How Much Can I Deduct?

Generally, you can deduct the lesser of:

1. The contributions to your traditional IRA for the year, or
2. The general limit (or the spousal IRA limit, if applicable) explained earlier under How Much Can Be Contributed?

However, if you or your spouse were covered by an employer retirement plan, you may not be able to deduct this amount. See Limit if Covered by Employer Plan, later.

Trustees' fees. Trustees' administrative fees that are billed separately and paid in connection with your traditional IRA are not deductible as IRA contributions. However, they are deductible (if they are ordinary and necessary) as a miscellaneous itemized deduction on Schedule A (Form 1040). The deduction is subject to the 2%-of-adjusted-gross-income limit.

Brokers' commissions. These commissions are part of your IRA contribution and are not deductible as a miscellaneous itemized deduction on Schedule A (Form 1040).

Full deduction. If neither you nor your spouse were covered for any part of the year by an employer retirement plan, you can take a deduction for total contributions to one or more of your traditional IRAs of up to the lesser of:

1. $2,000, or
2. 100% of your compensation.

This limit is reduced by any contributions made to a 501(c)(18) plan on your behalf.

Spousal IRA. In the case of a married couple with unequal compensation who file a joint return, the deduction for contributions to the traditional IRA of the spouse with less compensation is limited to the lesser of:

1. $2,000, or
2. The total compensation includible in the gross income of both spouses for the year reduced by the following two amounts.
   1. The IRA deduction for the year of the spouse with the greater compensation.
   2. Any contributions for the year to a Roth IRA on behalf of the spouse with the greater compensation.

This limit is reduced by any contributions to a section 501(c)(18) plan on behalf of the spouse with less compensation.

Note. If you were divorced or legally separated (and did not remarry) before the end of the year, you cannot deduct any contributions to your spouse's IRA. After a divorce or legal separation, you can deduct only the contributions to your own IRA and your deductions are subject to the rules for single individuals.

Covered by an employer retirement plan. If you or your spouse were covered by an employer retirement plan at any time during the year for which contributions were made, your deduction may be further limited. This is discussed later under Limit if Covered by Employer Plan. Limits on the amount you can deduct do not affect the amount that can be contributed.

Form 5498. You should receive by June 1, 2001, Form 5498 (or a similar statement) from the sponsor of your IRA, showing all the contributions made to your IRA for 2000.

Are You Covered by an Employer Plan?

The Form W-2 you receive from your employer has a box used to indicate whether you were covered for the year. The "Pension Plan" box should be checked if you were covered.

Reservists and volunteer firefighters should also see Situations in Which You Are Not Covered, later.

If you are not certain whether you were covered by your employer's retirement plan, you should ask your employer.

Judges. For purposes of the IRA deduction, federal judges are covered by an employer plan.

Can I Take an IRA Deduction?

For Which Year(s) Are You Covered?

Special rules apply to determine the tax years for which you are covered by an employer plan. These rules differ depending on whether the plan is a defined contribution plan or a defined benefit plan.

Tax year. Your tax year is the annual accounting period you use to keep records and report income and expenses on your income tax return. For most people, the tax year is the calendar year.

Defined contribution plan. A defined contribution plan is a plan that provides for a separate account for each person covered by the plan. In a defined contribution plan, the amount to be contributed to each participant's account is spelled out in the plan. The level of benefits actually provided to a participant depends on the total amount contributed to that participant's account and any earnings on those contributions. Types of defined contribution plans include profit-sharing plans, stock bonus plans, and money purchase pension plans.

Generally, you are covered by a defined contribution plan for a tax year if amounts are contributed or allocated to your account for the plan year that ends with or within that tax year. See Situations in Which You Are Not Covered, later.

Example. Company A has a money purchase pension plan. Its plan year is from July 1 to June 30. The plan provides that contributions must be allocated as of June 30. Bob, an employee, leaves Company A on December 30, 1999. The contribution for the plan year ending on June 30, 2000, is made February 15, 2001. Because an amount is contributed to Bob's account for the plan year, Bob is covered by the plan for his 2000 tax year.

No vested interest. If an amount is allocated to your account for a plan year, you are covered by that plan even if you have no vested interest in (legal right to) the account.

