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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up, ∙ How much you can contribute and deduct, ∙ How retirement plan assets can be transferred, ∙ When IRA assets can be withdrawn, ∙ What acts result in penalties, and ∙ Simplified Employee Pensions (SEPs).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.