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Chapter 18. Individual Retirement Arrangements (IRAs)
Important Reminders
Interest earned. Although interest earned from your IRA(s) is generally not
taxed in the year earned, it is not tax-exempt interest. Do not report this
interest on your tax return as tax-exempt interest.
Penalty for failure to file Form 8606. If you make nondeductible IRA
contributions and you do not file Form 8606, Nondeductible IRA Contributions,
IRA Basis, and Nontaxable IRA Distributions, with your tax return, you may
have to pay a $50 penalty.
Introduction
This chapter discusses:
∙ Who can set up an IRA,
∙ When and how an IRA can be set up,
∙ How much you can contribute and deduct,
∙ How retirement plan assets can be transferred,
∙ When IRA assets can be withdrawn,
∙ What acts result in penalties, and
∙ Simplified Employee Pensions (SEPs).
An individual retirement arrangement (IRA) is a personal savings plan that
offers you tax advantages to set aside money for your retirement. That means
that you may be able to deduct your contributions to your IRA in whole or in
part, depending on your circumstances, and that, generally, amounts in your
IRA, including earnings and gains, are not taxed until they are distributed.
If you work for yourself, you may be able to deduct contributions to a
Simplified Employee Pension (SEP), which involves the use of IRAs (SEP-IRAs).
You may also be able to deduct contributions to other retirement plans for
the self-employed (sometimes called Keogh or HR─10 plans). Only self-employed
individuals can deduct such contributions. For details, get Publication 560,
Retirement Plans for the Self-Employed.
Related publication and forms.
This chapter refers to a publication and some forms that you may need.
The list of forms does not include Forms 1040, 1040A, or 1040EZ. For more
information, you may want to order the following:
Publication 590, Individual Retirement Arrangements (IRAs)
Form 5329, Return for Additional Taxes Attributable to Qualified
Retirement Plans (Including IRAs), Annuities, and Modified Endowment
Contracts
Form 8606, Nondeductible IRA Contributions, IRA Basis, and Nontaxable
IRA Distributions
Who Can Set Up an IRA?
You can set up and make contributions to an IRA if you received taxable
compensation during the year and have not reached age 70-1/2 by the end of
the year.
Compensation includes wages, salaries, commissions, tips, professional fees,
bonuses, and other amounts you receive for providing personal services. For
1992, the IRS treats as compensation any amount properly shown in box 10 of
Form W-2, provided that amount is reduced by any amount properly shown in
box 16 (nonqualified plans). Compensation also includes taxable alimony
and separate maintenance payments.
If you are self-employed (a sole proprietor or a partner), compensation is
your net earnings from your trade or business (provided your personal services
are a material income-producing factor), reduced by your deduction for
contributions on your behalf to retirement plans and the deduction allowed
for one-half of your self-employment taxes.
Compensation includes earnings from self-employment that are not subject to
self-employment tax because of your religious beliefs. See Publication
533, Self-Employment Tax, for more information.
Compensation does not include:
∙ Earnings and profits from property, such as rental income, interest
income, and dividend income,
∙ Pension or annuity income,
∙ Deferred compensation,
∙ Foreign earned income and housing cost amounts that are excluded from
gross income, or
∙ Any other amounts that are excluded from income.
IRA for your spouse. You may be eligible to set up and contribute to an IRA
for your spouse, whether or not he or she received compensation. This is
called a spousal IRA and is generally set up for a nonworking spouse. (See
How Much Can I Contribute and Deduct? later.)
Eligibility requirements. To contribute to a spousal IRA:
∙ You must be married at the end of the tax year,
∙ Your spouse must not have reached age 70-1/2 by the end of the tax year,
∙ You must file a joint return for the tax year,
∙ You must have taxable compensation for the tax year, and
∙ Your spouse must either have no compensation or choose to be treated as
having no compensation for the tax year.
When and How Can an IRA Be Set Up?
You can set up different kinds of IRAs with a variety of organizations. You
can set up an IRA at a bank or other financial institution, or with a mutual
fund or life insurance company. You can also set up an IRA through your
stockbroker. Any plan must meet Internal Revenue Code requirements.
Kinds of IRAs. Your IRA can be an individual retirement account or annuity.
It can be either a part of a simplified employee pension (SEP) or a part of
an employer or employee association trust account.
How Much Can I Contribute and Deduct?
Contributions to an IRA must be in the form of money (cash, check, or money
order). You cannot contribute property.
Contribution Limits
The most that you can contribute for any year to your IRA is the smaller of
the following amounts:
1) Your compensation (defined earlier) that you must include in income
for the year, or
2) $2,000.
This is the most you can contribute regardless of whether your contributions
are to one or more IRAs or whether all or part of your contributions are
nondeductible (see Nondeductible Contributions, later).
Example 1. Betty, who is single, earns $24,000 in 1992. Her IRA contributions
are limited to $2,000.
Example 2. John, a college student working part-time, earns $1,500 in 1992.
His IRA contributions for 1992 are limited to $1,500, the amount of his
compensation.
Spousal IRA. The total combined contributions you can make each year to your
IRA and a spousal IRA (discussed earlier) is the smaller of:
1) Your taxable compensation for the year, or
2) $2,250.
You can divide your IRA contributions between your IRA and the spousal IRA any
way you choose, as long as you do not contribute more than $2,000 to either
IRA.
Spouse has compensation during the year. If your spouse also has taxable
compensation during the year and each of you is under age 70-1/2 at the end
of the year, you and your spouse can each have regular IRAs. You each can
contribute up to the $2,000 limit, unless your taxable compensation (or
your spouse's) is less than $2,000.
However, you or your spouse can choose to be treated as having no compensation
for the year and use the rules for spousal IRAs. Generally, if one spouse has
compensation of less than $250 for the year, a spousal IRA is more advantageous
than a regular IRA.
Example 1. Bill and Linda file a joint return for 1992. Bill earned $27,000
and Linda earned $190. Linda chose to be treated as having no compensation;
therefore, Bill set up a spousal IRA for her. Since he contributed $1,800 to
his IRA, the most he can contribute to the spousal IRA is $450 ($2,250 minus
$1,800).
Example 2. Assume the same facts as in Example 1 except that Bill's
contribution to the spousal IRA is $2,000 (the limit for either IRA). The
most he can contribute to his own IRA is $250 ($2,250 minus $2,000).