Defined benefit plan. A defined benefit plan is any plan that is not a defined contribution plan. In a defined benefit plan, the level of benefits to be provided to each participant is spelled out in the plan. The plan administrator figures the amount needed to provide those benefits and those amounts are contributed to the plan. Defined benefit plans include pension plans and annuity plans.

If you are eligible to participate in your employer's defined benefit plan for the plan year that ends within your tax year, you are covered by the plan. This rule applies even if you:

• Declined to participate in the plan,
• Did not make a required contribution, or
• Did not perform the minimum service required to accrue a benefit for the year.

Example. Nick, an employee of Company B, is eligible to participate in Company B's defined benefit plan, which has a July 1 to June 30 plan year. Nick leaves Company B on December 30, 1999. Since Nick is eligible to participate in the plan for its year ending June 30, 2000, he is covered by the plan for his 2000 tax year.

No vested interest. If you accrue a benefit for a plan year, you are covered by that plan even if you have no vested interest in (legal right to) the accrual.

Situations in Which You Are Not Covered

Unless you are covered by another employer plan, you are not covered by an employer plan if you are in one of the situations described below.

Social security or railroad retirement. Coverage under social security or railroad retirement is not coverage under an employer retirement plan.

Benefits from previous employer's plan. If you receive retirement benefits from a previous employer's plan, you are not covered by that plan.

Reservists. If the only reason you participate in a plan is because you are a member of a reserve unit of the armed forces, you may not be covered by the plan. You are not covered by the plan if both of the following conditions are met.

1. The plan you participate in is established for its employees by:
   1. The United States,
   2. A state or political subdivision of a state, or
   3. An instrumentality of either (a) or (b) above.
2. You did not serve more than 90 days on active duty during the year (not counting duty for training).

Volunteer firefighters. If the only reason you participate in a plan is because you are a volunteer firefighter, you may not be covered by the plan. You are not covered by the plan if both of the following conditions are met.

1. The plan you participate in is established for its employees by:
   1. The United States,
   2. A state or political subdivision of a state, or
   3. An instrumentality of either (a) or (b) above.
2. Your accrued retirement benefits at the beginning of the year will not provide more than $1,800 per year at retirement.

Limit If Covered By Employer Plan

As discussed earlier, the deduction you can take for contributions made to your traditional IRA depends on whether you or your spouse were covered for any part of the year by an employer retirement plan. Your deduction is also affected by how much income you had and by your filing status. Your deduction may also be affected by social security benefits you received.

Reduced or no deduction. If either you or your spouse were 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.

Your deduction begins to decrease (phase out) when your income rises above a certain amount and is eliminated altogether when it reaches a higher amount. These amounts vary depending on your filing status.

To determine if your deduction is subject to the phaseout, you must determine your modified adjusted gross income (AGI) and your filing status, as explained under Deduction Phaseout. Once you have determined your modified AGI and your filing status, you can use Table 1.1 to determine if the phaseout applies.

Social Security Recipients

Instead of using Table 1.1 and the Worksheet For Reduced IRA Deduction, later, complete the worksheets in Appendix B of this publication if, for the year, all of the following apply.

• You received social security benefits.
• You received taxable compensation.
• Contributions were made to your traditional IRA.
• You or your spouse was covered by an employer retirement plan.

Use the worksheets in Appendix B to figure your IRA deduction, your nondeductible contribution, and the taxable portion, if any, of your social security benefits. Appendix B includes an example with filled-in worksheets to assist you.

Deduction Phaseout

The amount of any reduction in the limit on your IRA deduction (phaseout) depends on whether you or your spouse were covered by an employer retirement plan.

If you were covered. If you were covered by an employer retirement plan and you did not receive any social security retirement benefits, your IRA deduction may be reduced or eliminated entirely depending on your filing status and modified AGI, as shown in Table A, below.

*See Lived apart from spouse under Filing status, later.

For 2001, if you are covered by a retirement plan at work, your IRA deduction will not be reduced (phased out) unless your modified AGI is between:

If your spouse is covered. If you are not covered by an employer retirement plan, but your spouse is, and you did not receive any social security benefits, your IRA deduction may be reduced or eliminated entirely depending on your filing status and modified AGI as shown in Table B next.

*See Lived apart from spouse below.

