There isn’t much you can do now, in 2014, to lower your client’s tax liability for 2013. One possible way to do so, however, even at this late date, is to make a deductible contribution to a retirement plan. IRA contributions for 2013 can be made up until April 15, 2014, and, if clients meet certain criteria, they can take a deduction for that contribution, reducing their 2013 tax liability. Some business owner clients can take this a step further, by establishing and contributing to a SEP IRA, which in some cases can be done as late as October 15, 2014 for 2013.
More of your clients will be able to make deductible contributions to a traditional IRA than a SEP IRA, so let’s start there. If your client hasn’t yet made a 2013 IRA contribution and you are wondering if they can make a deductible IRA contribution now, here are the three questions you must ask to find out the answer.
1. Did your client have “compensation?”
Compensation only includes certain types of income, such as wages, self-employment income and taxable alimony. It does not include interest, dividends, capital gains or other passive income.
If the answer is no, your client CANNOT make a deductible IRA contribution for 2013. In fact, they can’t make any traditional IRA or Roth IRA contribution at all.
If the answer is yes, move on to the next question.
2. Was your client born after June 30, 1943?
If the answer is no, your client CANNOT make a deductible IRA contribution for 2013. He or she also cannot make a nondeductible contribution to a traditional IRA. Traditional IRA contributions of any type are prohibited in the year a client turns 70½ and beyond. Your client may be able to make a Roth IRA contribution, however.
If the answer is yes, move on to the next question.
3. Was either your client or their spouse an “active participant” in a company-sponsored retirement plan for 2013?
The definition of active participation varies depending on the type of plan. For 401(k) and similar plans, there is active participation if any salary deferrals or employer contributions were made during 2013.
If the answer is no, here’s some good news: You can stop asking questions and your client CAN make a deductible IRA contribution for 2013. Note that if neither your client nor their spouse were active participants in a company plan, there is no income limit preventing them from taking a deduction for their IRA contributions.
If your client and/or their spouse were active participants in a company plan for 2013, it gets more complicated. They MAY be able to deduct all or a portion of an IRA contribution, but they may not. The final answer depends on three factors: your client’s 2013 modified adjusted gross income (MAGI), their filing status for 2013 and whether it was your client and/or their spouse that was the active participant in 2013. Once you know your client’s 2013 income and filing status, you can use the following two charts to see if they can deduct all or a portion of a 2013 IRA contribution.
If your client was an active participant in a company plan in 2013, click here to see if they can deduct all, part or none of a 2013 IRA contribution.
If your client was not an active participant in a company plan in 2013 but their spouse was, click here to see if they can deduct all, part or none of a 2013 IRA contribution.
Self-employed/business owner clients can take it a step further
Clients that are self-employed or own a business can take this idea one step further. Most 2013 retirement plan options for businesses have long since passed. Now that it’s 2014, clients cannot set up 401(k)s or SIMPLE IRAs for their businesses for 2013. They can, however, set up and fund SEP IRAs for 2013. That’s because SEP IRAs can be established and funded up to the filing deadline, plus extensions. For clients that are self-employed or own corporations (usually S-Corps), that means that an SEP plan can be established and a contribution made for 2013 all the way up to October 15, 2014.
For 2013, SEP contributions can be up to $51,000, so they are a great way to beef up a client’s retirement savings in a hurry. Plus, SEP IRA contributions can be converted to a Roth IRA at any time, giving you the ability to quickly build a sizeable tax-free retirement account for certain clients. Of course, as with traditional IRAs, there are a few questions you should ask to see if the SEP might be a good fit.
1. Did your client have SEP-eligible compensation?
If your client is self-employed, their SEP IRA contribution is based on their Schedule C net profit, along with a few adjustments (for the exact calculation, use the worksheet in IRS Publication 560). So if your self-employed client’s business did not make a profit in 2013, they can’t make an SEP contribution for themselves.
If your client is the owner of a corporation, the profits of the corporation do not count for SEP compensation. For example, suppose your client owns an S-Corporation. Throughout the year, he received $40,000 in salary from the company and also received $60,000 of pass-though S-Corporation profits. Only the $40,000 is taken into consideration for SEP IRA contribution purposes. If your client owned a corporation and received no salary or other SEP eligible compensation for 2013, it’s too late now to go back and have them take a salary.
2. Does it pay for your client to make an SEP contribution?
If your client is self-employed and has no employees, or they are the only employee of their corporation, then there’s not much to worry about here. However, if your client does have employees, it’s important to see how much your client would need to contribute to those employees’ SEP IRAs in order for your client to qualify to make their own contribution. The SEP IRA contribution formula, usually a percentage of compensation, has to be uniform for all employees (although there are some modifications, as discussed above, for self-employed persons).
For example, suppose your client is the owner of an S-Corporation and took a $100,000 salary in 2013. In addition to your client, there is one other employee, who made $30,000 in 2013. Your client can set up an SEP and contribute up to 25% of their 2013 salary ($25,000) into an SEP IRA, but if they do, they’ll also have to make a contribution of 25% of their employee’s 2013 salary ($7,500) to the employee’s SEP IRA.
It’s important to note that there is limited ability to discriminate based on a few factors, including age (those under 21 can be excluded) and years of service (employers can require service of 3 years before making contributions). Remember, though, that whatever discrimination rules are put in place apply to everyone, including your business owner client.
SEP IRA contributions do not impact your client’s ability to make IRA contributions, so if your business owner client wants to, he or she can contribute both to their SEP IRA and a traditional/Roth IRA. This means that for 2013, you can still potentially reduce your clients taxable income by up to $56,500 ($51,000 SEP IRA contribution + $5,500 IRA contribution), or $57,500 if your client was 50 or older by the end of the year, saving them tens of thousands of dollars in tax.
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