Monday, February 24, 1997
Not too late
to reduce '96 tab

Retirement accounts are
sheltered harbor for tax-free income

BY GARY KLOTT
Gannett News Service

Third in a series

It's not too late for many people to pick up hundreds or thousands of dollars in extra deductions for their 1996 income tax returns, supercharge some existing write-offs and reduce or even eliminate some IRS penalties.

There is also a bit of red tape that some parents and charitable donors will need to take care of before they file their return in order to protect some of their personal tax benefits from being confiscated by the IRS.

Depositing money in an individual retirement account (IRA) or self-employed retirement plan is the most fruitful way still left for most individuals to prune their 1996 tax bill.

If you're eligible to make a tax-deductible retirement contribution - and tens of millions of workers are - consider making the maximum deductible contribution.

Besides earning hundreds or thousands of dollars in deductions for your deposit, contributing to a retirement plan can help inflate some other deductions on your return and even bail you out of some IRS penalties that you'd otherwise be forced to pay.

Despite the restrictive eligibility requirements for IRA deductions - an issue President Clinton and congressional Republicans have promised to examine for the future - most middle- and lower-income workers are eligible for at least a partial IRA deduction on 1996 returns.

And anyone with self-employment income, including employees with free-lance earnings or sideline businesses, can make tax-deductible deposits to a Keogh or Simplified Employee Pension (SEP) plan.

Contributions to an IRA can yield up to $2,000 in deductions for each worker, $2,250 for one-income couples.

Depending on the type of plan, most self-employed workers can make tax-deductible contributions of as much as 13 percent to 20 percent of their self-employment earnings, up to a maximum deposit of $22,500 or $30,000.

Contributing to a retirement plan can also soup up other deductions on your return. The reason: IRA, Keogh and SEP contributions reduce your adjusted gross income, which in turn will increase various tax benefits whose size is linked to adjusted gross income - such as deductions for medical and ''miscellaneous'' itemized expenses.

Contributing to a retirement account also can be your salvation if your withholding and estimated tax payments last year came up short of what was required. Deductible contributions cut your tax liability and thereby reduce or eliminate your underpayment penalty.

In addition, stashing money in a retirement plan now will provide tax savings for many years to come because your money is allowed to grow and compound tax-free as long as it remains in the account.

''The name of the game in taxes is to try to defer paying taxes as long as possible and let the magic of compounding increase your investment,'' said Andrew Zuckerman, a former IRS attorney who is now an employee benefits counsel for Milliman & Robertson, a benefits consulting firm.

Couples with adjusted gross incomes below $50,000 and single individuals with adjusted incomes of less than $35,000 are eligible for at least a partial IRA deduction. No matter how high your income, a full IRA deduction is available if neither you nor your spouse were covered by a retirement plan at work last year.

You have until the April 15 filing deadline to make your IRA deposit. Contributions to self-employed plans can be made up until the due date of your return - which can be later than April 15 with a filing extension.

To make a deductible contribution to a Keogh this tax season, you must have had a Keogh established at a financial institution by Dec. 31. Otherwise, you'll need to use a SEP. Both plans are similar, but with certain types of Keoghs, you can make much larger deductible contributions than with an SEP.

Dodging the tax bullets

If contributing to a retirement account doesn't absolve you of IRS under-withholding penalties, there might be another step you can take to dodge the penalty or at least further reduce it.

Instead of letting the IRS figure the penalty for you after you file your return, it will sometimes pay to figure the penalty yourself on Form 2210. In some cases, you might be able to reduce or even eliminate the penalty by taking advantage of an alternative formula for calculating the penalty, such as the ''annualized income installment method.'' This method can be of help to people who didn't receive their income evenly throughout the year, such as individuals who sold a big investment late in the year and self-employed workers with seasonal businesses.

Some taxpayers might be able to escape underpayment penalties if the shortfall was due to tax law changes made by the Small Business Job Protection Act, which Congress passed last summer. In such cases, the IRS is waiving penalties for underpayment of either of the first two installments of quarterly estimated tax payments for 1996.

Besides trying to ward off penalties and pick up extra deductions, some taxpayers need to take care of a couple of critical paperwork matters before they file their returns in order to safeguard tax benefits they've already earned.

List numbers

Parents need to be sure they've obtained Social Security numbers for all their dependents, including infants born through the end of November. Under the new tax law, Congress gave the IRS authority to automatically disallow the dependency exemption, child-care credit and earned-income credit if you fail to list on your return a Social Security number for a dependent born before Dec. 1.

Some charitable donors can also automatically lose deductions because of paperwork deficiencies. If you made a charitable gift of $250 or more last year, you'll need to obtain a written acknowledgment from the charity before you file your return in order to claim a deduction for the gift.

Canceled checks are no longer sufficient evidence to substantiate large contributions. The 1993 deficit-reduction law now requires a written statement from the charity verifying the amount of your contribution and disclosing whether you received any benefits in exchange for your contribution.

The substantiation letter doesn't get filed with your return. But you need to have the letter in your possession by the time you file your tax return. If you don't, and you later get audited, the IRS can automatically disallow your deduction. New IRS regulations issued in December stress that you can claim the deduction only if you get the letter on time. If you obtain the letter late, you can't remedy the situation by filing an amended return to claim the charitable deduction.

Many charities automatically send out substantiation letters to donors who made a gift of $250 or more.

''But there are still many organizations that don't,'' said Thomas Ochsenschlager, a tax partner at the accounting firm Grant Thornton.

If you don't receive one, contact the charity. Under the tax law, the onus is on the donor to obtain the substantiation letter on time.

The substantiation requirement applies only to donations of $250 or more made on a given day to a particular charity. Separate contributions to a charity during the course of the year aren't aggregated for purposes of applying the $250 threshold. As a result, employees who made contributions through payroll deduction at work, such as to the United Way, aren't subject to the substantiation requirement unless $250 or more is deducted from a single paycheck for donation to that charity.

Volunteer workers also need a substantiation letter to deduct an unreimbursed expense of $250 or more, such as an airline ticket. The statement needs to describe the type of services you performed for the charity and whether you received any benefits in return.

tax strategies

About this series

This eight-part series on tax strategies was written by tax columnist Gary Klott for Gannett News Service. Installments appear on Mondays. Following are the subjects of each part:

Feb. 10: Uncle Sam changes some rules

Feb. 17 General strategies to save on 1996 income taxes.

TODAY: Maximizing personal deductions.

March 3: Tax-saving strategies for homeowners.

March 10: Tax angles for investors.

March 17: Tax-saving guide for employees and the self-employed.

March 24: Costly tax traps to avoid.

March 31: Preparing 1996 returns with an eye to saving next year.


Comments? Questions? Criticisms? Contact Greg Noble, online editor.
Entire contents Copyright (c) 1997 by The Cincinnati Enquirer, a Gannett Co. Inc. newspaper.