Calculating Your IRA Deduction


Are you covered by a retirement plan at work?

A "retirement plan at work" is a plan set up by your employer, who then makes contributions to the plan for your benefit and the benefit of other employees. If you are not sure whether you are covered by a retirement plan at work, your employer can tell you. The Form W-2, Wage and Tax Statement, that you receive will have a check in either the "Pension Plan" or "Deferred Compensation" checkbox if you are covered by a plan of that employer.

What types of plans constitute an employer retirement Plan?
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 pension plan, etc. (including Keough plans). 

  • A 401(k) plan (generally an arrangement included in a profit-sharing or stock bonus plan that allows you to choose to take part of your compensation from your employer 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 its employees by the United States, a state or political subdivision thereof, or by an agency or instrumentality of any of the foregoing (other than an eligible state deferred compensation plan [section 457 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. 

  • A 501(c)(18) trust (a certain type of tax-exempt trust created before June 25, 1959, that is funded only by employee contributions) if you made deductible contributions during the year. 

What type of activity does not mean you are covered by a retirement plan for IRA deduction purposes?
Social Security and Railroad Retirement. Coverage under Social Security or Railroad Retirement does not count as coverage by a plan at work for this purpose. 

Receiving Benefits. If you are receiving retirement benefits from a previous employer's plan, you are not considered as covered by that plan for this purpose. 

Are you ineligible to make an IRA contribution because you are covered by a retirement plan at work?
No. The fact that you are covered by a retirement plan at work affects your ability to claim a tax deduction for the contribution, but not your ability to be eligible to make the contribution.

When can you take a full IRA deduction?
If you are not married and you are not covered by a retirement plan at work, then you can take a full IRA deduction of up to $2,000, or the amount of your taxable W-2 or other qualifying compensation for the year, whichever is less.

If you are not married and you are covered by a retirement plan at work, then you can take a full IRA deduction of up to $2,000, or the amount of your taxable compensation, whichever is less as long as your adjusted gross income is $25,000 or less for the year.

If you are married and you and your spouse are not covered by a retirement plan at work, then each of you can take a full IRA deduction of up to $2,000, or the amount of your respective compensation, whichever is less.

If you are married and you or your spouse are covered by a retirement plan at work, then each of you can take a full IRA deduction up to $2,000, or the amount of your respective compensation, whichever is less as long as you and your spouse's adjusted gross income is $40,000 or less for the year, and a joint income tax return is filed.

When are you (or your spouse) not entitled to any deduction with respect to an IRA contribution?
If you are not married, then you are not able to deduct any portion of your IRA contribution if you are covered by a retirement plan at work and your adjusted gross income is $35,000 or more.

If you are married and you file a joint income tax return, then you are not entitled to deduct any portion of your IRA contribution if either you or your spouse is covered by a retirement plan at work and you and your spouse's adjusted gross income is $50,000 or more.

If you are married, but you file separate tax returns, then you are not entitled to deduct any portion of your IRA contribution if either you or your spouse is covered by a retirement plan at work and your adjusted gross income is $10,000 or more.

When are you (or your spouse, if any) entitled to a partial tax deduction with respect to an IRA contribution?
The following chart indicates when you are entitled to a partial tax deduction.

If you file as: Your deduction is
reduced if your 
Modified AGI*
is within the 
phase out range of:
Single, or head of household $25,000.01 - $34,999.99
Married-Joint Return, or
Qualifying Widow(er)
$40,000.01 - $49,999.99
Married-Separate Return $0.01 - $9,999.99

*Adjusted Gross Income

Also see the chart, "Can You Take an IRA Deduction?"

How do you calculate the maximum partial deduction?
You use the following worksheet:

Worksheet for Reduced IRA Deduction
(Use only if you are covered, or considered covered, by an employer plan and your modified AGE is within the phase out range that applies.)

If your filing status is: And your modified AGI is over Enter on line 1 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 the amount from above that applies
  2. Enter your 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% (.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, but do not enter more than $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.)
  8. Nondeductible contribution. Subtract line 7 from line 5 or 6, whichever is smaller. Enter the result here and on line 1 of your Form 8606.
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Examples

Example # 1: Sonny Jones is single. In 1996, he is covered by a retirement plan at work. His salary is $28,000. His modified adjusted gross income (MAGI) is $30,000. Sonny makes a $2,000 IRA contribution that year. Because he is covered by a retirement plan, and his MAGI is above $25,000, he cannot deduct his $2,000 IRA contribution. However, he may deduct $1,000 of his contribution. With respect to the other $1,000, he may either designate it as a nondeductible contribution on Form 8606, or withdraw it if special rules are met.
 
Example # 2: Mary, a single taxpayer with $49,400 of adjusted gross income, is not covered by her employer's retirement plan.

How much can Mary contribute to her IRA for 1996?       $2,000. 
How much can Mary deduct on her tax return for 1996?  $2,000. 

Since Mary is not covered by an employer-sponsored retirement plan, she is entitled to take the full $2,000 deduction. Her level of adjusted gross income is not of any concern because she is not considered an active participant.

Example # 3: Avery and Glenda are a married couple with $43,800 of combined adjusted gross income. Both have salaries of $20,000 plus other joint income of $3,800. Glenda is an active participant in her employer's money purchase pension plan.

How much can Avery contribute to his IRA for 1997?         $2,000 
How much can Glenda contribute to her IRA for 1997?      $2,000 
How much can Avery deduct on his tax return for 1997?    $1,240 
How much can Glenda deduct on her tax return for 1997? $1,240 

Avery and Glenda, or their tax preparer, must apply the formula as discussed above to determine the nondeductible and deductible amounts.

(50,000-43,800) $10,000 = 62% Deductible Amount

Avery's IRA Account: $2,000 x .62 = $1,240 deductible portion and $760 is the nondeductible portion. 

Glenda's IRA Account: $2,000 x .62 = $1,240 deductible portion and $760 is the nondeductible portion.

When Avery and Glenda file their joint income tax return, they will be permitted to take a total deduction of $2,480 for their IRA contributions. NOTE: SEPARATE CALCULATIONS ARE TO BE MADE FOR EACH SPOUSE.

Example # 4: Gary and Rita are married and Gary is an active participant. Rita does not have any earned income. Their adjusted gross income is $38,700 for tax year 1997.

How much can Gary and Rita contribute to their spousal IRA accounts when added together for 1997?

$4,000 

What is the maximum contribution that can be made to either Gary's or Rita's IRA account for 1997? 

$2,000 

How much can Gary and Rita deduct on their tax return for 1997?

$4,000 

Even though Gary is considered an active participant, this couple is entitled to a full IRA deduction because their adjusted gross income does not exceed the threshold level of $40,000.

For more information
Refer to IRA Publication 590 or consult with your tax advisor.

 

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