Minimize impact of bonus at tax time

Q: I’ve got a quick ques­tion I’m hop­ing you can put to rest. I’m a CPT with eight years ser­vice, and I got a $60,000 con­tin­u­a­tion bonus this year that kicked us up into a much higher tax bracket than usual.  I am try­ing to reduce my tax­able income as much as pos­si­ble. I made a $17,000 con­tri­bu­tion to my TSP account, and put $5,000 into my wife’s Roth IRA. Can (and should) I switch that Roth IRA con­tri­bu­tion from its cur­rent “Roth” sta­tus to a “tra­di­tional” so as to be able to deduct it from our tax­able income? Can I make a $5,000 tra­di­tional con­tri­bu­tion too (in addi­tion to my TSP con­tri­bu­tion) to fur­ther reduce our tax­able income? I make about $5500 a month and with my bonus I don’t know if my yearly income would pre­clude me from being eli­gi­ble for any of these deduc­tions, either in full or in part. I’d appre­ci­ate any help you might be able to pro­vide. 
Thank you.
–Gar­ri­son, Hohen­fels, Germany

A: Hey, you’ve done some excel­lent work this year on both the tax and retire­ment fronts. By max­ing out your con­tri­bu­tion to the TSP, you took advan­tage of one of the most read­ily avail­able steps to reduce your tax­able income. In addi­tion to help­ing reduce income tax, that’s a pretty nice addi­tion to your retire­ment savings!

As it sounds like you know, your wife’s Roth IRA con­tri­bu­tion does not help reduce your tax­able income. Instead, it is an after tax invest­ment that offers the poten­tial of tax free with­drawals of both her con­tri­bu­tions and the future earn­ings. While an excit­ing propo­si­tion, it doesn’t help with your imme­di­ate prob­lem. If your focus is truly on reduc­ing your 2012 taxes, you should con­sider “undo­ing” her 2012 Roth con­tri­bu­tion before you file and hav­ing her make a Tra­di­tional IRA Con­tri­bu­tion.  As the non-working spouse of some­one who is an active par­tic­i­pant in a retire­ment plan you could have mod­i­fied adjusted gross income of up to $173,000 (mar­ried fil­ing jointly) and still be able to fully deduct her Tra­di­tional IRA con­tri­bu­tion. Based on the sit­u­a­tion as you described it, this would be the case.

There’s no pro­hi­bi­tion against max­ing out your TSP and mak­ing IRA con­tri­bu­tions. You can do both. On the other hand, since you do par­tic­i­pate in a retire­ment plan the deductibil­ity of your Tra­di­tional IRA con­tri­bu­tion would be sub­ject to lower thresh­olds than your wife’s con­tri­bu­tion. In 2012, if your mod­i­fied adjusted gross income is greater than $112,000 no por­tion of your IRA con­tri­bu­tion would be deductible.  Based on the num­bers you pro­vided, it appears that at least a por­tion of your con­tri­bu­tion would be deductible. To get an accu­rate sense of whether it’s worth your time, I would sug­gest using tax prepa­ra­tion soft­ware to run the num­bers, with and with­out the Tra­di­tional IRA con­tri­bu­tion, to see what the impact is. This will give you some real num­bers upon which to base your deci­sion. IRS Pub­li­ca­tion 590 is a handy ref­er­ence.  Good luck and keep up the good work.