In this chapter the original IRA (sometimes called an ordinary or regular IRA) is referred to as the "traditional IRA." Two advantages of a traditional IRA are that you may be able to deduct some or all of your contributions to it, depending on your circumstances, and, generally, amounts in your IRA, including earnings and gains, are not taxed until they are distributed.

What Is a Traditional IRA?

A traditional IRA is any IRA that is not a Roth IRA, a SIMPLE IRA, or an education IRA.

Who Can Set Up a Traditional IRA?

You can set up and make contributions to a traditional IRA if you (or if you file a joint return, your spouse) received taxable compensation during the year and you were not age 70 1/2 by the end of the year.

What is compensation? Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans). Compensation also includes commissions and taxable alimony and separate maintenance payments.

Self-employment income. If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your personal services are a material income-producing factor) reduced by the deduction for contributions made on your behalf to retirement plans and the deduction allowed for one-half of your self-employment taxes.

Compensation includes earnings from self-employment even if they are not subject to self-employment tax because of your religious beliefs. See Publication 533, Self-Employment Tax, for more information.

What is not compensation? Compensation does not include any of the following items.

• Earnings and profits from property, such as rental income, interest income, and dividend income.
• Pension or annuity income.
• Deferred compensation received (compensation payments postponed from a past year).
• Income from a partnership for which you do not provide services that are a material income-producing factor.
• Any amounts you exclude from income, such as foreign earned income and housing costs.

When and How Can a Traditional IRA Be Set Up?

You can set up a traditional IRA at any time. However, the time for making contributions for any year is limited. See When Can Contributions Be Made?, later.

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 IRA must meet Internal Revenue Code requirements.

Your traditional 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.

Inherited IRAs. If you inherit a traditional IRA, that IRA becomes subject to special rules.

If you are a surviving spouse, you can elect to treat a traditional IRA inherited from your spouse as your own.

For more information, see the discussions of inherited IRAs under How Much Can Be Contributed? and under Rollover From One IRA Into Another, later.

How Much Can Be Contributed?

Contributions to a traditional IRA must be in the form of money (cash, check, or money order). Property cannot be contributed.

There are limits and other rules that affect the amount that can be contributed and the amount you can deduct. These rules are explained next.

General limit. The most that can be contributed for any year to your traditional 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 that can be contributed regardless of whether the contributions are to one or more traditional IRAs or whether all or part of the contributions are nondeductible. (See Nondeductible Contributions, later.)

Example 1. Betty, who is single, earns $24,000 in 1999. Her IRA contributions for 1999 are limited to $2,000.

Example 2. John, a college student working part time, earns $1,500 in 1999. His IRA contributions for 1999 are limited to $1,500, the amount of his compensation.

Spousal IRA limit. If you file a joint return and your taxable compensation is less than that of your spouse, the most that can be contributed for the year to your IRA is the smaller of the following amounts:

1. $2,000, or
2. The total compensation includible in the gross income of both you and your spouse for the year, reduced by the following amounts.
   1. Your spouse's IRA contribution for the year.
   2. Any contribution for the year to a Roth IRA on behalf of your spouse.

This means that the total combined contributions that can be made for the year to your IRA and your spouse's IRA can be as much as $4,000.

Contributions to your traditional IRAs reduce the limit for contributions to Roth IRAs (see Roth IRAs, later).

Age 70 1/2 rule. Contributions cannot be made to your traditional IRA for the year in which you reach age 70 1/2 or any later year.

Community property laws. Except as just discussed, each spouse figures his or her limit separately, using his or her own compensation.

Contributions not required. You do not have to contribute to your traditional IRA for every tax year, even if you can.

Inherited IRAs. If you inherit a traditional IRA from your spouse, you can choose to treat it as your own by making contributions to it.

If, however, you inherit a traditional IRA and you are not the decedent's spouse, you cannot contribute to that IRA, because you cannot treat it as your own.

Trustees' fees. Trustees' administrative fees are not subject to the contribution limit. A trustee's administrative fees that are billed separately and paid in connection with your traditional IRA are deductible. 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 (see chapter 30).