Spouse under age 70-1/2. Although you cannot make contributions to your IRA
for the year you reach age 70-1/2 or any later year, you can continue to make
contributions to a spousal IRA. You can contribute to a spousal IRA until the
year your spouse reaches age 70-1/2.
Contributions not required. You are not required to make contributions to
your IRA or a spousal IRA for every tax year, even if you can.
If you and your spouse each contribute to an IRA, the contribution limit for
each of you is figured separately.
IRA contributions under community property laws. If you work and have an IRA,
contributions cannot be made to your IRA based on the earnings of your spouse,
unless you have a spousal IRA. The contributions must be based on your own
compensation, even in community property states.
Inherited IRAs. You can make contributions to an IRA that you inherited from
your spouse.
If you inherited an IRA from someone who died after December 31, 1983, and you
were not the decedent's spouse, you will not be allowed to contribute to that
inherited IRA.
When To Contribute
You can make contributions to your IRA (or to a spousal IRA) for a year at any
time during the year or by the due date of your return for that year, not
including extensions. For most people, this means that contributions for 1992
must be made by April 15, 1993.
Designating year for which contribution is made. If you contribute an amount
to your IRA between January 1, 1993, and April 15, 1993, tell the sponsor (the
trustee or issuer) which year (1992 or 1993) the contribution is for. If you
do not tell the sponsor which year it is for, the sponsor must assume, for
reporting to IRS, that the contribution is for 1993, the year the sponsor
received it.
Filing before making your contribution. You can file your return claiming an
IRA contribution before you actually make the contribution. You must,
however, make the contribution by the due date of your return, not including
extensions.
Deductible Contributions
Generally, you can take a deduction for the contributions that you are allowed
to make to your IRA. However, if you or your spouse is covered by an employer
retirement plan at any time during the year, your IRA deduction may be reduced
or eliminated depending on your filing status and the amount of your income.
Who Is Covered by an Employer Plan?
The Form W-2, Wage and Tax Statement, you receive from your employer includes
a box to indicate whether or not you are covered for the year. The form should
have a mark in the "Pension Plan" box if you are covered. If a mark was
required, but was omitted, you are covered.
You are also covered by a plan if you are self-employed and participate in
a qualified retirement plan (such as a Keogh plan) or a simplified employee
pension (SEP) plan.
If you are not certain whether you are covered by your employer's retirement
plan, you should ask your employer. Also see Publication 590 for more
information.
Employer Plans
An employer retirement plan is one that an employer sets up for the benefit of
the employees. For purposes of the IRA deduction rules, an employer retirement
plan is any of the following:
∙ A qualified (meets Internal Revenue Code requirements) pension,
profit-sharing, stock bonus, money purchase, etc., plan (including
Keogh plans),
∙ A 401(k) plan (generally a profit-sharing or stock bonus plan to which
contributions can be made under an arrangement allowing you to choose
to take your income in cash or have your employer pay it into the plan),
∙ A union plan (a qualified stock bonus, pension, or profit-sharing plan
created by a collective bargaining agreement between employee
representatives and one or more employers),
∙ A qualified annuity plan,
∙ A plan established for employees by a federal, state, or local
government, or any of their political subdivisions, agencies, or
instrumentalities (other than an eligible state deferred compensation
plan),
∙ A tax-sheltered annuity plan for employees of public schools and certain
tax-exempt organizations (403(b) plan),
∙ A simplified employee pension (SEP) plan, or
∙ A 501(c)(18) trust (a certain type of tax-exempt trust created before
June 25, 1959, that is funded only by employee contributions).
Effects of marital status. Generally, you are considered covered by an
employer retirement plan if your spouse is covered by one. To determine
whether you are considered covered for the year because of your spouse, you
must wait until the last day of the year. This is because your marital status
(whether you are considered married or single) for the year depends on your
filing status on the last day of the tax year.
If you were married to two different spouses during the same year, for this
purpose, you are considered married for the year to the spouse to whom you
were married at the end of the year.
If your spouse died during the year, and you file a joint return as the
surviving spouse, coverage by an employer retirement plan for that year
is determined as if your spouse were still alive.
If you are married filing a joint return, both you and your spouse are
considered covered by a plan if either of you is covered by a plan.
If you are married filing a separate return and you are not covered by an
employer retirement plan, but your spouse is, you are considered covered
if you and your spouse lived together at any time during the year.
Effect of amounts. Even if your employer sets aside only a very small amount
for you under a retirement plan, you are considered covered by a plan for that
year.
Nonvested employees. If, for a plan year, an amount is allocated to your plan
account in a defined contribution plan, or you accrue a benefit in a defined
benefit plan, but you have no vested interest (legal right) in such account
or accrual, you are still an active participant in (covered by) such plan.
Federal judges are considered covered by an employer retirement plan for
figuring the IRA deduction.
When Are You Not Covered?
You are not covered by an employer plan if neither you nor your spouse is
covered for any part of the year. You are also not covered for this purpose
in the following situations.
If you are married filing a separate return and you are not covered by an
employer retirement plan, you may not be considered covered by a plan even
if your spouse is covered. You would not be considered covered if you and
your spouse did not live together at any time during the year.
Coverage under social security or railroad retirement does not count as
coverage under an employer retirement plan for figuring the IRA deduction.
If you receive retirement benefits from a previous employer's plan, (and you
are not covered under your current employer's plan), you are not considered
covered for this purpose.
Reservists and volunteer firefighters. Certain members of the reserve units of
the Armed Forces (in general, those members who did not serve in excess of 90
days during the year) and certain volunteer firefighters (in general, those
members whose accrued retirement benefit at the beginning of the year will not
exceed $1,800 per year at retirement) are not considered covered by U.S. or
local government retirement plans.
Social Security Recipients
If you receive social security benefits, have taxable compensation, contribute
to your IRA, and are covered (or considered covered) by an employer retirement
plan, complete the worksheets in Appendix B of Publication 590. Use those
worksheets to figure your IRA deduction and the taxable portion, if any, of
your social security benefits.
Deduction Limits
As discussed under Deductible Contributions, earlier, the deduction you can
take for contributions made to your IRA depends on whether you or your spouse
is covered for any part of the year by an employer retirement plan. But your
deduction is also affected by how much income you have and your filing status,
as discussed below under Adjusted Gross Income Limit.
