to a 401(k), experts say you're still eligible to contribute to an individual retirement account, which can help reduce your annual income.
"Some investors mistakenly believe that if they participate in a 401(k) plan they are not eligible to contribute to an IRA, but that is not so," Brian Frey, a financial advisor at JOYN in Atlanta.
Understand how a traditional or Roth IRA operate. Since traditional IRA contributions are taxable income, these investments can potentially reduce your taxable liability by potentially reducing your tax bracket. A last-minute contribution can also be done by depositing a tax refund using IRS form 8888. Filers can also claim a tax deduction for this contribution, as long the money is deposited into their retirement account by April 18.
Investors can make a tax-deductible contribution to a traditional IRA, or Roth IRA up to the legal limit -- $5,500 for anyone younger than 50 and $6,500 for anyone who is 50 or older until the April tax filing date. Experts suggest when making a deposit in 2017 for a 2016 tax year, make sure to specify where you want the contribution applied to make sure it is done correctly.
Roth IRA contributors need to consider their modified adjusted gross income to make sure their income isn't over the limit since investors who make too much money aren't allowed to open Roth IRAs. For the 2016 tax season individual filers the income threshold starts at $117,000 and goes to $132,000. For married filers, the income threshold starts at $184,000 and ends at $194,000.
Some high-wage earners who aren't initially eligible for a Roth IRA will do a backdoor Roth IRA, where assets are put into a traditional IRA and then converted to a Roth IRA, which typically has no limits on the amount of the conversion.
"Every year, we are seeing an increase on the number of high-income earners maximizing their back-door Roth IRAs," says Elier Peraza, financial advisor at JY WealthCare in San Jose, California.
Even if a Roth IRA doesn't help reduce your taxable income for 2016 there are other advantages since withdrawals during retirement aren't taxable, Nelson says.
Keep in mind, investors must wait five years after contributing to their Roth IRAs to make tax free withdrawals. "If not, the withdrawal can trigger a 10 percent penalty, much like if you were to take a distribution prior to age 59.5," Nelson says.
Other contribution options. If business owners are looking to reduce their tax liability, another avenue is the simplified employee pension . With a SEP, employers can contribute 25 percent of net compensation per employee -- up to $265,000 -- or $53,000 that year, whatever is less.
"While you do have to make contributions for every employee, it's a no-brainer for anyone operating solo or who have just a few employees," says Lauren Klein, founder and president of Klein Financial Advisors in Newport Beach, California.
Self-employed individuals can contribute up to 20 percent of their adjusted net earnings to a SEP, or the yearly limit, whichever is less. "We see a big amount of SEP contributions taking place between now and April or extended until the business owners file -- up until October," Peraza says.
Use the saver's credit. Low wage earners may be able to claim this tax credit in addition to an IRA contribution, if your adjusted gross income is below $30,750 as an individual, $46,125 as a head of household or $61,500 as a married couple filing jointly in 2016. This credit may amount between 10 to 50 percent of your IRA contribution up to $2,000 for individuals and $4,000 for married couples filing jointly.
Extra income considerations. In this gig economy many investors have a side hustle from delivering pizza and teaching swimming lessons to renting out a room through Airbnb or becoming a Lyft or Uber driver. That person may find themselves with a business profit that can be saved away tax free for their retirement, says Lisa London, a certified financial planner and author of "The Accountant Beside You " series.
Before making a contribution, London suggests self-employed individuals ask themselves:
-- Am I showing a profit?
-- Do I have enough other retirement savings?
-- Does the business have the cash to fund the IRA without causing problems for any growth and/or expansion?
-- If not, is the tax benefit significant enough to pull money from personal savings to fund it?
"Sometime a good business decision is a bad long-term tax decision," London says, when there's an immediate need for capital expenses to grow a business but it comes at the cost of saving for retirement.
Other deductible considerations. Defined benefit plans are another option for small business owners looking to save for retirement and reduce taxes. "Sole proprietors with very healthy cash flows should consider super-sized IRAs -- defined-benefit plans in which they can contribute $50,000 or more for at least three to five years," Peraza says.
For investors who were covered by a high-deductible health plan during 2016, experts suggest investors consider making a tax deductible contribution to their health savings account, which can be done up until the April filing date.
"People need to start thinking about HSAs as their IRAs earmarked for medical expenses during retirement," Peraza says. "If you don't use the money for medical expenses now, it grows tax free -- contributions were tax free, and distributions will be tax free."
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