Brokers' commissions. Brokers' commissions paid in connection with your traditional IRA are subject to the contribution limit. They are not deductible as a miscellaneous itemized deduction on Schedule A (Form 1040).

When Can Contributions Be Made?

Contributions can be made to your traditional IRA for a year at any time during the year or by the due date for filing your return for that year, not including extensions. For most people, this means that contributions for 1999 must be made by April 17, 2000.

Designating year for which contribution is made. If an amount is contributed to your traditional IRA between January 1 and April 17, tell the sponsor (the trustee or issuer) to which year (the current year or the previous year) the contribution applies. If you do not tell the sponsor which year it is for, the sponsor can assume, for reporting to IRS, that the contribution is for the current year (the year the sponsor received it).

Filing before a contribution is made. You can file your return claiming a traditional IRA contribution before the contribution is actually made. However, the contribution must be made by the due date of your return, not including extensions.

How Much Can I Deduct?

Generally, you can deduct the lesser of the contributions to your traditional IRA for the year or the general limit (or the spousal IRA limit, if it applies). However, if you or your spouse were covered by an employer retirement plan at any time during the year for which contributions were made, you may not be able to deduct all the contributions. Your deduction may be reduced or eliminated, depending on your filing status and the amount of your income, as discussed later under Deduction Limits. Any limit on the amount you can deduct does not affect the amount that can be contributed. See Nondeductible Contributions, later.

Are You Covered by an Employer Plan?

The Form W-2, Wage and Tax Statement, you receive from your employer has a box used to indicate whether you were covered for the year. The "Pension Plan" box should have a mark in it if you were covered.

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

18-1. Can You Take an IRA Deduction?

Employer plans. An employer retirement plan is one that an employer sets up for the benefit of its employees. For purposes of the traditional IRA deduction rules, an employer retirement plan is any of the following plans.

• A qualified pension, profit-sharing, stock bonus, money purchase pension, etc., plan (including Keogh plans).
• A 401(k) plan (generally an arrangement included in a profit-sharing or stock bonus plan that allows you to choose to either 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).
• 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(b) 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.
• A SIMPLE plan.

A qualified plan is one that meets the requirements of the Internal Revenue Code.

When Are You Covered?

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

Defined contribution plan. A defined contribution plan is a plan that provides for a separate account for each person covered by the plan. Types of defined contribution plans include profit-sharing plans, stock bonus plans, and money purchase pension plans.

Generally, you are considered covered by a defined contribution plan if amounts are contributed or allocated to your account for the plan year that ends within your tax year.

Defined benefit plan. A defined benefit plan is any plan that is not a defined contribution plan which includes pension plans and annuity plans.

If you are eligible (meet minimum age and years of service requirements) to participate in your employer's defined benefit plan for the plan year that ends within your tax year, you are considered covered by the plan. This rule applies even if you declined to be covered by the plan, you did not make a required contribution, or you did not perform the minimum service required to accrue a benefit for the year.

No vested interest. If an amount is allocated to your account, or 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 account or the accrual.

When Are You Not Covered?

You are not covered by an employer plan in the following situations.

Social security or railroad retirement. Coverage under social security or railroad retirement (Tier I and Tier II) does not count as coverage under an employer retirement plan.

Benefits from a previous employer's plan. 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.

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 considered covered by the plan. You are not considered 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 considered covered by the plan. You are not considered 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.

Social Security Recipients

Complete the worksheets in Appendix B of Publication 590 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 were covered by an employer retirement plan.

Use those worksheets to figure your IRA deduction and the taxable portion, if any, of your social security benefits.

Deduction Limits

As discussed under How Much Can I Deduct? earlier, the deduction you can take for contributions made to your traditional IRA depends on whether you or your spouse was 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, as explained later under Reduced or no deduction.

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 total contributions to one or more traditional IRAs of up to $2,000, or 100% of your compensation, whichever is less. 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 smaller of the following two amounts:

1. $2,000, or
2. The total compensation includible in the gross income of both you and your spouse for the year reduced by the following two amounts.
   1. Any deduction allowed for contributions to the traditional IRAs of the spouse with more compensation, and
   2. Any contributions for the year to a Roth IRA on behalf of your spouse.

