Ok, it’s official. Pretty much everyone in America is getting a [tag]tax rebate[/tag] this summer. The IRS says they’ll start mailing checks in May. So how would you like to get a nice tax-free bonus on your tax rebate? Here’s how.
Your tax-rebate is part of the [tag]economic stimulus[/tag] package recently passed by Congress and signed by the President. You will get up to $600 per person or up to $1200 per joint couple. You also will get up to $300 per child. That money will be a tax free payment from the government. So how do you collect your bonus?
If you qualify for a deductible traditional [tag]IRA[/tag] contribution in 2008 and you put your rebate into a traditional IRA then you will get to deduct the amount of the contribution. So, if you are in the 30% tax bracket, it’s like getting a 30% bonus in the form of a deduction on your 2008 taxes (which you will file in 2009). If you are self-employed you can accomplish the same thing using your SEP or SIMPLE IRAs.
Let’s say a joint couple with two children put their rebates into traditional IRAs. That’s $1200 for the couple + $600 for the children for a total of $1800. By putting the $1800 into their IRAs they will be able to deduct $1800 from their 2008 taxes (which they will file in 2009, don’t try and get too clever and do it this year). At the 30% tax bracket that works out to a savings of approximately $540! Instead of a $1800 gift from the government, they get $2,340! Wait, it gets better. If that $1,800 grows at 8% for the next 25 years, they’ll have an extra $12,327. I don’t do my math this way, but one could say that it is like getting $12,000 from the government.
If you don’t qualify to make a deductible contribution to a traditional IRA (usually because you have a retirement plan at work and make more than $62,000 for single filers or $103,000 joint) you might still be able to get a bonus. Many states (but not all) offer a state income tax deduction on contributions to the state sponsored [tag]529 plan[/tag]. In Colorado, for example, every dollar contributed to one of the Colorado 529 plans can be deducted from your state income tax. At a tax rate of just over 4.6% that same $1,800 in our example gets a much smaller, but still nice $83 bonus. Not to mention the extra money their children will have for college. Make it a double bonus situation by having their grandparents contribute their rebates. The grandparents can either setup their own 529 plans for your children (you can have as many as you want) if they want the tax break, or the can give the money to you and you can increase your tax break (an especially good idea if Grandma and Grandpa live in a state where there is no tax break for 529 contributions.)
If you don’t have children and you don’t qualify for a deductible contribution then the easy bonus option isn’t for you, but you can still come out ahead. If the couple above put their $1,800 into a Roth IRA, they would get that same $12,000. The difference? They’re money will come out tax-free. So, they will get tax-free money from dollars they NEVER paid taxes on! An opportunity like that doesn’t come along very often.
In the coming days, look for detailed articles on www.financegourmet.com on how to open Traditional IRA, Roth IRA and 529 Plan accounts.
By the way, there is some mis-information out there about the rebates. These rebates are NOT taxable, and they do NOT reduce your refund next year. Read this http://www.irs.gov/newsroom/article/0,,id=179181,00.html on the IRS official web site and you’ll see both of these issues directly addressed right from the horse’s mouth. Or, you can read this copy and paste of the exact words:
Q. Is my stimulus payment taxable?
A. No. You will not owe tax on your payment when you file your 2008 federal [tag]income tax[/tag] return. But you should keep a copy of the IRS letter you receive later this year listing the amount of your payment. You will need to know this amount next year when you fill out your 2008 return.
Q. Will the payment I receive in 2008 reduce my 2008 refund or increase the amount I owe for 2008?
A. No, the stimulus payment will not reduce or increase your refund when you file your 2008 return.
Just FYI:
My current list of states that offer at least some kind of deduction for 529 plan contributions is: Arkansas, Colorado, Connecticut, District of Columbia, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine, Maryland, Michigan, Mississippi, Missouri, Montana, Nebraska, New Mexico, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Utah, Vermont, Virginia, West Virginia, Wisconsin.
More states are adding it each year, so check with your state if they aren’t on the list.