Full deduction. If neither you nor your spouse was covered for any part of
the year by an employer retirement plan, you can take a deduction for your
total contributions to one or more IRAs of up to $2,000, or 100% of your
compensation, whichever is less. Your spouse can also take a total deduction
of up to $2,000, or 100% of his or her compensation, whichever is less. This
amount is reduced by any contributions to a 501(c)(18) plan (generally, a plan
created before June 25, 1959, funded entirely by employee contributions).
Reduced or no deduction. If either you or your spouse is covered by an
employer retirement plan, you may be entitled to only a partial (reduced)
deduction or no deduction at all, depending on your income and your filing
status. The deduction begins to decrease (phase out) when your income rises
above a certain amount and is eliminated altogether when it reaches a higher
amount. The amounts vary depending on your filing status.
Adjusted Gross Income Limit
The effect of income on your deduction, as just described, is sometimes called
the adjusted gross income limit (AGI limit). To compute your reduced IRA
deduction, you must first determine your modified adjusted gross income and
your filing status.
Modified adjusted gross income (modified AGI) is:
∙ If you file Form 1040 - the amount on the page 1 "adjusted gross income"
line, but modified (changed) by figuring it without taking any:
a) IRA deduction,
b) Foreign earned income exclusion,
c) Foreign housing exclusion or deduction, and
d) Exclusion of Series EE bond interest shown on Form 8815, Exclusion
of Interest From Series EE U.S. Savings Bonds Issued After 1989.
∙ If you file Form 1040A - the amount on the page 1 "adjusted gross income"
line, but modified by figuring it without any IRA deduction, or any
exclusion of series EE bond interest shown on Form 8815.
Note. Do not assume modified AGI is the same as your compensation. You will
find that your modified AGI may include income in addition to your taxable
compensation, discussed earlier.
Filing status. Your filing status depends primarily on your marital status.
For this purpose, you need to know if your filing status is single (or head
of household), married filing jointly (or qualifying widow(er)), or married
filing separately. If you need more information on filing status, see Chapter
2.
Married filing separately exception. If you did not live with your spouse at
any time during the year and you file a separate return, your filing status is
considered, for this purpose, as single.
Deduction phaseout. Your IRA deduction is reduced or eliminated entirely
depending on your filing status and modified AGI as follows:
If your Your deduction Your deduction
filing is reduced if is eliminated if
status your modified your modified
is: AGI is within AGI is:
the phaseout
range of:
Single, or $25,000 to $35,000 or
Head of $35,000 more
household
Married - joint $40,000 to $50,000 or
return, or $50,000 more
Qualifying
widow(er)
Married - $ 0 to $10,000 or
separate $10,000 more
return
How To Figure Your Reduced IRA Deduction
If you are covered or considered covered by an employer retirement plan and
your modified AGI is within the phaseout range for your filing status (see the
table under Deduction phaseout, above), your IRA deduction must be reduced.
You can figure your reduced IRA deduction for either Form 1040 or Form 1040A
by using the following worksheet. Also, the instructions for these tax forms
include an IRA Worksheet 2, which you can use instead.
Note. If you were married and both you and your spouse worked and you both
contributed to IRAs, figure the deduction for each of you separately.
If you are divorced or legally separated before the end of the year, you
cannot deduct any contributions you make to your spouse's IRA. You can deduct
only the contributions you make to your own IRA, and your deductions are
subject to the adjusted gross income limit rules for single individuals.
Deductible (and nondeductible) IRA contributions for an IRA other than
a spousal IRA. Complete lines 1 through 8 to figure your deductible and
nondeductible contributions for the year.
Worksheet for Reduced IRA Deduction
(Use only if you are covered or considered covered
by an employer retirement plan and your modified
AGI is within the applicable phaseout range)
If your And your Enter on
filing status modified AGI line 1
is: is over: below:
-------------------- ------------- -----------
Single, or Head
of household $25,000 $35,000
Married─joint
return, or
Qualifying
widow(er) $40,000 $50,000
Married─separate return $ ─0─ $10,000
1. Enter applicable amount
from above ................................ __________
2. Enter you modified AGI
(combined, if married
filing jointly) ........................... __________
Note: If line 2 is equal to or more than the amount on line 1, stop here; your
IRA contributions are not deductible. See Nondeductible Contributions, later.
3. Subtract line 2 from line 1. (If line
3 is $10,000 or more, stop here; you
can take a full IRA deduction for
contributions of up to $2,000 or 100%
of your compensation, whichever is
less.) .................................... __________
4. Multiply line 3 by .20. If the result
is not a multiple of $10, round it to
the next highest multiple of $10. (For
example, $611.40 is rounded to $620.)
However, if the result is less than $200,
enter $200 ................................ __________
5. Enter your compensation. Do not
include your spouse's compensation,
and, if you file Form 1040, do not
reduce your compensation by any
losses from self-employment ............... __________
6. Enter contributions you made, or plan to
make, to your IRA for 1992, but do not
enter more than $2,000. (If contributions
are more than $2,000, see Excess
Contributions, later.) .................... __________
7. IRA deduction. Compare lines 4, 5,
and 6. Enter the smallest amount
(or a smaller amount if you choose)
here and on the Form 1040 or 1040A line
for your IRA, whichever applies. (If
line 6 is more than line 7 and you want
to make a nondeductible contribution,
go to line 8.) ............................. __________
8. Nondeductible contributions.
Subtract line 7 from line 5 or 6,
whichever is smaller. Enter the result
here and on line 2 of your Form 8606,
Nondeductible IRA Contributions, IRA
Basis, and Nontaxable IRA Distributions ... __________
Deductible (and nondeductible) IRA contributions for spousal IRA. The
deduction phaseout rules that reduce or eliminate your IRA deduction also
apply to a spousal IRA. If you have a spousal IRA, are covered by an employer
retirement plan, and your modified AGI is within the applicable phaseout
range, you can take only a reduced spousal IRA deduction.
Complete lines 9 through 17 to figure deductible and nondeductible
contributions (discussed later) for the year to a spousal IRA (see IRA
for your spouse and Spousal IRA, earlier).