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

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. The amounts vary depending on your filing status. See Table 18-1, Can I Take A Traditional IRA Deduction?, earlier.

To determine if your deduction is limited, you must determine your modified adjusted gross income (AGI) and your filing status as explained next.

Deduction Phaseout

If you are covered by an employer retirement plan, your IRA deduction is reduced or eliminated depending on your filing status and modified AGI as shown in Table 1.

	Table 1
If your filing status is:	Your deduction is reduced if your modified AGI is between:	Your deduction is eliminated if your modified AGI is:
Single, or Head of household	$31,000 and $41,000	$41,000 or more
Married--joint return, or Qualifying widow(er)	$51,000 and $61,000	$61,000 or more
Married-- separate return	$-0- and $10,000	$10,000 or more

See Married filing separately exception, under Filing status, later.

For 2000, 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:

• $32,000 (a $1,000 increase) and $42,000 for a single individual (or head of household),
• $52,000 (a $1,000 increase) and $62,000 for a married couple (or a qualifying widow(er)) filing a joint return, or
• $-0- (no increase) and $10,000 for a married individual filing a separate return.

If you are not covered, but your spouse is. If you are not covered by an employer retirement plan, but your spouse is, your IRA deduction is reduced or eliminated depending on your filing status and modified AGI as shown in Table 2.

	Table 2
If your filing status is:	Your deduction is reduced if your modified AGI is between:	Your deduction is eliminated if your modified AGI is:
Married--joint return, or Qualifying widow(er)	$150,000 and $160,000	$160,000 or more
Married-- separate return	$-0- and $10,000	$10,000 or more

See Married filing separately exception, under Filing status, next. Also, see Table 18-1 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, you are not treated as married and your filing status is considered, for this purpose, as single.

Modified adjusted gross income (AGI). How you figure your modified AGI depends on whether you are filing Form 1040 or Form 1040A.

Form 1040. If you file Form 1040, figure the amount on page 1 "adjusted gross income" line without taking into account any:

• 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 Interest From Series EE and I U.S. Savings Bonds Issued After 1989 (For Filers With Qualified Higher Education Expenses), or
• Exclusion of employer-paid adoption expenses shown on Form 8839, Qualified Adoption Expenses.

This is your modified AGI.

Form 1040A. If you file Form 1040A, figure the amount on page 1 "adjusted gross income" line without taking into account any:

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

This is your modified AGI.

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), such as interest, dividends, and taxable IRA distributions.

How to figure your reduced IRA deduction. You can figure your reduced IRA deduction for either Form 1040 or Form 1040A by using the worksheets in chapter 1 of Publication 590. Also, the instructions for these tax forms include similar worksheets.

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 contributions to your own IRA, and your deductions are subject to the rules for single individuals.

Reporting Deductible Contributions

You do not have to itemize deductions to claim your deduction for IRA contributions. If you file Form 1040, deduct IRA contributions for 1999 on line 23. If you file Form 1040A, deduct contributions on line 15. Form 1040EZ does not provide for IRA deductions.

Form 5498. You should receive by June 1, 2000, Form 5498, Individual Retirement Arrangement Information, or similar statement from plan sponsors, showing all the contributions made to your IRA for 1999.

Nondeductible Contributions

Although your deduction for IRA contributions may be reduced or eliminated (see Deduction Limits, earlier), a contribution can be made to your IRA of up to $2,000 or 100% of compensation, whichever is less. For a spousal IRA, see Spousal IRA limit, under How Much Can Be Contributed?, earlier. The difference between your total permitted contributions and your total deductible contributions, if any, is your nondeductible contribution.

Example. Sonny Jones is single. In 1999, 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 $41,000, he cannot deduct his $2,000 IRA contribution. However, he can 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 under Tax-free withdrawal of contributions under When Can I Withdraw or Use IRA Assets?, later.

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. See When Can I Withdraw or Use IRA Assets?, later.

Cost basis. You will have a cost basis in your IRA if there are nondeductible contributions. Your basis is the sum of the nondeductible contributions to your IRA less any distributions of those amounts. When you withdraw (or receive distributions of) these amounts, as discussed later under Are Distributions Taxable?, you can do so tax free.

