March 21 , 2010 - Timely action on IRAs & retirement plan contributions can cut An individual's 2009 tax bill

I am just now getting my tax documents together to file my 2009 tax return, is it too late to realize any tax savings for 2009?

Many individuals think that the time to plan for the 2009 tax year has come and gone, and most of them are right-the door to almost all tax-saving moves for 2009 closed on Dec. 31, 2009. However, there are some noteworthy exceptions involving IRA and retirement plan contributions.

Here are some moves available right now to reduce 2009 adjusted gross income:

Make regular IRA contributions. Contributions to traditional IRAs for tax year 2009 including deductible contributions by those eligible to make them, can be made as late as Apr. 15, 2010. A married individual also should be reminded that he or she won't be treated as an active participant in an employer-sponsored retirement plan subject to the usual joint filer's IRA deduction phaseout (for 2009, between $89,000 and $109,000 of modified adjusted gross income (AGI)) merely because his or her spouse is a participant. Instead, the non-active-participant-spouse's IRA deduction phases out over $166,000 to $176,000 of modified AGI.

Example: For 2009, one spouse has $140,000 of salary income and is covered by a retirement plan, but the other is a home-maker with no earned income. Their combined modified AGI is $160,000. The home-maker can contribute $5,000 to a traditional IRA ($6,000 if age 50 or older) as late as Apr. 15, 2010, and the couple can deduct the full amount on their 2009 return.

Back out of a traditional-IRA-to-Roth-IRA conversion. A taxpayer who converted a traditional IRA to a Roth IRA during 2009 may decide that this wasn't a good tax move after all. For example, the taxpayer may realize that 2010 would be a better time to make the conversion because his tax bracket will be much lower this year than it was last year. Or the taxpayer may have made the conversion when the value of the assets held in the traditional IRA were much higher than they are now. The taxpayer can back out of the conversion by recharacterizing the Roth IRA as a traditional IRA. This involves transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a direct (trustee-to-trustee) transfer.

Example: In 2009, a taxpayer converted a traditional IRA invested in a stock fund to a Roth IRA invested in the same stock fund. At that time, the regular IRA had a $50,000 balance, all of it attributable to deductible contributions and their earnings. The taxpayer's Roth IRA currently is worth only $40,000. To avoid paying tax on $10,000 of evaporated income, the taxpayer can recharacterize the Roth IRA as a traditional IRA.

The easiest way to make a recharacterization is to do so by the due date (plus extensions) of the taxpayer's return for the affected year, and reflect it on that year's return. Thus, a taxpayer who made a 2009 conversion may recharacterize it on the return he files on or before Apr. 15, 2010 (he has until Oct. 15, 2010, if he gets an automatic extension of six months to file his 2009 return). However, a taxpayer who timely files his 2009 return without having recharacterized a 2009 conversion may do so as late as six months after the original due date for filing the 2008 return, i.e., by Oct. 15, 2010. If a 2009 conversion is recharacterized after the taxpayer timely files his 2009 return, he should file an amended return for 2009 reflecting the recharacterization.

Example: A person who converted an amount from a traditional IRA to a Roth IRA may not only transfer the amount back to a traditional IRA in a recharacterization, but may later reconvert that amount from the traditional IRA to a Roth IRA. The reconversion cannot be made before the later of: (a) the beginning of the tax year following the tax year in which the amount was converted to a Roth IRA; or (b) the end of the 30-day period beginning on the day on which the IRA owner transfers the amount from the Roth IRA back to a traditional IRA by way of a recharacterization.

Turn a Roth IRA contribution into a traditional IRA contribution. A taxpayer in the process of getting together his documents for return preparation may now realize that a deductible contribution to a traditional IRA for 2009 would be preferable to the nondeductible Roth IRA contribution he actually made in 2009. The recharacterization strategy (if implemented by deadlines shown above for traditional-IRA-to-Roth IRA conversions) allows him to change his mind and get a 2009 deduction.

Shelter self-employment income. A taxpayer who earned self-employment income during 2009 can shelter part of it by making a deductible retirement plan contribution even if he didn't set up a retirement plan before the end of last year. He can both set up and contribute to a SEP (simplified employee pension) as late as his return due date (plus extensions). For 2009, the maximum deductible contribution generally is 20% of net earnings from self-employment income, or $49,000, whichever is less.

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