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 Publication 501, Exemptions, Standard Deduction, and Filing Information.

Lived apart from spouse. If you did not live with your spouse at any time during the year and you file a separate return, your filing status, for this purpose, is single.

Modified adjusted gross income (AGI). How you figure your modified AGI depends on whether you are filing Form 1040 or Form 1040A. If you made contributions to your IRA for 2000 and received a distribution from your IRA in 2000, see Both contributions for 2000 and distributions in 2000, later.

Do not assume that your modified AGI is the same as your compensation. Your modified AGI may include income in addition to your compensation such as interest, dividends, and income from IRA distributions.

Form 1040. If you file Form 1040, refigure the amount on the page 1 "adjusted gross income" line without taking into account any of the following amounts.

• IRA deduction.
• Student loan interest deduction.
• Foreign earned income exclusion.
• Foreign housing exclusion or deduction.
• Exclusion of qualified bond interest shown on Form 8815.
• Exclusion of employer-paid adoption expenses shown on Form 8839.

This is your modified AGI.

Form 1040A. If you file Form 1040A, refigure the amount on the page 1 "adjusted gross income" line without taking into account any of the following amounts.

• IRA deduction.
• Student loan interest deduction.
• Exclusion of qualified bond interest shown on Form 8815.
• Exclusion of employer-paid adoption expenses shown on Form 8839.

This is your modified AGI.

Income from IRA distributions. If you received distributions in 2000 from one or more traditional IRAs and your traditional IRAs include only deductible contributions, the distributions are fully taxable.

Both contributions for 2000 and distributions in 2000. If all three of the following occurred, any IRA distributions you received in 2000 may be partly tax free and partly taxable.

1. You received distributions in 2000 from one or more traditional IRAs - AND -
2. You made contributions to a traditional IRA for 2000 - AND -
3. Some of those contributions may be nondeductible contributions depending on whether your IRA deduction for 2000 is reduced.

If all three of the above occurred, you must figure the taxable part of the traditional IRA distribution before you can figure your modified AGI. To do this, you can use the Worksheet To Figure Taxable Part of Distribution.

If at least one of the above did not occur, figure your modified AGI as explained earlier under either Form 1040 or Form 1040A.

Using the worksheet. Form 8606 and the related instructions may be helpful when using this worksheet.

When used in the following worksheet the term outstanding rollover refers to an amount distributed from a traditional IRA as part of a rollover that, as of December 31, 2000, had not yet been reinvested into another traditional IRA.

Note. If the amount on line 5 of this worksheet includes an amount converted to a Roth IRA by 12/31/00, you must determine the percentage of the distribution allocable to the conversion. To figure the percentage, divide the amount converted (from line 14c of Form 8606) by the total distributions shown on line 5. To figure the amounts to include on line 10 of this worksheet and on line 16, Part II of Form 8606, multiply line 9 of the worksheet by the percentage you figured.

How To Figure Your Reduced IRA Deduction

If you or your spouse is covered by an employer retirement plan and you did not receive any social security benefits, you can figure your reduced IRA deduction by using the Worksheet for Reduced IRA Deduction, that follows. The instructions for both Form 1040 and Form 1040A include similar worksheets that you can use instead of the worksheet in this publication.

If you or your spouse is covered by an employer retirement plan, and you did receive any social security benefits, see Social Security Recipients, earlier.

Note. If you were married and both you and your spouse contributed to IRAs, figure your deduction and your spouse's deduction separately.

Note. If line 2 is equal to or more than the
   amount on line 1, STOP HERE. Your IRA
   contributions are not deductible. See Non-
   deductible Contributions.

Reporting Deductible Contributions

If you file Form 1040, enter your IRA deductions on line 23 of that form. If you file Form 1040A, enter your IRA deductions on line 16 of that form. You cannot deduct IRA contributions on Form 1040EZ.

Self-employed. If you are self-employed (a sole proprietor or partner) and have a SEP-IRA or a SIMPLE IRA, enter your deduction for allowable plan contributions on line 29, Form 1040.

Nondeductible Contributions

Although your deduction for IRA contributions may be reduced or eliminated, contributions can be made to your IRA of up to the general limit ($2,000 or 100% of compensation, whichever is less) or the spousal IRA limit (whichever applies). The difference between your total permitted contributions and your IRA deduction, if any, is your nondeductible contribution.