Reporting Nondeductible Contributions

You must report nondeductible contributions, but 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.

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

Form 8606. You must file Form 8606 if either of the following applies.

• You made nondeductible contributions to your traditional IRA for 1999, or
• You received IRA distributions in 1999 and you have ever made nondeductible contributions to any of your traditional IRAs.

Also, see Roth IRAs, later.

Contribution and distribution in the same year. 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 1 of Publication 590 to figure the taxable portion of the distribution. Then you can figure the amount of nondeductible contributions to report on Form 8606.

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. 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.

Can I Move Retirement Plan Assets?

Traditional IRA rules permit you to transfer, tax free, assets (money or property) from other retirement plans (including traditional IRAs) to a traditional IRA. The rules permit the following kinds of transfers.

• Transfers from one trustee to another.
• Rollovers.
• Transfers incident to a divorce.

Transfers to Roth IRAs. Under certain conditions, you can move assets from a traditional IRA to a Roth IRA. See Can I Move Amounts Into a Roth IRA?, under Roth IRAs, later.

Trustee-to-Trustee Transfer

A transfer of funds in your traditional IRA from one trustee directly to another, either at your request or at the trustee's request, is not a rollover. Because there is no distribution to you, the transfer is tax free. Because it is not a rollover, it is not affected by the 1-year waiting period that is required between rollovers, discussed later under Rollover From One IRA Into Another. For information about direct transfers to IRAs from retirement plans other than IRAs, see Publication 590.

Rollovers

Generally, 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.

Kinds of rollovers to an IRA. There are two kinds of rollover contributions to a traditional IRA. In one, you put amounts you receive from one traditional IRA into another traditional IRA. In the other, you put amounts you receive from an employer's qualified retirement plan for its employees into a traditional IRA.

Treatment of rollovers. You cannot deduct a rollover contribution, but you must report the rollover distribution on your tax return as discussed later under Reporting rollovers from IRAs, and under Reporting rollovers from employer plans.

Time limit for making a rollover contribution. You must make the rollover contribution by the 60th day after the day you receive the distribution from your traditional IRA or your employer's plan.

Extension of rollover period. If an amount distributed to you from a traditional 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 rollover period. For more information, get Publication 590.

Rollover From One IRA Into Another

You can withdraw, tax free, all or part of the assets from one traditional IRA if you reinvest them within 60 days in another traditional IRA. Because this is a rollover, you cannot deduct the amount that you reinvest in the new IRA.

Waiting period between rollovers. You can take (receive) a distribution from a traditional IRA and make a rollover contribution (of all or part of the amount received) to another traditional IRA only once in any 1-year period. The 1-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.

Example. If you have two traditional IRAs, IRA-1 and IRA-2, and you roll over assets of IRA-1 into a new traditional IRA (IRA-3), you may also make a rollover from IRA-2 into IRA-3, or into any other traditional IRA, within 1 year after the rollover distribution from IRA-1. These are both allowable rollovers because you have not received more than one distribution from either IRA within 1 year. However, you cannot, within the 1-year period, again roll over the assets you rolled over into IRA-3 into any other traditional IRA.

Exception. There is an exception to this 1-year waiting period rule for distributions from certain failed financial institutions. Get Publication 590 for more information.

Partial rollovers. If you withdraw assets from a traditional IRA, you can roll over part of the withdrawal tax free into another traditional IRA and keep the rest of it. The amount you keep generally will be taxable (except for the part that is a return of nondeductible contributions) and may be subject to the 10% additional tax on premature distributions, discussed later under Premature Distributions (Early Withdrawals).

Required distributions. Amounts that must be distributed during a particular year under the required distribution rules (discussed later) are not eligible for rollover treatment.

Inherited IRAs. If you inherit a traditional IRA from your spouse, you generally can roll it over into a traditional IRA established for you.

Not inherited from spouse. If you inherit a traditional IRA from someone other than your spouse, you cannot roll it over or allow it to receive a rollover contribution. You must withdraw the IRA assets within a certain period. For more information, see Publication 590.

