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Use your tax refund to feather your IRA nest

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in Small Business Tax

You can contribute up to $4,000 to an IRA for the 2006 tax year ($5,000 if you’re age 50 or over). Depending on your situation, you may be able to deduct all or part of the contribution or contribute funds on a nondeductible basis.

But it might not be so easy coming up with the cash.

Strategy: File your return early and use your tax refund for the contribution. It’s perfectly OK with the IRS, as long as you make the contribution by the April 15 deadline.

In fact, a little-noticed provision in the new Pension Protection Act of 2006 makes it easier than ever to use this timing technique. The new law instructs the IRS to provide a means for depositing tax refunds directly into IRAs.

As a result, the IRS has devised Form 8888 (Direct Deposit of Refund). This new form, which is first available for 2006 returns, enables you to divide your refund among up to three accounts, including:

  • Checking.
  • Savings.
  • IRA.
  • Health Savings Account.
  • Archer Medical Savings Account.
  • Coverdell Education Savings Account.

Note: The split-refund option is available whether you file your return electronically or on paper.

Simply attach Form 8888 to your return, and indicate the amount you’re allocating to your IRA.

Form 8888 instructions explain all the requirements for depositing part of your tax refund into an IRA, but here are the basic steps:

  1. Establish the IRA at a financial institution.
  2. Notify the account’s trustee of the tax year for which you’re making the IRA deposit.
  3. Verify that you made the direct deposit by the due date of the return. If the deposit isn’t made to your account by April 16, it won’t qualify as an IRA contribution for the 2006 tax year.

Tip: The early bird gets the worm. Don’t wait until the filing deadline is closing in.

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