Still Want a Deduction for Tax Year 2011? It’s Not Too Late

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Now that 2012 is underway, many are concerned that it is too late to log more deductions for 2011.

For the most part, you’re out of luck: It’s too late to sell those losing investments for a deduction, or donate to a charity for a 2011 deduction.  December 31 has passed, and many of your chances to lower your taxable income have passed along with the old year.

However, it’s not too late to squeeze in a couple other tax deductions.

Indeed, you have the opportunity to find new tax deductions if you can contribute to a Health Savings Account or a traditional IRA.  You have until April 15 to make contributions to traditional IRAs and HSAs for the previous tax year (this year April 17th).

Contributing to a Traditional IRA

Realize, though, that this doesn’t work with your Roth IRA. B ecause your Roth IRA contributions are made with after tax dollars, contributing now isn’t going to affect your tax liability.  However, you can contribute to a traditional IRA — or even open one if you don’t have a traditional IRA right now.

Every year, my accountant runs a scenario to determine whether or not my tax situation would benefit from opening a traditional IRA in addition to my Roth IRA.  So far, the difference hasn’t been enough to prompt me to do it, but it is something that I’ve considered. You can open a traditional IRA and make a contribution that can lower your taxable income enough to keep you in a lower tax bracket, and reduce what you owe in general.

Before you contribute, though, you need to make sure that you are eligible to make the contributions.

If you have already maxed out your IRA contributions for 2011, you won’t be able to make a previous-year contribution in 2012.

Open a Health Savings Account

I opened a Health Savings Account (HSA) earlier this year and love it.

It works well with the high deductible health plan that I signed up for, and it provides me with a tax deduction — and tax free growth (as long as I use withdraw the money for qualified health care expenses).  There are contribution limits for these plans as well, but I didn’t reach mine in 2011.  As a result, I am waiting to see what my taxes look like.

In many ways, a HSA functions like an IRA.  And the ability to make previous-year contributions is no different.

When we figure up my taxes in February 2012, we will also consider whether a 2011 contribution, made prior to April 15, 2012, is in order for my HSA.  If it will save me money in taxes, I will contribute more money to my HSA.

Checking the Right Box

When deciding to make a 2011 contribution in 2012, it is essential that you pay attention and check the right box.

The paperwork, as well as the online version of your contribution, will ask you whether or not you are making a current-year contribution.  If you want your contribution to count for 2011 instead of being credited to 2012, you have make it clear that you are not making a current-year contribution; your contribution should go toward the previous year.

Also, keep good records so you know which year your IRA or HSA contribution is being used for.

You aren’t allowed to use the same contribution for two different tax years.  If you make the contribution, in 2012, to be used as a deduction against your 2011 income, you can’t use deduct that contribution next year, as you prepare your 2012 taxes.

Is It Worth It to Contribute More?

Before you contribute, you also want to make sure that it is worth it to contribute more.  Remember that a tax deduction does not represent a dollar for dollar reduction in your taxes.  Instead, a tax deduction reduces your income.

While this results in a lower amount paid due to your lower income, you can make a contribution of thousands of dollars, only to have your actual tax liability reduced by a couple hundred dollars.

What you need to weigh is how much of a benefit you will receive by making that contribution.

Ask yourself these questions:

• Can you afford to tie the money up in an IRA or HSA right now? You might be put into a tough financial position if you tie up that money.  You won’t have access to it anymore, so saving $300 on your taxes might not be worth the loss of liquidity in your finances.
• Does staying in a lower tax bracket mean that much to you? In some cases, the extra bracket won’t add that much to your taxes, due to our marginal system.  However, if you have to owe taxes on short-term capital gains on top of your regular income, being in a lower tax bracket can make a big difference.  Look at your whole picture.

Also, it’s worth considering that making that decision to contribute puts that money to work for you.

An extra $2,500 in your IRA may not reduce your taxes by very much, but it puts extra money in an investment account for you, and puts the power of compound interest at your disposal.

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