Reporting rollovers from IRAs. Report any rollover from one traditional IRA to another traditional IRA on lines 15a and 15b, Form 1040, or lines 10a and 10b, Form 1040A. Enter the total amount of the distribution on line 15a, Form 1040, or line 10a, Form 1040A. If the total amount on line 15a, Form 1040, or line 10a, Form 1040A, was rolled over, enter zero on line 15b, Form 1040, or line 10b, Form 1040A. Otherwise, enter the taxable portion of the part that was not rolled over on line 15b, Form 1040, or line 10b, Form 1040A.

Rollover From Employer's Plan Into an IRA

Special rules apply to distributions made from qualified employer plans that are rolled over or transferred to traditional IRAs. The rules primarily relate to requirements affecting rollovers, income tax withholding, and notices to recipients. See Publication 590 for more information.

Generally, if you receive an eligible rollover distribution from your (or your deceased spouse's) employer's qualified pension, profit-sharing or stock bonus plan, annuity plan, or tax-sheltered annuity plan (403(b) plan), you can roll over all or part of it into a traditional IRA.

Eligible rollover distribution. Generally, an eligible rollover distribution is the taxable part of any distribution of all or part of the balance to your credit in a qualified retirement plan except:

1. A required minimum distribution,
2. Hardship distributions from 401(k) plans and 403(b) plans, or
3. Any of a series of substantially equal periodic distributions paid at least once a year over:
   1. Your lifetime or life expectancy,
   2. The lifetimes or life expectancies of you and your beneficiary, or
   3. A period of 10 years or more.

The taxable parts of most other distributions are eligible rollover distributions. See Publication 575, Pension and Annuity Income, for additional exceptions.

Maximum rollover. The most that you can roll over is the taxable part of any eligible rollover distribution from your employer's qualified plan. The distribution you receive generally will be all taxable unless you have made nondeductible employee contributions to the plan.

Reporting rollovers from employer plans. To report a rollover from an employer retirement plan to a traditional IRA, use lines 16a and 16b, Form 1040, or lines 11a and 11b, Form 1040A. Do not use lines 15a or 15b, Form 1040, or lines 10a or 10b, Form 1040A.

For more information on rollovers, get Publication 590.

Transfers Incident to Divorce

If an interest in a traditional IRA is transferred from your spouse or former spouse to you by a divorce or separate maintenance decree or a written document related to such a decree, the interest in the IRA, starting from the date of the transfer, is treated as your IRA. The transfer is tax free. For detailed information, see Publication 590.

When Can I Withdraw or Use IRA Assets?

There are rules limiting the withdrawal and use of your IRA assets. Violation of the rules generally results in additional taxes in the year of violation. See Prohibited Transactions, Premature Distributions (Early Withdrawals), and Excess Accumulations (Insufficient Distributions), later.

Distributions (withdrawals)--general rule. If during a year you receive distributions from a traditional IRA, you must generally include them in your gross income for the year.

Age 59 1/2 rule. Generally, if you are under age 59 1/2 and you withdraw assets (money or other property) from your traditional IRA, you must pay a 10% additional tax. Withdrawals before you are age 59 1/2 are called premature distributions or early withdrawals. This tax is 10% of the part of the distribution that you have to include in gross income. It is in addition to any regular income tax on the amount you have to include in gross income. However, there are a number of exceptions to that rule.

Exceptions. There are several exceptions to the age 59 1/2 rule. You may qualify for an exception if you are in one of the following situations.

• You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
• The distributions are not more than the cost of your medical insurance.
• You are disabled.
• You are the beneficiary of a deceased IRA owner.
• You are receiving distributions in the form of an annuity.
• The distributions are not more than your qualified higher education expenses.
• You use the distributions to buy, build, or rebuild a first home.
• The distribution is of contributions returned before the due date of your tax return.
• The distribution is due to an IRS levy of the qualified plan.

Most of these exceptions are explained in Publication 590.

Note. Distributions that are timely and properly rolled over, as discussed earlier, are not subject to either regular income tax or the 10% additional tax. Certain withdrawals of excess contributions after the due date of your return are also tax free and not subject to the 10% additional tax (see Contributions returned before the due date, next).

