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Timely action on IRAs & retirement plan contributions can cut an individual’s 2013 tax bill

January 22, 2014

Many individuals think that the time to plan for the 2013 tax year has come and gone, and most of them are right—the door to almost all tax-saving moves for 2013 closed on Dec. 31, 2013. However, as this Practice Alert explains, there are some noteworthy exceptions involving IRA and retirement plan contributions.

Here are some moves clients can take right now to reduce their 2013 adjusted gross income (AGI):

Make regular IRA contributions

Contributions to traditional IRAs for tax year 2013, including deductible contributions by those eligible to make them, can be made as late as Apr. 15, 2014. A married client 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 2013, between $95,000 and $115,000 of modified AGI) merely because his or her spouse is a participant. Instead, the non-active-participant-spouse’s IRA deduction phases out over $178,000 to $188,000 of modified AGI.

RIA illustration: For 2013, one spouse has $150,000 of salary income and is covered by a retirement plan, but the other is a homemaker with no earned income. Their combined modified AGI is $175,000. The homemaker can contribute $5,500 to a traditional IRA ($6,500 if age 50 or older) as late as Apr. 15, 2014, and the couple can deduct the full amount on their 2013 return. (Note that such IRAs, sanctioned by Code Sec. 219(c)(1), are now formally called “Kay Bailey Hutchison Spousal IRAs” in honor of a former U.S. Senator who pushed for adoption of this deduction.)

Salvage a late-2013 IRA or qualified plan payout

A taxpayer who was financially compelled to take a distribution from a traditional IRA or an individual account in a qualified retirement plan late in 2013, but now has the money to replenish the retirement savings, can avoid taxes on the withdrawal by making a rollover to a traditional IRA generally no later than the 60th day after the day he received the distribution. Thus, for example, a taxpayer who had to withdraw $10,000 from a traditional IRA on Dec. 27, 2013, but now is able to replenish those funds, can avoid paying a tax on the withdrawal by recontributing $10,000 to a traditional IRA no later than Feb. 25, 2014. Even if he doesn’t have the full $10,000, he can reduce his tax by rolling over a lesser amount, say $5,000. Note that the 60-day requirement may be waived under some circumstances.

Back out of a traditional-IRA-to-Roth-IRA conversion

A taxpayer who converted a traditional IRA to a Roth IRA during 2013 may decide that this wasn’t a good tax move after all. For example, the taxpayer may realize that 2014 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 was higher than they are now. The taxpayer can back out of the taxable 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.

RIA illustration: In 2013, Jim converted a traditional IRA invested in a gold fund to a Roth IRA invested in the same fund. At that time, the regular IRA had a $50,000 balance, all of it attributable to deductible contributions and their earnings. Jim’s Roth IRA currently is worth only $40,000. To avoid paying tax on $10,000 of evaporated income, Jim 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 2013 conversion may recharacterize it on the return he files on or before Apr. 15, 2014 (he has until Oct. 15, 2014, if he gets an automatic extension of six months to file his 2013 return). However, a taxpayer who timely files his 2013 return without having recharacterized a 2013 conversion may do so as late as six months after the original due date for filing the 2013 return, i.e., by Oct. 15, 2014. If a 2013 conversion is recharacterized after the taxpayer timely files his 2013 return, he should file an amended return for 2013 reflecting the recharacterization.

RIA observation: 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 2013 would be preferable to the nondeductible Roth IRA contribution he actually made in 2013. For example, he may realize that by making a deductible contribution, he would have avoided one or several AGI-based phaseouts or reductions of tax breaks. 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 2013 IRA deduction.

Shelter self-employment income

A taxpayer who earned self-employment income during 2013 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 2013, the maximum deductible contribution generally is 20% of net earnings from self-employment income, or $51,000, whichever is less.