9. Enter the smaller of $2,250 or the
amount on line 5 ........................... __________
10. Add lines 7 and 8. Enter the total. If
this amount is equal to or more than line 9,
stop here; you cannot make contributions
to a spousal IRA. Also, see Excess
Contributions, later. ..................... __________
11. Subtract line 10 from line 9 .............. __________
12. Enter the smallest of: (a) contributions
for 1992 to your spouse's IRA; (b)
$2,000; or (c) the amount on line 11. (If
contributions are more than $2,000, see
Excess Contributions, later.) ............. __________
13. Multiply line 3 by .225. If the
result is not a multiple of $10, round it to
the next highest multiple of $10. However,
if the result is less than $200,
enter $200 ................................ __________
14. Enter the amount from line 7 .............. __________
15. Subtract line 14 from line 13. Enter the
result but do not enter more than the
amount on line 12 ......................... __________
16. Spousal IRA deduction. Compare lines
4, 5, and 15. Enter the smallest amount
(or a smaller amount if you choose) here
and on your Form 1040 or 1040A. (If line 12
is more than line 16 and you want to make
a nondeductible contribution for your spouse,
go to line 17.) ........................... __________
17. Spousal IRA nondeductible contributions.
Subtract line 16 from line 12. Enter the
result here and on line 2 of your spouse's
Form 8606 ................................. __________
Reporting Deductible Contributions
You do not have to itemize deductions to claim your deduction for IRA
contributions. If you file Form 1040, deduct your IRA contributions for
1992 on line 24a and, if you file a joint return, deduct your spouse's IRA
contributions on line 24b.
If you file Form 1040A, deduct your contributions on line 15a and, if you
file a joint return, deduct contributions to your spouse's IRA on line 15b.
You can use either form in most cases. You cannot use Form 1040EZ.
Form 5498. You should receive by May 31, 1993, Form 5498, Individual
Retirement Arrangement Information, or similar statement, from plan
sponsors, showing all the contributions made to your IRA for 1992.
Trustee's fees. Trustee's administrative fees, which are billed separately and
paid by you in connection with your IRA, are deductible. They are deductible
(to the extent they are ordinary and necessary) as a miscellaneous deduction
on Schedule A (Form 1040). The deduction is subject to the 2% adjusted gross
income floor (see chapter 30). These fees are not subject to the IRA
contribution limit.
Broker's commissions that you paid in connection with your IRA are subject
to the IRA contribution limit. They are not deductible as a miscellaneous
deduction on Schedule A (Form 1040).
Nondeductible Contributions
Although your deduction for IRA contributions may be reduced or eliminated
because of the adjusted gross income limit (see Deductible Contributions,
earlier), you can still make contributions of up to $2,000 ($2,250 for a
regular IRA and a spousal IRA) or 100% of compensation, whichever is less.
Generally, the difference between your total permitted contributions and your
total deductible contributions, if any, is your nondeductible contribution.
Example. Sonny Jones is single. In 1992, he is covered by a retirement plan at
work. His salary is $52,312. His modified AGI is $55,000. Sonny makes a $2,000
IRA contribution for that year. Because he is covered by a retirement plan and
his modified AGI is over $35,000, he cannot deduct his $2,000 IRA contribution
on his 1992 tax return. However, he may choose to either:
1) Designate this contribution as a nondeductible contribution by reporting
it on his tax return, as explained later under Reporting Nondeductible
Contributions, or
2) Withdraw the contribution as explained later under Tax-Free Withdrawal of
Contributions.
As long as your contributions are within the contribution limits just
discussed, none of the earnings on those contributions (deductible or
nondeductible) or gains will be taxed until they are distributed. See When
Can I Withdraw or Use Assets From an IRA? later.
You will also have a cost basis in your IRA to the extent of your
nondeductible contributions. Your basis is the sum of the nondeductible
amounts you have contributed to your IRA less any distributions of those
amounts. When you withdraw these amounts representing your basis, as discussed
later under When Can I Withdraw or Use Assets From an IRA? you can do so tax
free.
Reporting Nondeductible Contributions
You must report nondeductible contributions to the IRS, but you do not have to
designate a contribution as nondeductible until you file your tax return. When
you file, you can also designate otherwise deductible contributions as
nondeductible.
To designate contributions as nondeductible you must file Form 8606,
Nondeductible IRA Contributions, IRA Basis, and Nontaxable IRA Distributions.
You must file Form 8606 to report nondeductible contributions even if you do
not have to file a tax return for the year.
File Form 8606 if:
∙ You made nondeductible contributions to your IRA for 1992, or
∙ You received IRA distributions in 1992 and you have at any time made
nondeductible contributions to any of your IRAs.
If you receive a distribution from an IRA in the same year that you make
an IRA contribution that may be partly nondeductible, use the worksheet
in chapter 6 of Publication 590 to figure the taxable portion of the
distribution.
If you do not report nondeductible contributions, all of your IRA
contributions will be treated as deductible. Thus, when you make withdrawals
from your IRA, the amounts you withdraw will be taxed unless you can show,
with satisfactory evidence, that nondeductible contributions were made.
Penalty for overstatement. If you overstate the amount of nondeductible
contributions on your Form 8606 for any tax year, you must pay a penalty of
$100 for each overstatement, unless it was due to reasonable cause.
Penalty for failure to file Form 8606. You will have to pay a $50 penalty if
you do not file a required Form 8606, unless you can prove that the failure
was due to reasonable cause.
Tax-Free Withdrawal of Contributions
If you made IRA contributions in 1992 for 1992, you can withdraw them tax free
(except for any earnings on them) by April 15, 1993 (or a later date if you
have an extension to file your return). You can do this if:
∙ You did not take a deduction for the contributions you withdraw, and
∙ You also withdraw any interest or other income earned on the
contributions. You must report this income on your 1992 return.
Examples ─ Deductible and Nondeductible Contributions
The following examples illustrate the use of the IRA deduction worksheet shown
earlier under How to Figure Your Reduced IRA Deduction.
Example 1. For 1992, Tom and Betty Smith file a joint return on Form 1040.
They both work and Tom is covered by a retirement plan at work. Tom's salary
is $40,000 and Betty's is $6,555. They each have an IRA and their combined
modified AGI is $46,555. Since they are covered by an employer plan, and their
modified AGI is between $40,000 and $50,000, they can only take a reduced IRA
deduction on a joint return (see Deduction Limits, earlier).
For 1992, Tom contributed $2,000 to his IRA and Betty contributed $500 to
hers. They must use separate worksheets to figure the reduced IRA deduction
for each of them because both had IRAs.
Tom can take a deduction of only $690 (see the worksheet below). Even though
he contributed the maximum amount allowable ($2,000), $1,310 ($2,000 minus
$690) of his contributions must be treated as nondeductible.