Contributions returned before the due date. If you made IRA contributions for 1999, you can withdraw them tax free by the due date of your return. If you have an extension of time to file your return, you can withdraw them tax free by the extended due date. You can do this if both the following apply.

• You did not take a deduction for the contributions you withdraw.
• You also withdraw any interest or other income earned on the contributions.

You must include in income any earnings on the contributions you withdraw. Include the earnings in income for the year in which you made the withdrawn contributions.

Generally, except for any part of a withdrawal that is a return of nondeductible contributions (basis), any withdrawal of your contributions after the due date (or extended due date) of your return will be treated as a taxable distribution. Another exception is the return of an excess contribution as discussed under What Acts Result in Penalties?, later.

Premature distributions tax. The 10% additional tax on withdrawals made before you reach age 59 1/2 does not apply to these tax-free withdrawals of your contributions. However, your early withdrawal of interest or other income must be reported on Form 5329 and, unless the withdrawal qualifies as an exception to the age 59 1/2 rule, it will be subject to this tax.

Excess contributions tax. If any part of these contributions is an excess contribution for 1998, it is subject to a 6% excise tax. You will not have to pay the 6% tax if any 1998 excess contribution was withdrawn by April 15, 1999 (plus extensions), and if any 1999 excess contribution is withdrawn by April 17, 2000 (plus extensions). See Excess Contributions under What Acts Result in Penalties?, later.

When Must I Withdraw IRA Assets? (Required Distributions)

You cannot keep funds in your traditional IRA indefinitely. Eventually you must withdraw them. If you do not make any withdrawals, or if you do not withdraw enough, you may have to pay a 50% excise tax on the amount not withdrawn as required. See Excess Accumulations (Insufficient Distributions), later. The requirements for withdrawing IRA funds differ depending on whether you are the IRA owner or the beneficiary of a decedent's IRA.

IRA owners. If you are the owner of a traditional IRA, you must withdraw the entire balance in your IRA or start receiving periodic distributions from your IRA by April 1 of the year following the year in which you reach age 70 1/2. This date is referred to as the required beginning date.

Periodic distributions. If you choose to receive periodic distributions, you must receive at least a minimum amount for each year starting with the year you reach age 70 1/2 (your 70 1/2 year). If you do not (or did not) receive the minimum amount in your 70 1/2 year, then you must receive distributions for your 70 1/2 year that reach the minimum amount by April 1 of the next year.

Distributions after the required beginning date. The required minimum distribution for any year after your 70 1/2 year must be made by December 31 of that later year.

Beneficiaries. If you are the beneficiary of a decedent's traditional IRA, the requirements for withdrawals from that IRA depend on whether distributions that satisfy the minimum distributions requirement have begun.

More information. For more information, including how to figure your required minimum distribution each year and how to figure your required distribution if you are a beneficiary of a decedent's IRA, see Publication 590.

Are Distributions Taxable?

In general, include distributions from a traditional IRA in your gross income in the year you receive them.

Exceptions. Exceptions to this general rule are rollovers and tax-free withdrawals of contributions, discussed earlier, and the return of nondeductible contributions, discussed later under Distributions Fully or Partly Taxable.

Ordinary income. Distributions from traditional IRAs that you include in income are taxed as ordinary income.

No special treatment. In figuring your tax, you cannot use the special averaging or capital gain treatment that applies to lump-sum distributions from qualified employer plans.

Distributions Fully or Partly Taxable

Distributions from your traditional IRA may be fully or partly taxable, depending on whether your IRA includes any nondeductible contributions.

Fully taxable. If only deductible contributions were made to your traditional IRA (or IRAs, if you have more than one) since it was set up, you have no basis in your IRA. Because you have no basis in your IRA, any distributions are fully taxable when received. See Reporting taxable distributions on your return, later.

Partly taxable. If you made nondeductible contributions to any of your traditional IRAs, you have a cost basis (investment in the contract) equal to the amount of those contributions. These nondeductible contributions are not taxed when they are distributed to you. They are a return of your investment in your IRA.

