As I mentioned in an earlier BUZZ installment, a recent report by the Treasury Inspector General for Tax Administration (TIGTA) titled "A Service-wide Strategy Is Needed to Address Growing Noncompliance With Individual Retirement Account Contribution and Distribution Requirements" (2010-40-043) indicates that there is widespread noncompliance regarding Individual Retirement Accounts (IRA).
According to the report -
“TIGTA found that 295,141 individuals made more than $1.5 billion in excess contributions to their IRAs in 2006 and 2007, resulting in an estimated loss of $94 million in excise tax and $17 million in income tax. In addition, TIGTA found that 255,498 individuals did not take the required minimum distributions totaling $348 million during that time, resulting in an estimated tax revenue loss of $174 million.”
As with other areas of noncompliance many of the errors result from confusion and misunderstanding of the rules rather than intentional fraud. What follows is the beginning of a week-long series of posts explaining the various IRA rules.
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An Individual Retirement Account is an account that lets you save money for retirement. The earnings on an IRA accrue tax-free at least until you take money out of the account, and possibly forever. Your contribution to an IRA may be tax deductible, and your withdrawals from an IRA may be partially or totally tax free.
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There are two types of Individual Retirement Account – the “traditional” IRA and the ROTH IRA. While anyone can have a “traditional” IRA the ability to open, or convert an existing traditional IRA to, a ROTH, and the amount of contribution allowed, is based on one’s “modified” Adjusted Gross Income (MAGI).
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According to the report -
“TIGTA found that 295,141 individuals made more than $1.5 billion in excess contributions to their IRAs in 2006 and 2007, resulting in an estimated loss of $94 million in excise tax and $17 million in income tax. In addition, TIGTA found that 255,498 individuals did not take the required minimum distributions totaling $348 million during that time, resulting in an estimated tax revenue loss of $174 million.”
As with other areas of noncompliance many of the errors result from confusion and misunderstanding of the rules rather than intentional fraud. What follows is the beginning of a week-long series of posts explaining the various IRA rules.
.
An Individual Retirement Account is an account that lets you save money for retirement. The earnings on an IRA accrue tax-free at least until you take money out of the account, and possibly forever. Your contribution to an IRA may be tax deductible, and your withdrawals from an IRA may be partially or totally tax free.
.
There are two types of Individual Retirement Account – the “traditional” IRA and the ROTH IRA. While anyone can have a “traditional” IRA the ability to open, or convert an existing traditional IRA to, a ROTH, and the amount of contribution allowed, is based on one’s “modified” Adjusted Gross Income (MAGI).
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You must have “earned income” – salary and wages reported on a Form W-2 or “net earnings from self-employment” – in order to contribute to an IRA.
For IRA purposes net earnings from self-employment is the bottom line on Schedule C – or Form K-1 if from a partnership – less the above-the-line deductions for contributions to a retirement plan, like a SEP or Keogh, and one-half of self-employment taxes. If you have more than one source of self-employment income you would net the combined income and losses. If your self-employed activities result in a net loss this does not reduce your other earned income. With a W-2 of $4,000 and net Sch C losses of $500 you could contribute $4,000 to an IRA.
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For 2010 the maximum IRA contribution is the lesser of $5,000 or earned income, with an additional $1,000 contribution allowed for taxpayers who will be age 50 or older at the end of the year. If a person only has $4,000 in earned income the maximum IRA contribution is $4,000.
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The maximum contribution applies to both the ROTH and traditional IRA combined. You can have a ROTH IRA and a traditional IRA – but the combined total contributions to both are subject to the $5,000, $6,000 or earned income annual limitation.
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For IRA purposes net earnings from self-employment is the bottom line on Schedule C – or Form K-1 if from a partnership – less the above-the-line deductions for contributions to a retirement plan, like a SEP or Keogh, and one-half of self-employment taxes. If you have more than one source of self-employment income you would net the combined income and losses. If your self-employed activities result in a net loss this does not reduce your other earned income. With a W-2 of $4,000 and net Sch C losses of $500 you could contribute $4,000 to an IRA.
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For 2010 the maximum IRA contribution is the lesser of $5,000 or earned income, with an additional $1,000 contribution allowed for taxpayers who will be age 50 or older at the end of the year. If a person only has $4,000 in earned income the maximum IRA contribution is $4,000.
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The maximum contribution applies to both the ROTH and traditional IRA combined. You can have a ROTH IRA and a traditional IRA – but the combined total contributions to both are subject to the $5,000, $6,000 or earned income annual limitation.
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A non-working spouse can open and contribute to an IRA as long as the other spouse has earned income. The combined contributions of working and non-working spouses are limited to the working spouse’s earned income.
If the working spouse earns only $9,000 for the year the maximum contribution that can be made to the IRA accounts of both spouses is $9,000, allocated as the couple sees fit. Each can contribute $4,500 to their separate accounts, the working spouse can contribute $5,000 and the non-working spouse $4,000, or the working spouse can contribute $4,000 and the non-working spouse $5,000. If the working spouse is age 50 or older he/she can contribute $6,000 and the non-working spouse $3,000.
A contribution to an individual’s IRA cannot be made once the individual has passed away. Jack makes a contribution to his IRA for 2010 in January of 2010. He goes to his final audit in March. This contribution is OK, provided he had sufficient earned income prior to passing. However, Jack’s Executor cannot make a contribution to Jack’s IRA for 2010, based on eligible earned income prior to death, in June.
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You will be charged a 6% penalty if you contribute more than the maximum amount allowed to an IRA. To avoid the penalty you must withdraw the excess amount, plus any earnings on this amount, by the statutory due date, including extensions, of the return for the year the excess contributions were made. If you make an excess contribution for 2009 in 2010 you can re-allocate the excess amount to your 2010 contribution.
You cannot borrow money from your IRA, like you can from a 401(k), sell property or investments to your IRA, use your IRA as security for a loan, or use IRA monies to purchase an item for personal use.
Tomorrow – History of the IRA . . . . .
TTFN
If the working spouse earns only $9,000 for the year the maximum contribution that can be made to the IRA accounts of both spouses is $9,000, allocated as the couple sees fit. Each can contribute $4,500 to their separate accounts, the working spouse can contribute $5,000 and the non-working spouse $4,000, or the working spouse can contribute $4,000 and the non-working spouse $5,000. If the working spouse is age 50 or older he/she can contribute $6,000 and the non-working spouse $3,000.
A contribution to an individual’s IRA cannot be made once the individual has passed away. Jack makes a contribution to his IRA for 2010 in January of 2010. He goes to his final audit in March. This contribution is OK, provided he had sufficient earned income prior to passing. However, Jack’s Executor cannot make a contribution to Jack’s IRA for 2010, based on eligible earned income prior to death, in June.
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You will be charged a 6% penalty if you contribute more than the maximum amount allowed to an IRA. To avoid the penalty you must withdraw the excess amount, plus any earnings on this amount, by the statutory due date, including extensions, of the return for the year the excess contributions were made. If you make an excess contribution for 2009 in 2010 you can re-allocate the excess amount to your 2010 contribution.
You cannot borrow money from your IRA, like you can from a 401(k), sell property or investments to your IRA, use your IRA as security for a loan, or use IRA monies to purchase an item for personal use.
Tomorrow – History of the IRA . . . . .
TTFN
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