He can choose to treat the $690 as either deductible or nondeductible
contributions. He can also either leave the $1,310 of nondeductible
contributions in his IRA or withdraw them by April 15, 1993. He decides
to treat the $690 as deductible contributions and leave the $1,310 of
nondeductible contributions in his IRA.
Betty can treat all or part of her contributions as either deductible or
nondeductible. This is because her $500 contribution for 1992 is less than the
$690 deduction limit for her IRA contributions that year (see line 4 of her
worksheet, later). She decides to treat her $500 IRA contributions as
deductible.
Using the Worksheet for Reduced IRA Deduction, Tom figures his deductible and
nondeductible amounts as follows:
Worksheet for Reduced IRA Deduction
(Use only if you are covered or considered covered
by an employer retirement plan and your modified
AGI is within the applicable phaseout range)
If your And your Enter on
filing status modified AGI line 1
is: is over: below:
-------------------- -------------- ------------
Single, or Head
of household $25,000 $35,000
Married─joint
return, or
Qualifying
widow(er) $40,000 $50,000
Married─separate return $ ─0─ $10,000
1. Enter applicable amount
from above ................................. 50,000
__________
2. Enter you modified AGI
(combined, if married
filing jointly) ............................ 46,555
__________
Note: If line 2 is equal to or more than the amount on line 1, stop here;
your IRA contributions are not deductible; see Nondeductible Contributions,
earlier.
3. Subtract line 2 from line 1. (If line
3 is $10,000 or more, stop here; you
can take a full IRA deduction for
contributions of up to $2,000 or 100%
of your compensation, whichever is
less.) .................................... 3,445
__________
4. Multiply line 3 by .20. If the result
is not a multiple of $10, round it to
the next highest multiple of $10. (For
example, $611.40 is rounded to $620.)
However, if the result is less than $200,
enter $200 ................................ 690
__________
5. Enter your compensation. Do not
include your spouse's compensation,
and, if you file Form 1040, do not
reduce your compensation by any
losses from self-employment ................. 40,000
__________
6. Enter contributions you made, or plan to
make, to your IRA for 1992, but do not
enter more than $2,000. (If contributions
are more than $2,000, see Excess
Contributions, later.) ...................... 2,000
__________
7. IRA deduction. Compare lines 4, 5,
and 6. Enter the smallest amount
(or a smaller amount if you choose)
here and on the Form 1040 or 1040A line
for your IRA, whichever applies. (If
line 6 is more than line 7 and you want
to make a nondeductible contribution,
go to line 8.) .............................. 690
__________
8. Nondeductible contributions.
Subtract line 7 from line 5 or 6,
whichever is smaller. Enter the result
here and on line 2 of your Form 8606,
Nondeductible IRA Contributions, IRA
Basis, and Nontaxable IRA Distributions ..... 1,310
__________
Betty figures her IRA deduction as follows:
Worksheet for Reduced IRA Deduction
(Use only if you are covered or considered covered
by an employer retirement plan and your modified
AGI is within the applicable phaseout range)
If your And your Enter
filing status modified AGI line 1
is: is over: on below:
Single, or Head
of household $25,000 $35,000
Married─joint
return, or
Qualifying
widow(er) $40,000 $50,000
Married─separate return $ -0- $10,000
1. Enter applicable amount
from above ................................ 50,000
__________
2. Enter you modified AGI
(combined, if married
filing jointly) ........................... 46,555
__________
Note: If line 2 is equal to or more than the amount on line 1, stop here;
your IRA contributions are not deductible; see Nondeductible Contributions,
earlier.
3. Subtract line 2 from line 1. (If line
3 is $10,000 or more, stop here; you
can take a full IRA deduction for
contributions of up to $2,000 or 100%
of your compensation, whichever is
less.) .................................... 3,445
__________
4. Multiply line 3 by .20. If the result
is not a multiple of $10, round it to
the next highest multiple of $10. (For
example, $611.40 is rounded to $620.)
However, if the result is less than $200,
enter $200 ................................ 690
__________
5. Enter your compensation. Do not
include your spouse's compensation,
and, if you file Form 1040, do not
reduce your compensation by any
losses from self-employment ................ 6,555
__________
6. Enter contributions you made, or plan to
make, to your IRA for 1992, but do not
enter more than $2,000. (If contributions
are more than $2,000, see Excess
Contributions, later.) ..................... 500
__________
7. IRA deduction. Compare lines 4, 5,
and 6. Enter the smallest amount
(or a smaller amount if you choose)
here and on the Form 1040 or 1040A line
for your IRA, whichever applies. (If
line 6 is more than line 7 and you want
to make a nondeductible contribution,
go to line 8.) ............................. 500
__________
8. Nondeductible contributions.
Subtract line 7 from line 5 or 6,
whichever is smaller. Enter the result
here and on line 2 of your Form 8606,
Nondeductible IRA Contributions, IRA
Basis, and Nontaxable IRA Distributions .... 0
__________
The IRA deductions of $690 and $500 on the joint return for Tom and Betty
total $1,190. Betty's unused IRA deduction limit of $190 ($690 - $500)
cannot be transferred to Tom to increase his deduction. Tom's deductible
IRA contribution for 1992 is still limited to $690.
Example 2. Assume the facts in Example 1, except that Tom contributed $250 to
a spousal IRA because Betty chose to be treated as having no compensation for
the year and did not contribute to an IRA. Tom completes the spousal IRA
portion of the worksheet as follows.
9. Enter the smaller of $2,250 or the
amount on line 5 ............................ 2,250
__________
10. Add lines 7 and 8. Enter the total. If
this amount is equal to or more than line
9, stop here; you cannot make contributions
to a spousal IRA. Also, see Excess
Contributions, later. ....................... 2,000
__________
11. Subtract line 10 from line 9 ............... 250
__________
12. Enter the smallest of: (a) contributions
for 1992 to your spouse's IRA; (b)
$2,000; or (c) the amount on line 11. (If
contributions are more than $2,000, see
Excess Contributions, later.) .............. 250
__________
13. Multiply line 3 by .225. If the
result is not a multiple of $10, round it to
the next highest multiple of $10. However,
if the result is less than $200,
enter $200 ................................. 780
__________
14. Enter the amount from line 7 .............. 690
__________
15. Subtract line 14 from line 13. Enter the
result but do not enter more than the
amount on line 12 .......................... 90
__________
16. Spousal IRA deduction. Compare lines
4, 5, and 15. Enter the smallest amount
(or a smaller amount if you choose) here
and on your Form 1040 or 1040A. (If line 12
is more than line 16 and you want to make
a nondeductible contribution for your spouse,
go to line 17.) ............................ 90
__________
17. Spousal IRA nondeductible contributions.
Subtract line 16 from line 12. Enter the
result here and on line 2 of your spouse's
Form 8606 .................................. 160
__________
Although Tom contributed the maximum amount (a total of $2,250) to his and
Betty's IRAs, because of the adjusted gross income limit, their allowable IRA
deductions total only $780 ($690 + $90).