Only the part of the distribution that represents nondeductible contributions (your cost basis) is tax free. If nondeductible contributions have been made, distributions consist partly of nondeductible contributions (basis) and partly of deductible contributions, earnings, and gains (if there are any). Until all of your basis has been distributed, each distribution is partly nontaxable and partly taxable.

Form 8606. You must complete Form 8606 and attach it to your return if you receive a distribution from a traditional IRA and have ever made nondeductible contributions to any of your traditional IRAs. Using the form, you will figure the nontaxable distributions for 1999, and your total IRA basis for 1999 and earlier years.

Note. If you are required to file Form 8606, but you are not required to file an income tax return, you still must file Form 8606. Send it to the IRS at the time and place you would otherwise file an income tax return.

Distributions reported on Form 1099-R. If you receive a distribution from your traditional IRA, you will receive Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, Etc., or a similar statement. IRA distributions are shown in boxes 1 and 2 of Form 1099-R. A number or letter code in box 7 tells you what type of distribution you received from your IRA.

Withholding. Federal income tax is withheld from distributions from traditional IRAs unless you choose not to have tax withheld. See chapter 5.

IRA distributions delivered outside the United States. 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 distributions from your traditional IRA.

Reporting taxable distributions on your return. Report fully taxable distributions, including taxable premature distributions, on line 15b, Form 1040 (no entry is required on line 15a), or line 10b, Form 1040A. If only part of the distribution is taxable, enter the total amount on line 15a, Form 1040, or line 10a, Form 1040A, and the taxable part on line 15b, Form 1040, or line 10b, Form 1040A. You cannot report distributions on Form 1040EZ.

What Acts Result in Penalties?

The tax advantages of using traditional 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 the following activities.

• Investing in collectibles.
• Making excess contributions.
• Making early withdrawals (taking premature distributions).
• Allowing excess amounts to accumulate (failing to make required withdrawals).

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 traditional IRA by you, your beneficiary, or any disqualified person.

Examples of disqualified persons include your fiduciary, and members of your family (spouse, ancestor, lineal descendent, and any spouse of a lineal descendent).

The following are examples of prohibited transactions with a traditional IRA.

• Borrowing money from it.
• Buying property for personal use (present or future) with IRA funds.
• Selling property to it.
• Receiving unreasonable compensation for managing it.
• Using it 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, the account stops being 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 traditional 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 have to pay the 10% additional tax on premature distributions, discussed later.

Taxes on prohibited transactions. If someone other than the owner or beneficiary of a traditional IRA engages in a prohibited transaction, that person may be liable for certain taxes. In general, there is a 15% tax on the amount of the prohibited transaction and a 100% additional tax if the transaction is not corrected.

More information. For more information on prohibited transactions, get Publication 590.

Investment in Collectibles

If your traditional 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, discussed later.

Collectibles. These 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. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion.

Excess Contributions

Generally, an excess contribution is the amount contributed to your traditional IRA(s) for the year that is more than the smaller of:

• Your taxable compensation for the year, or
• $2,000.

Tax on excess contributions. In general, if the excess contribution for a year and any earnings on it are not withdrawn by the date your return for the year is due (including extensions), you are subject to a 6% tax. You must pay the 6% tax each year on excess amounts that remain in your traditional IRA at the end of your tax year. The tax cannot be more than 6% of the value of your IRA as of the end of your tax year.

Excess contributions withdrawn by due date of return. You will not have to pay the 6% tax if you withdraw an excess contribution made during a tax year and you also withdraw interest or other income earned on the excess contribution by the date your return for that year is due, including extensions.

How to treat withdrawn contributions. Do not include in your gross income an excess contribution that you withdraw from your traditional IRA before your tax return is due if both the following conditions are met.

1. No deduction was allowed for the excess contribution.
2. You withdraw the interest or other income earned on the excess contribution.

How to treat withdrawn interest or other income. You must include in your gross income the interest or other income that was earned on the excess contribution. Report it on your return for the year in which the excess contribution was made. Your withdrawal of interest or other income may be subject to an additional 10% tax on early withdrawals, discussed later.