Example. Sonny Martin is single. In 2000, he is covered by a retirement plan at work. His salary is $52,312. His modified adjusted gross income (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 above $42,000, he cannot deduct his $2,000 IRA contribution. However, he designates this contribution as a nondeductible contribution by reporting it on his tax return as explained later under Reporting Nondeductible Contributions.

Designating contributions as nondeductible. To designate contributions as nondeductible, you must file Form 8606. (See the filled-in Forms 8606 in Appendix D.)

You do not have to designate a contribution as nondeductible until you file your tax return. When you file, you can even designate otherwise deductible contributions as nondeductible contributions.

Tax on earnings on nondeductible contributions. As long as contributions are within the contribution limits, none of the earnings or gains on those contributions (deductible or nondeductible) will be taxed until they are distributed.

Cost basis. You will have a cost basis in your IRA if there are nondeductible contributions. Your cost basis is the sum of the nondeductible contributions to your IRA minus any withdrawals or distributions of nondeductible contributions.

Generally, distributions from any of your traditional IRAs will include both taxable and nontaxable (cost basis) amounts. See Are Distributions Taxable?, later, for more information.

Recordkeeping. There is a recordkeeping worksheet, Appendix A, Summary Record of Traditional IRA(s) for 2000, that you can use to keep records of deductible and nondeductible IRA contributions.

You must file Form 8606 to report nondeductible contributions even if you do not have to file a tax return for the year.

Failure to report nondeductible contributions. If you do not report nondeductible contributions, all of the contributions to your traditional IRA will be treated as deductible. All distributions from your IRA 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.

Examples -- Worksheet for Reduced IRA Deduction

The following examples illustrate the use of the IRA deduction worksheet shown earlier under How To Figure Your Reduced IRA Deduction.

Example 1. For 2000, Tom and Betty Smith file a joint return on Form 1040. They both work and Tom is covered by his employer's retirement plan. Tom's salary is $40,000 and Betty's is $16,555. They each have a traditional IRA and their combined modified AGI, which includes $2,000 interest and dividend income, is $58,555. Since their modified AGI is between $52,000 and $62,000 and Tom is covered by an employer plan, Tom is subject to the deduction phaseout discussed earlier under Limit If Covered By Employer Plan.

For 2000, Tom contributed $2,000 to his IRA and Betty contributed $2,000 to hers. Even though they file a joint return, they must use separate worksheets to figure the IRA deduction for each of them.

Tom can take a deduction of only $690. He must treat $1,310 ($2,000 minus $690) of his contributions as nondeductible.

He can choose to treat the $690 as either deductible or nondeductible contributions. He can either leave the $1,310 of nondeductible contributions in his IRA or withdraw them by April 16, 2001. He decides to treat the $690 as deductible contributions and leave the $1,310 of nondeductible contributions in his IRA.

Using the Worksheet for Reduced IRA Deduction, Tom figures his deductible and nondeductible amounts as follows:

Note. If line 2 is equal to or more than the
   amount on line 1, STOP HERE. Your IRA
   contributions are not deductible. See Non-
   deductible Contributions.

Betty figures her IRA deduction as follows. Betty can treat all or part of her contributions as either deductible or nondeductible. This is because her $2,000 contribution for 2000 is not subject to the deduction phaseout discussed earlier under Limit If Covered By Employer Plan. She does not need to use the Worksheet for Reduced IRA Deduction since their modified AGI is not within the phaseout range that applies. Betty decides to treat her $2,000 IRA contributions as deductible.

The IRA deductions of $690 and $2,000 on the joint return for Tom and Betty total $2,690.

Example 2. Assume the same facts as in Example 1, except that Tom contributed $2,000 to his Roth IRA and $2,000 to a traditional IRA for Betty (a spousal IRA) because Betty had no compensation for the year and did not contribute to an IRA. Also, their modified AGI, because of capital gains from sales of stock, increased to $156,555. Betty figures her IRA deduction as follows:

Note. If line 2 is equal to or more than the
   amount on line 1, STOP HERE. Your IRA
   contributions are not deductible. See Non-
   deductible Contributions.

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