By Catherine Gordon, Toolkit Staff Writer
When calculating your annual income taxes before the April 15 deadline, certain filers have the option of sheltering some additional income, tax-free, in an Individual Retirement Account (IRA). And even though the calendar has turned to a new year, that IRA contribution is considered valid for the tax year that just ended.
But with all the holiday spending and likely increases in health coverage premiums for the new year, where do you actually find the money to make that tax-advantageous IRA investment? Thanks to new federal legislation, you may have another source for funding your deposit--your tax refund.
The recent passage of the Pension Protection Act of 2006 has resulted in sweeping changes in the pension and tax areas. One of these changes provides an opportunity for taxpayers to use overpayments of tax toward building IRA retirement savings.
Currently, the IRS is required to refund any overpayment of tax to a taxpayer. And a taxpayer may elect to have the IRS deposit the refund directly into a checking or savings account, rather than have the refund issued by check. But until now, taxpayers who used the direct deposit option did not have the option to divide a refund into more than one account.
Under the Pension Protection Act, beginning with the 2007 tax year, the IRS was directed to design a form or modify existing forms so that taxpayers would be able to deposit all or a portion of their refund into an IRA.
As a result, the IRS unveiled a new program that will allow taxpayers who use direct deposit to divide their refunds in up to three financial accounts, such as checking, savings and retirement accounts.
The new form, Form 8888, to be created by the IRS, will give all individual filers the ability to split their refunds. All taxpayers have to do is attach the new form to their tax returns and indicate the amount of each allocation and the account information. Refunds may be deposited with any U.S. financial institution with valid routing and account numbers.
Taxpayers who want their entire refund deposited directly into one account can still use the appropriate line on the Form 1040 series, but will now have the option of depositing their refund into an IRA. The program will take effect in January 2007.
It's important to note that the timing of the direct deposit of a tax refund to an IRA is crucial. Generally, the deadline for contributing to an IRA and receiving a tax deduction is the date on which the contributing taxpayer's tax return is due, not including extensions, for the tax year for which a deduction is claimed (usually the April 15 following the recently concluded tax year).
The new tax refund direct deposit provision does not modify the rules relating to IRAs, including the rules relating to timing and deductibility of contributions. Therefore, if you want your IRA contribution to relate back to the prior year you should allow sufficient time for your refund to be directly deposited by April 15. If you file your tax return close to the filing deadline, you may risk losing the deduction for your contribution by having your refund deposited to your IRA after April 15.
So if you file your taxes early enough, and you have a refund coming, you may be able to use that refund to fund an IRA and lower your taxes. Or pay off those holiday purchases. But at least you have a choice.
- Related items:
- New Pension Law Expands Investment Advice Options
- Congress Passes Comprehensive Pension Reform Bill
- Introducing the New Roth 401(k) Retirement Plan
- Estate Tax/Minimum Wage Bill Falls in Senate; Pension Legislation Approved
Added to the news on December 5, 2006.
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