Can Retirement Plan Assets Be Transferred?
IRA rules permit you to transfer, tax free, assets (money or property) from
other retirement programs (including IRAs) to an IRA. The rules permit the
following kinds of transfers:
∙ Transfers from one trustee to another,
∙ Rollovers, and
∙ Transfers incident to a divorce.
Transfer From One Trustee to Another
A transfer of funds in your IRA from one trustee directly to another, either
at your request or at the trustee's request, is not a rollover. It is,
however, a tax-free transfer. As such it is not affected by the one-year
waiting period that is required between rollovers, discussed next.
Rollovers
A rollover is a tax-free distribution to you of cash or other assets from one
retirement plan that you contribute (roll over) to another retirement plan.
The amount you roll over tax free, however, is generally taxable later when
the new plan pays that amount to you or your beneficiary.
There are two kinds of rollover contributions to an IRA. In one, you put
amounts you receive from one IRA into another. In the other, you put amounts
from a qualified (meets certain requirements) employer retirement plan, such
as a qualified pension plan, into an IRA.
You cannot deduct a rollover contribution on your tax return.
You must make the rollover contribution by the 60th day after the day you
receive the distribution from your IRA or your employer's plan. If the amount
distributed to you from an IRA or a qualified employer retirement plan becomes
a frozen deposit in a financial institution during the 60-day period allowed
for a rollover, a special rule extends the period. For more information, get
Publication 590.
Waiting period between rollovers. You can take (receive) a distribution from
a particular IRA and make a rollover contribution to another IRA only once in
any one-year period. The one-year period begins on the date you receive the
IRA distribution, not on the date you roll it over into another IRA. This
rule applies separately to each IRA you own. For details, get Publication 590.
Partial rollovers. If you withdraw assets from an IRA, you may roll over part
of the withdrawal tax free into another IRA and keep the rest of it. The
amount you keep is generally taxable (except to the extent it is a return of
nondeductible contributions) and may be subject to the 10% additional tax on
premature distributions and the 15% tax on excess distributions, discussed
later.
If you roll over a distribution from your pension plan into an IRA, the most
that you can roll over is the fair market value of the assets that you receive
as your share from the plan, minus any nondeductible contributions you made to
the plan. Any later distribution to you from that IRA will not qualify for the
special averaging and capital gain treatment applicable to lump-sum pension
distributions.
If you inherited an IRA from your spouse, you can roll it over as though you
had established it.
If you inherited an IRA from someone (other than your spouse) who died after
December 31, 1983, you cannot roll it over or allow it to receive a rollover
contribution.
Reporting Your Rollover
Report any rollover from a qualified plan into an IRA or other qualified plan
on line 17a, Form 1040, or line 11a, Form 1040A. If the total distribution
was rolled over, enter zero on line 17b, Form 1040, or line 11b, Form 1040A.
Otherwise, enter the taxable part of the distribution on line 17b, Form 1040,
or line 11b, Form 1040A. Use lines 16a and 16b, Form 1040, or lines 10a and
10b, Form 1040A, to report rollovers from one IRA to another IRA.
For further information on rollovers, get Publication 590.
Transfers Incident to Divorce
If an IRA is transferred from your spouse or former spouse to you by a decree
of divorce or separate maintenance, or a written document related to such a
decree, the IRA, starting from the date of the transfer, is treated as your
IRA. The transfer is tax free.
When Can I Withdraw or Use Assets From an IRA?
There are rules limiting the withdrawal and use of your IRA assets. When you
do receive distributions from an IRA, you must generally include in gross
income for the year any amount that is paid out or distributed to you from the
IRA during the tax year. A properly handled rollover, as discussed earlier, is
an exception to this rule, as is a return of nondeductible contributions. For
the special rules for figuring the taxable and nontaxable parts of an IRA
distribution that includes a return of nondeductible contributions, get
Publication 590.
Violation of the rules generally results in additional taxes in the year of
violation. See Prohibited Transactions, Premature Distributions (Early
Withdrawals), Excess Accumulations (Insufficient Distributions) and Excess
Distributions, later.
Age 59-1/2 rule. Generally, until you reach the age of 59-1/2, you cannot
withdraw assets (money or other property) from your IRA without having to pay
an additional tax. However, there are a number of exceptions to that rule.
See Premature Distributions (Early Withdrawals), later.
Required Distributions
You cannot keep funds in your IRA indefinitely. You must eventually withdraw
them or pay an excise tax on excess accumulations in your IRA. See Excess
Accumulations, later.
You must choose to withdraw the balance in your IRA in one of the following
two ways:
1) By withdrawing the entire balance in your IRA by the required beginning
date (defined below), or
2) By starting to withdraw periodic distributions of the balance in your IRA
by the required beginning date.
Required beginning date (age 70-1/2 rule). You must begin receiving
distributions from your IRA by April 1 of the year following the year in which
you reach age 70-1/2. If the distributions are to be made over a period of
years, the distributions made by April 1 are treated as made for the previous
year in which the IRA owner reached age 70-1/2. Required distributions for
later years must be made by December 31 of each year.
For more information, including how to figure your required minimum
distribution each year, get Publication 590.
Distributions reported on Form 1099─R. You will receive Form 1099─R,
Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans,
IRAs, Insurance Contracts, Etc., or similar statement, if you receive a
distribution from your IRA. IRA distributions are shown in boxes 1 and 2
of Form 1099─R. A number in box 7 tells you what type of distribution you
received from your IRA.
Reporting taxable distributions on your return. Report fully taxable
distributions, including taxable premature distributions, on line 16b, Form
1040 (no entry is required on line 16a), or line 10b, Form 1040A. If only part
of the distribution is taxable, enter the total amount on line 16a, Form 1040
(or line 10a, Form 1040A), and the taxable part on line 16b, Form 1040 (or
line 10b, Form 1040A). You cannot report distributions on Form 1040EZ.