Excess contributions withdrawn after due date of return. In general, you must include all withdrawals from your traditional IRA in your gross income. However, if the total contributions (other than rollover contributions) for the year to your IRA are $2,000 or less and there were no employer contributions for the year, you can withdraw any excess contribution after the due date for filing your tax return for that year, including extensions. You do not include the withdrawn contribution in your gross income. This exclusion from income applies only to the part of the withdrawn excess contribution for which you did not take a deduction.

Premature Distributions (Early Withdrawals)

You must include premature distributions of taxable amounts from your traditional IRA in your gross income. Premature distributions (sometimes called early withdrawals or early distributions) are also subject to an additional 10% tax. See the discussion of Form 5329 under Reporting Additional Taxes, later, to figure and report the tax.

Premature distributions defined. Premature distributions are amounts you withdraw from your traditional IRA account or annuity before you are age 59 1/2.

Exceptions. There are several exceptions to the age 59 1/2 rule. You may qualify for an exception if you are in one of the following situations.

• You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
• The distributions are not more than the cost of your medical insurance.
• You are disabled.
• You are the beneficiary of a deceased IRA owner.
• You are receiving distributions in the form of an annuity.
• The distributions are not more than your qualified higher education expenses.
• You use the distributions to buy, build, or rebuild a first home.
• The distribution is of contributions returned before the due date of your tax return.
• The distribution is due to an IRS levy of the qualified plan.

Note. Distributions that are timely and properly rolled over, as discussed earlier, are not subject to either regular income tax or the 10% additional tax. Certain withdrawals of excess contributions after the due date of your return are also tax free and not subject to the 10% additional tax (see Excess contributions withdrawn after due date of return, earlier).

Additional tax. The additional tax on premature distributions is 10% of the amount of the premature distribution that you must include in your gross income. This tax is in addition to any regular income tax resulting from including the distribution in income.

Nondeductible contributions. The tax on premature distributions does not apply to the part of a distribution that represents a return of your nondeductible contributions (basis).

More information. For more information on premature distributions, see Publication 590.

Excess Accumulations (Insufficient Distributions)

You cannot keep amounts in your traditional IRA indefinitely. Generally, you must begin receiving distributions by April 1 of the year following the year in which you reach age 70 1/2 (your 70 1/2 year). The required minimum distribution for any year after your 70 1/2 year must be made by December 31 of that later year.

Tax on excess. If distributions are less than the required minimum distribution for the year, you may have to pay a 50% excise tax for that year on the amount not distributed as required.

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 by filing Form 5329.

Exemption from tax. If you are unable to make required distributions because you have a traditional IRA invested in a contract issued by an insurance company that is in state insurer delinquency proceedings, the 50% excise tax does not apply if the conditions and requirements of Revenue Procedure 92-10 are satisfied.

More information. For more information on excess accumulations, see Publication 590.

Reporting Additional Taxes

Generally, you must use Form 5329 to report the tax on excess contributions, premature (early) distributions, and excess accumulations.

Filing Form 1040. 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 53, Form 1040.

Note. If you have to file an individual income tax return and Form 5329, you must use Form 1040.

Not filing 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. Be sure to include your address on page 1 and your signature on page 2. Enclose, but do not attach, a check or money order payable to the United States Treasury for the tax you owe, as shown on Form 5329. Write your social security number and "1999 Form 5329" on your check or money order.

Form 5329 not required. You do not have to use Form 5329 if any of the following conditions exist.

• Distribution code 1 (early distribution) is shown in box 7 of Form 1099-R. Instead, multiply the taxable part of the distribution by 10% and enter the result on line 53 of Form 1040. Write "No" next to line 53 to indicate that you do not have to file Form 5329. However, if you owe this tax and also owe any other additional tax on a distribution, do not enter this 10% additional tax directly on your Form 1040. You must file Form 5329 to report your additional taxes.
• You qualify for an exception to the additional tax on early distributions. You need not report the exception if distribution code 2, 3, or 4 is shown in box 7 of Form 1099-R. However, if one of those codes is not shown, or the code shown is incorrect, you must file Form 5329 to report the exception.
• You properly rolled over all distributions you received during the year.

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