Time is running out on a tax planning technique that can reduce 2023 tax return liability. If a taxpayer qualifies, they can deduct their contributions to a traditional IRA, but the rules are tricky.

Background: The maximum amount you can contribute to a traditional IRA for the 2023 tax year is the lesser of 100% of earned income or $6,500 or $7,500 if you are age 50 or older. You have until the filing due date for 2023 returns—April 15, 2024—to make a contribution. However, if you obtain a filing extension, this does not extend the time for making a contribution for the 2023 tax year.

For starters, contributions are tax-deductible, but the deduction is phased out if the individual (or spouse, if married) actively participates in an employer’s qualified retirement plan, like a 401(k) plan, AND their modified adjusted income (MAGI) exceeds the annual threshold. The figures for 2023 are as follows. (These thresholds are also increasing for 2024.)

  • The phase-out range for single filers who are active plan participants is between $73,000 and $83,000 of MAGI and between $116,000 and $136,000 for joint filers.
  • If one spouse of a couple is an active participant in a plan, the phase-out range is between $218,000 and $228,000 of MAGI.

For example, a 40-year-old single filer who has a MAGI of $78,000 for 2023 and participates in an employer’s 401(k) plan can deduct 50% of a $6,500 contribution, or $3,250. These IRA contributions are deducted ”above the line” so they reduce adjusted gross income (AGI) for other tax purposes.

Best of all, contributions made to an IRA can continue to compound without any current tax erosion until withdrawals are made. This may supplement a qualified retirement plan.

Caveat: This tax break is available if the individual has “earned income” such as compensation from a job. If they only have investment income, they cannot deduct their contributions to an IRA.

Note, however, that a couple can contribute to a spousal IRA if just one spouse works. For example, if one spouse has wages of $100,000, they can effectively double the annual contribution to $13,000. Accordingly, the maximum for a spousal IRA where both spouses are age 50 or over is $14,000.

What about Roth IRA contributions? Similar rules apply. For instance, the contribution limits for Roth IRAs are the same as they are for traditional IRAs. Alternatively, you can combine traditional and Roth IRA contributions up to the total limit of $6,500 for 2023 or $ 7,500 if you are age 50 or older.

However, contributions to Roth IRAs are never tax-deductible, although future payouts are completely exempt from tax if the Roth has been in existence for at least five years and you are age 59½ or older. In contrast, the portion of a traditional IRA distribution representing deductible contributions and earnings is taxable at ordinary income rates.

Practical approach: Consult with your JMF professional advisors regarding your personal situation.