Withholding. Federal income tax is withheld from IRA distributions unless
you choose not to have tax withheld.
Distributions paid outside the United States or its possessions. In general,
if you are a U.S. citizen or resident alien and your home address is outside
the United States or its possessions, you cannot choose exemption from
withholding on your IRA payments.
What Acts Result in Penalties?
The tax advantages of using IRAs for retirement savings can be offset by
additional taxes and penalties if you do not follow the rules. For example,
there are additions to the regular tax for using your IRA funds in prohibited
transactions. There are also additional taxes for:
∙ Making excess contributions,
∙ Making early withdrawals (taking premature distributions),
∙ Allowing excess amounts to accumulate (failing to make required
withdrawals), or
∙ Receiving excess distributions.
There are penalties for overstating the amount of nondeductible contributions
and for failure to file a required Form 8606. See Reporting Nondeductible
Contributions, earlier.
Prohibited Transactions
Generally, a prohibited transaction is any improper use of your IRA by you
or any disqualified person.
Some examples of disqualified persons for this purpose are:
Your fiduciary, or
Members of your family (spouse, ancestor, lineal descendent, and any
spouse of a lineal descendent).
Some examples of prohibited transactions with an IRA are:
∙ Borrowing money from it,
∙ Selling property to it,
∙ Receiving unreasonable compensation for managing it, or
∙ Using the IRA as collateral for a loan.
Effect on an IRA account. Generally, if you or your beneficiary engage in a
prohibited transaction at any time during the year with your IRA account,
it will not be treated as an IRA as of the first day of the year.
Effect on you (or your beneficiary). If you or your beneficiary engage in a
prohibited transaction with your IRA account at any time during the year, you
or your beneficiary must include the fair market value of all (or part, in
certain cases) of the IRA assets in your gross income for that year. The fair
market value is the price at which the IRA assets would change hands between a
willing buyer and a willing seller, when neither has any need to buy or sell,
and both have reasonable knowledge of the relevant facts.
You must use the fair market value of the assets as of the first day of the
year you engaged in the prohibited transaction. You may also have to pay
the 10% additional tax on premature distributions and the 15% tax on excess
distributions, discussed later.
Excise taxes. Those involved in prohibited transactions may be liable for
certain other excise taxes. In general, there is a 5% tax on the amount of the
prohibited transaction and a 100% additional tax if the transaction is not
corrected.
Investment in collectibles. If your IRA invests in collectibles, the amount
invested is considered distributed to you in the year invested. You may have
to pay the 10% additional tax on premature distributions and the excise taxes
discussed above.
Collectibles include art works, rugs, antiques, metals, gems, stamps, coins,
alcoholic beverages, and other tangible personal property if specified by the
IRS.
Exception. Your IRA can invest in one, one-half, one-quarter, or one-tenth
ounce U.S. gold coins, or one ounce silver coins minted by the Treasury
Department beginning October 1, 1986.
For more information on prohibited transactions, get Publication 590.
Excess Contributions
Generally, an excess contribution is the amount contributed to your IRA(s) for
the year that is more than the smaller of the following amounts:
∙ Your taxable compensation for the year, or
∙ $2,000.
Example. You were single and earned $30,000 in 1992. You contributed $2,500
to your IRA for 1992. Your contribution limit is $2,000. Your reduced IRA
deduction, figured using the Worksheet for Reduced IRA Deduction, is $1,000.
You made an excess contribution for 1991 of $500 ($2,500 minus $2,000).
Tax on excess contributions. You must pay a 6% tax each year on excess amounts
that remain in your IRA at the end of your tax year. The excess is taxed for
the year the excess contribution is made and for each year after that until
you correct it. The tax cannot be more than 6% of the value of your IRA as of
the end of your tax year. The tax does not apply to a rollover contribution.
Excess contributions you withdraw by the date your return is due. You will not
have to pay the 6% tax if you withdraw the excess amount and interest or other
income earned on it by the due date of your return, plus extensions.
You do not have to include in your gross income an excess contribution that
you withdraw from your IRA before your tax return is due if you did not take
a deduction for that excess amount on your return, and the interest or other
income earned on the excess was also withdrawn.
However, you must include in your gross income any interest or other income
earned on the excess contributions (whether deductible or nondeductible
contributions). Report it on your return for the year the excess contribution
was made.
Excess contributions you withdraw after your return is due. If the total
contributions (other than rollover contributions) for the year were $2,250
or less, and there are no employer contributions, you may withdraw any excess
contribution after the due date for filing your return, plus extensions. You
do not include the withdrawn contributions in your income. This applies only
to the part of the excess for which you did not take a deduction.
Premature Distributions (Early Withdrawals)
You must include premature distributions in your gross income and, because
they are premature, there will be an additional 10% tax on them. Use Form 5329
(discussed later) to figure the tax.
Premature distributions are amounts you withdraw from your IRA before you are
59-1/2.
Exceptions. The 10% tax will not apply to the following distributions:
∙ Portions of any distributions treated as a return of nondeductible
contributions.
∙ Distributions made after the owner's death.
∙ Distributions made because you become disabled.
∙ Distributions that are a part of a series of substantially equal payments
over your life (or life expectancy), or over the lives of you and your
beneficiary (or your life expectancies). For this exception to apply, you
must take at least one distribution annually. Also, the payments must
continue for at least 5 years, or until you reach age 59-1/2, whichever
is the longer period. This 5-year rule does not apply if the payment
change is because of the death or disability of the IRA owner.
∙ Distributions that are rolled over, as discussed earlier under Rollovers.
For more information on premature distributions, get Publication 590.
Excess Accumulations (Insufficient Distributions)
If distributions from your IRA(s) during the year are less than the required
minimum distribution for the year, you may have to pay a 50% excise tax for
that year on the excess amount remaining in your IRA.
Request to excuse the tax. If the excess accumulation is due to reasonable
error and you have taken, or are taking, steps to remedy the insufficient
distribution, you can request that the tax be excused.
For more information on excess accumulations, get Publication 590.
Excess Distributions
If you received retirement distributions during the year of more than
$150,000, you may have to pay a 15% tax on the distributions exceeding that
amount. The term "retirement distributions" means your distributions from any
qualified employer plans, tax-sheltered annuity plans, or IRAs.
