You Can Still Lower Your 2008 Tax Bill

Even though 2008 is growing distant in the rearview mirror, you can still make some moves that will help you save on last year's taxes (and maybe on last year's state income taxes, too).

Here are four moves you can make right now to lower your 2008 tax bill, even while your 1040 is under construction.

If you haven't made a deductible traditional IRA contribution for the 2008 tax year, you can do so between now and April 15 and claim the resulting write-off on your 2008 Form 1040. You can potentially make a deductible contribution of up to $5,000, or $6,000 if you were age 50 or older as of Dec. 31, 2008. And if you're married, your spouse can, too. Just be sure to have enough earned income last year (from jobs, self-employment, or alimony received) to equal or exceed the amount you contribute to IRAs for the 2008 tax year. The only catch here is that deductible IRA contributions are phased out (reduced or eliminated) if your 2008 income was too high. (See box below for details.) The good news is the phase-out ranges for 2008 are much higher than just a few years ago, so your odds of being able to make a deductible contribution are better than ever.

Tax Savings Example: If you’re in the 25% federal bracket, a $5,000 deductible IRA contribution saves $1,250 in taxes (plus any state income tax savings). If you and your spouse are both over 50, two $6,000 contributions could save you $3,000 in taxes (maybe more depending on the state you live in).

If you’re self-employed and have not yet set up a tax-favored retirement plan for yourself, consider establishing and contributing to a simplified employee pension (SEP). Unlike other types of small business retirement plans, a SEP can be established this year and still generate a large deduction on last year’s return. Even better, if you extend the filing of your 1040 to Oct. 15, you’ll have until then to take care of the paperwork and make your deductible contribution for the 2008 tax year. Your deductible pay-in can be up to 20% of 2008 self-employment income or 25% of your salary if you worked for your own corporation. In either case, the maximum contribution to your account for 2008 is $46,000.

To establish a SEP go to your bank or brokerage firm and fill out Form 5305-SEP. It only takes five minutes (honest!). Of course, there's a hitch to this move: If you have employees and set up a SEP, you'll probably have to cover them and make contributions to their accounts. That might end up being pretty pricey. Bottom line: If you have employees, don’t start up a SEP without consulting your tax pro.

Tax Savings Example: If you’re in the 28% federal bracket, a $30,000 SEP contribution could lower your tax bill by $8,400 (plus any state income tax savings). That tax savings could actually finance a big chunk of your pay-in.

Say you converted a traditional IRA into a Roth IRA sometime last year. This generally triggers an income tax hit because the conversion is treated as a taxable distribution from the traditional IRA, followed by a contribution to the Roth account. The problem is: Given the market's downward slide, the amount you put into the Roth might be worth a lot less now. If so, you’ll be paying taxes on dollars that no longer exist. Fortunately, there’s an easy way to fix this. You can unwind the conversion by “re-characterizing” the Roth account back into traditional IRA status. Then it’s like the conversion never happened, and your 2008 tax bill is that much lower.

You have until Oct. 15 to unwind a 2008 conversion, but you should do it by April 15 unless you intend to extend your return to the Oct. 15 date. To do a re-characterization, contact your IRA trustee or custodian, then carefully follow the notification instructions given, and keep records to show what you did. Frankly, you may want to hire a tax pro to make sure things are handled right.

If you itemize deductions, you can claim write-offs for 2008 donations of cash and other goods (except for trashy used clothing and household items). However, you’re only entitled to deductions if you have the required documentation. Generally, you must have it in hand by the time you file your return. So please round it up now. For details on what you need, read our story here.