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Employers offer 401(k) plans as a tax-deferred retirement plan for their employees. Tax-deferred means that you don't have to pay taxes on the money when you contribute it, but you'll pay taxes when you take distributions. Though all contributions are tax-deferred, not all contributions to 401(k) plans are actually deductible on your tax return.
When you contribute to a 401(k) plan through your employer, your employer takes the money directly out of your paycheck. At the end of the year, your employer adds up the 401(k) plan contributions and reduces the amount of taxable income reported on your Form W-2. As a result, you don't ever include the money in your taxable income, so you don't get to claim an additional tax deduction for your contributions.
In addition to your contributions being excluded from your taxable income, any contributions your employer makes to your 401(k) plan on your behalf are also excluded from your taxable income and are not reported on your W-2. Again, since you did not include your employer's contributions to your 401(k) plan on your behalf in your income, you aren't entitled to claim a deduction.
If you are self-employed, you can set up a 401(k) plan and make contributions for yourself. In this case, you can claim an income tax deduction on your tax return. You must file your income taxes using Form 1040 and report the amount of the contribution to the plan on Line 28. This includes both the portion that you defer as an employee and the employer's matching contribution. Do not report the deduction on Schedule C.
Whether you work as an employee or are self-employed, your 401(k) plan contribution qualifies as an eligible contribution for the retirement savings credit. Other qualifications include having an adjusted gross income below the annual limit for your filing status and not being a full-time student. If you qualify, the credit equals between 10 and 50 percent of the first $1,000 you contribute. The lower your income, the higher the percentage of the credit. The specific limits are published in IRS Publication 590.
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