This tax is reduced by any tax on premature distributions that applies to the
excess distribution. See Premature Distributions, discussed earlier.
Excluded distributions. The excess distribution tax does not apply to the
following distributions:
∙ Distributions after the employee's death,
∙ Distributions that are rolled over, and
∙ Distributions that represent nondeductible contributions.
For more information on excess distributions, get Publication 590.
Reporting Additional Taxes
Use Form 5329, Return for Additional Taxes Attributable to Qualified
Retirement Plans (Including IRAs), Annuities, and Modified Endowment
Contracts, to report the tax on excess contributions, premature distributions,
excess distributions, and excess accumulations.
You also must file Form 5329 if you:
∙ Meet an exception to the 10% additional tax on early (premature)
distributions, but only if the exception is not shown on the Form 1099-R
that you received for the distribution, or
∙ Receive excess distributions from a qualified retirement plan, whether or
not you owe tax on them.
If you file Form 1040, complete Form 5329 and attach it to your Form 1040.
Enter the total amount of IRA tax due on line 51, Form 1040.
If you do not have to file a Form 1040 but do have to pay one of the IRA taxes
mentioned earlier, file the completed Form 5329 with IRS at the time and place
you would have filed your Form 1040. Include a check or money order payable to
the Internal Revenue Service for the tax you owe, as shown on Form 5329. Write
your social security number, tax form number, and tax year on your check or
money order.
Simplified Employee Pension (SEP)
A simplified employee pension (SEP) is a written plan that allows an employer
to make contributions toward his or her own (if a self-employed individual)
and employees' retirement, without becoming involved in more complex
retirement plans. The contributions are made to IRAs (SEP-IRAs) of the
participants in the plan. By choosing a SEP plan, an employer gives up an
advantage available to Keogh plans. The special averaging treatment that
may apply to Keogh plan lump-sum distributions does not apply to SEP-IRA
distributions.
The SEP rules permit an employer to contribute (and deduct) each year to each
participating employee's SEP-IRA up to 15% of the employee's compensation or
$30,000, whichever is less (the contribution limit). The contributions are
funded by the employer.
Deduction limit for a self-employed person. If you are self-employed and
contribute to your own SEP-IRA, special rules apply when figuring your
maximum deduction for these contributions.
For determining the percentage limit on contributions, discussed above, your
compensation is your net earnings from self-employment. See Net earnings,
later. Note that, for this purpose, your net earnings must take into account
your deduction for contributions to your own SEP-IRA. Because the deduction
amount and the net earnings amount are each dependent on the other, this
adjustment presents a problem.
To solve this problem, you make the adjustment to net earnings indirectly by
reducing the contribution rate called for in the plan. Use the following
worksheet to find this reduced contribution rate and your maximum deduction.
Make no reduction to the contribution rate for any other employees.
1) Contribution rate in plan shown as a
decimal .....................................
__________
2) Rate in line (1) plus one ..................
__________
3) Reduced rate for self-employed
person (divide line (1) by line (2)) .......
__________
4) Net earnings (if more than
$228,860, see Publication 560)
not reduced for
contributions to your SEP-IRA ...............
__________
5) Maximum deduction for contributions
to self-employed person's SEP-IRA
(multiply line (4) by line (3)) .............
__________
Example. You are a sole proprietor and have employees. The terms of your SEP
provide that you contribute for yourself 15% of your net earnings, and for
your employees 15% of their pay. Your net earnings from your business (not
taking into account a deduction for contributions to your own SEP-IRA) are
$196,000. In figuring this amount, you deducted your employees' pay of $60,000
and contributions for them of $9,000 (15% of $60,000). You also reduced your
earnings by the deduction for one-half of your self-employment tax. Using the
worksheet, you figure your maximum deduction for contributions to your own
SEP-IRA as follows.
1) Contribution rate in plan shown as a
decimal ..................................... .15
__________
2) Rate in line (1) plus one .................. 1.15
__________
3) Reduced rate for self-employed
person (divide line (1) by line (2)) ....... .130435
__________
4) Net earnings (if more than
$228,860, see Publication 560)
not reduced for
contributions to your SEP-IRA ............... $196,000
__________
5) Maximum deduction for contributions
to self-employed person's SEP-IRA
(multiply line (4) by line (3)) ............. $25,565
__________
Net earnings. For SEP purposes, your net earnings are your gross income from
your business minus your allowable deductions for that business. Allowable
deductions include contributions to the SEP-IRAs of your employees. You must
also reduce your earnings by the deduction for one-half of your self-employment
tax. Net earnings do not include tax-free items or deductions related to them.
The contribution limit (lesser of 15% of compensation or $30,000) discussed
above also applies to any amounts you elect to have taken out of your income
and contributed to the plan under a salary reduction arrangement, discussed
later.
The contribution limit discussed above does not apply to contributions up to
your IRA contribution limit that you make during the year to your SEP-IRAs or
regular IRAs independent of your employer's contributions. See How Much Can I
Contribute and Deduct? earlier.
Salary reduction arrangement. A SEP may include a salary reduction arrangement.
Under it, you can elect to have your employer contribute part of your pay to
the SEP-IRA. Only the remaining portion of your pay is currently taxable. The
tax on the contribution is deferred. This election is called an elective
deferral.
Employer's SEP contributions excluded from your wages on Form W-2. Your
employer's contributions to your SEP-IRA are generally excluded from your
income rather than deducted from it. Therefore, your employer's contributions
should not be included in your Form W─2 wages unless there are contributions
in excess of the applicable limit, or unless there are contributions under a
salary reduction arrangement. Form W─2 should include contributions under a
salary reduction arrangement for social security (FICA) tax purposes only.
Even if your employer makes contributions to your SEP-IRA, you may be able
to deduct the contributions you make to your SEP-IRA or another IRA.
Tax treatment by self-employed individuals. If you are self-employed (a sole
proprietor or partner) with a SEP, take your deduction for contributions to
your own SEP-IRA on line 27, Form 1040.
Excess contributions. If your employer contributes too much to your SEP-IRA,
resulting in an excess contribution, you will not have to pay the 6% tax on it
if you withdraw this excess amount (and interest or other income earned on it)
from your SEP-IRA before the due date for filing your tax return, plus
extensions. However, you must include the excess contribution in your
gross income. Your Form W-2 should include the amount.
For more information on a SEP-IRA, get Publication 590.