A Last-Ditch Plan To Avoid Paying Taxes

SMITH BRAIN TRUST – Sometimes the solution to a problem falls into a tax preparer’s lap, the Smith School’s Samuel Handwerger says. And sometimes that solution is a traditional Individual Retirement Account (IRA). The seemingly staid, old stalwart of the investment world has a last-ditch tax savings advantage that its peers just don’t have, he explains.

Handwerger is a lecturer in the Accounting and Information Assurance Department at the University of Maryland’s Robert H. Smith School of Business and the faculty leader of the Smith School’s Volunteer Income Tax Assistance (TerpTax) program.

Earlier this week, some student volunteer tax preparers came to him with a problem. They had completed the tax return of a single, middle-aged woman and discovered, unhelpfully, that she owed money on her return. Had they overlooked something? They asked Handwerger to have a look.

“Upon first review it looked right,” he says. “Then I noticed that even though she has a retirement plan at work, her income level was below the threshold phasing out the ability to deduct IRA contributions.”

Those thresholds are $62,000 for single filers and $99,000 for joint tax return filers. The maximum allowable deduction, which is usually $5,500, was for her increased to $6,500 because she’s over 50.

It was the solution the students were looking for. Filers have until April 17 to make a 2017 contribution to an IRA and to deduct that on their 2017 tax returns, yielding true tax savings. “It’s a really nice tax savings if you qualify for it,” Handwerger says. 

It made a significant difference to the woman’s tax return. No longer did she owe taxes. In fact she can expect a significant refund, a difference of about 28 percent, as the deduction applies to both the federal and state tax returns.

To qualify, the taxpayer didn’t have to contribute the maximum amount, but each dollar she contributed would save her roughly 28 cents in taxes.

The future earnings on the dollars invested inside the IRA are tax-deferred. That means the woman will pay the taxes on the money she draws from her IRA in retirement. Many investors favor the ROTH-IRA for that reason. With a ROTH-IRA, a saver avoids paying taxes on when the money when it is withdrawn, but doesn’t get the deduction today.

That’s what makes the traditional IRA more enticing at tax time.

“For those who believe that tax rates always go down, the (traditional IRA) is probably the best bet,” Handwerger says. “For example, take someone who deducted IRA contributions their entire working career for the past 40 years and is retiring in 2018. They probably deducted those contributions on tax rates higher than the rates on which they will pay taxes on the withdrawals because rates just went down. Those people look like geniuses, at least from a tax planning standpoint.”

There are other great benefits with IRAs, Handwerger says. For starters, savers can delay withdrawing any money until they are 70 years and 6 months old. And the minimum required distribution at that age “is generously small,” he says, allowing savers to keep the funds in the tax-deferred account even longer.

“That’s a true economic win,” he adds.

But the deadline to make a contribution to a 2017 IRA, he warns, is coming up quickly. It's April 17, 2018, – tax day – regardless of whether you plan to file for an extension for your return.