Tax planning- put holes in this logic.

[jIMOh]

OK, so I figured out I can deduct a traditional IRA deposit. I want anyone to poke holes in this logic.

I contribute $5000 to a deductable IRA. I get $1250 deducted from my taxes (or $1250 added to my expected refund). This is 25% back because deduction comes at highest marginal rate (25%) as best I can see.

I have taxable income in the 15% tax bracket.

At end of year (December 30) I convert the traditional IRA to a Roth. I pay $750 in taxes.

My tax refund just went up $500.

Tell me why I cannot do this?

AGI 103k
taxable income 62k.

Married filing jointly. We both have 401ks and send the 5k to Roths currently. The change in laws about who can deduct a traditional IRA deposit have changed (effective 2007)- so please read up on changes prior to replying if you are going to question the tax law. Technically there are Two IRA deposits (5k each), so all math gets doubled on deduction and taxes side.

 

[FIREd]

your tax bracket is 15% or 25%? something does not add up... If you are in the 15% tax bracket, then you get a tax deduction of $750 on your taxes for a $5000 IRA contribution (and not $1250. You can only get a $1250 deduction if you are in the 25% tax bracket)). If you convert in december, you will owe the $750 back.

 

[jIMOh]

your tax bracket is 15% or 25%? something does not add up...

The deductions are in 25% range and take us into 15% bracket. We have 40k of deductions now. We'll have two more with twins coming sometime in 2008.

 

[FIREd]

The deductions are in 25% range and take us into 15% bracket. We have 40k of deductions now. We'll have two more with twins coming sometime in 2008.

First, 40K of deductions!!!!! wow!
I guess I don't understand how all your deductions can be in the 25% range and your income can be in the 15% bracket. Some of your deductions have to be at a lower rate no (unless your taxable income is near the top of the 15% tax bracket)? I must confess I have never dealt with such a scenario... both my income and deductions are in the 25% bracket .

 

[jIMOh]

First, 40K of deductions!!!!! wow!
I guess I don't understand how all your deductions can be in the 25% range and your income can be in the 15% bracket. Some of your deductions have to be at a lower rate no (unless your taxable income is near the top of the 15% tax bracket)? I must confess I have never dealt with such a scenario... both my income and deductions are in the 25% bracket .

Deductions phase out the same way income phases in.

15% bracket caps at 66k. So from 103k AGI, my first 37k of deductions save me 25% and my last 4k of deductions save me 15%.

 

[growing_older]

If your pile (40k) of deductions push you into 15% bracket then some of them are saving you 15% and some are saving you 25%. If you count the IRA as 25%, with the conversion as 15% you have effectively moved a corresponding amount of other deductions from 25% to 15% to make up for it. You could check this by preparing two returns, one without the IRA and conversion and one with. They should come out with identical tax.

 

[FIREd]

Ok so if the scenario you outlined is what you plan on doing this year and if you pay your taxes as married filling jointly, the top of the 15% tax bracket will be at $65,100 for 2008. So most of your deductions will be in the 25% tax bracket. But, if at the end of the year you add $5000 to your $62,000 taxable income, about $3100 will be taxed at 15% and the rest ($1900) will be taxed at 25%. So you will end up paying about $940 in taxes on the conversion. If the scenario happened in 2007, then it is a bit worse because the top of the 15% tax bracket was $63,700, so you would end up paying 15% tax on $1700 and 25% on the rest ($3300), or about $1,080 total. So even if your consider the entire IRA deduction in the 25% tax bracket, it represents a smaller refund than what you calculated: $170 for 2007 and $310 for 2008.

 

[jIMOh]

FYI- a huge chunk of the deductions are mortgage interest (year 2 of 30 year fixed). Implying as this is paid down, some of that large deduction is lost.

The goal was to pile deductions in 25% bracket then only convert to Roth in years I am in 15% bracket.