IRA: the tax cutter's tool

The year 1998 is long gone and any hope of cutting income-tax liability is as stale as New Year's fruit cake, right?

Wrong.

As the final weeks wind down to the income-tax filing deadline on April 15, taxpayers can take some last minute steps to minimize the financial ravages of Uncle Sam.

Individual retirement accounts (IRA) have long been a way to either cut or defer tax bills. This year, the tax laws make the traditional IRA unusually enticing.

"The IRA is probably the best thing out there at this late date for cutting your 1998 taxes," says John Sabins, a tax preparer in Gaithersburg, Md.

Prior to last year, IRA deductions were phased out for investors with relatively modest income levels.

For taxpayers enrolled in an employee-sponsored retirement plan, those phaseouts began at $25,000 for single taxpayers and $40,000 for married couples filing a joint return.

Beginning with the 1998 return, though, the thresholds start steadily moving higher. In 2007, the limit for taxpayers filing a joint return will double to $80,000; in 2005 it will double to $50,000 for single taxpayers.

Also, beginning in 1998 a spouse not covered by an employer's retirement program can make a $2,000 deductible contribution to an IRA account as long as the joint adjusted gross income is $150,000 or less. Before, the spouse could not make such a contribution if his or her spouse was involved in a retirement plan at work.

If both spouses are not covered, they may each make a deductible $2,000 contribution regardless of their income. The combined compensation of both spouses must be at least equal to their combined contributions.

Some taxpayers have overlooked such a "spousal IRA" contribution because they've been distracted by the launch last year of the Roth IRA, says Mr. Sabins.

The Roth is a big gesture in deferred gratification: It offers the possibility of tax-free earnings but, unlike the traditional IRA, it's not deductible.

IRA contributions for 1998 may be made until April 15. That date is also the deadline for opening a traditional IRA for the 1998 tax year.

The IRA has also become a better tool for bankrolling an education. The 10-percent tax on early IRA withdrawals is waived if the money is used to pay for education, including tuition, fees, books, supplies, room and board, and equipment. (The tax is also dropped for a withdrawal amount up to $10,000 that is used to help pay for a first home.)

Moreover, taxpayers can defer tax and set aside money for education by making a $500 contribution to an Education IRA for children under 18. These are set up as a trust or custodial account.

Education IRA withdrawals are tax free if they are used for education fees.

As with the Roth IRA, the Education IRA is not deductible. But the contributions can be made regardless of whether the beneficiary has gross income.

The benefit is phased out for joint filers with adjusted gross income between $150,000 and $160,000, and for single filers with adjusted gross income between $95,000 and $110,000.

No doubt, these IRA windfalls, and a few other plums for 1988, have somewhat sweetened the chore of tax preparation.

"I would say this year [taxpayers] are pleasantly upbeat," says Carroll Stanley, a certified public accountant in Silver Spring, Md.