Using Your Tax Refund As An IRA Contribution

As you sharpen your pencil in an attempt to get every last tax deduction to which you are entitled, don't overlook the IRA contribution. Payments deposited by April 18, 2011 can count against 2010 tax earnings, if so designated.

Suppose you are short of cash to make that contribution. But if you were able to contribute a couple of thousand dollars, your refund would be that much bigger. Well, according to the Internal Revenue Service (IRS), it's possible to use your tax refund as a contribution -- if you can meet a couple of conditions.

The IRS will direct deposit your refund to your bank account, including an IRA. However, it will not indicate which year it is for. You must first make sure the financial institution holding your IRA accepts deposits to prior year IRA accounts. Most do.

Make sure you report the contribution for 2010

As with all IRA deposits, the account owner is responsible for informing the IRA trustee of the year for which the deposit is intended and for ensuring contributions do not exceed annual contribution limitations.

If you fail to notify your IRA trustee of the intended year for the deposit, your trustee can assume the deposit is for the current year. That means it will count against your 2011 taxes and not the current 3010 tax year.

Finally, you must file in time for the IRS to process your return and direct deposit your refund into your IRA before the April 18 filing deadline. The IRS says it is not responsible for the timeliness or contribution amounts related to an IRA direct deposit.

An error on your return or an offset of your refund could change the amount of refund available for deposit. You must verify the deposit was actually made to the account by the due date of the return (without regard to extensions) and the deposit amount.

What if you're late?

If the deposit is not made into your account by the due date of the return, without regard to extensions, the deposit is a contribution for 2011, rather than 2010. That will be a problem for you, since you figured your taxes based on a 2010 IRA contribution.

If you plan to use this strategy, it is best if you can file your taxes by the middle of March to allow for plenty of time for processing. Normally, the IRS will process an electronically filed return and issue a direct deposit refund within 10 days or so.

How much can you contribute? The limit for most people is $5,000, but increases to $6,000 if you are 50 years old or older. If your taxable earnings for the year is less than those amounts, your contribution limit is equal to your taxable compensation.

More information about IRAs is available in IRS Publication 590.