In this chapter the original IRA (sometimes called an ordinary or regular IRA) is referred to as a "traditional IRA." Two advantages of a traditional IRA are:

1. You may be able to deduct some or all of your contributions to it, depending on your circumstances, and,
2. 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 or a SIMPLE IRA.

Who Can Set Up a Traditional IRA?

You can set up and make contributions to a traditional IRA if:

1. You (or, if you file a joint return, your spouse) received taxable compensation during the year, and
2. 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, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans). Scholarship and fellowship payments are compensation for this purpose only if shown in box 1 of Form W-2. 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 total of:

1. The deduction for contributions made on your behalf to retirement plans, and
2. 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.

Kinds of traditional IRAs. Your traditional IRA can be an individual retirement account or annuity. It can be part of either a simplified employee pension (SEP) or an employer or employee association trust account.

How Much Can Be Contributed?

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

Community property laws. Except as discussed later under Spousal IRA limit, each spouse figures his or her limit separately, using his or her own compensation. This is the rule even in states with community property laws.

Brokers' commissions. Brokers' commissions paid in connection with your traditional IRA are subject to the contribution limit.

Trustees' fees. Trustees' administrative fees are not subject to the contribution limit.

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

General limit. The most that can be contributed 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 for 2001 ($3,000 for 2002 or $3,500 for 2002 if you are 50 or older).

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, earned $24,000 in 2001. Her IRA contributions for 2001 are limited to $2,000.

Example 2. John, a college student working part time, earned $1,500 in 2001. His IRA contributions for 2001 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 for 2001 ($3,000 for 2002 or $3,500 for 2002 if you are 50 or older), 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. Your spouse's contribution for the year to a traditional IRA.
   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 for 2001 ($6,000 for 2002, or $6,500 for 2002 if only one of you is 50 or older, or $7,000 for 2002 if both of you are 50 or older).

When Can Contributions Be Made?

As soon as you set up your traditional IRA, contributions can be made to it through your chosen sponsor (trustee or other administrator). Contributions to a traditional IRA must be in the form of money (cash, check, or money order). Property cannot be contributed.

Contributions must be made by due date. 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 2001 must be made by April 15, 2002.

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 for any later year.

Designating year for which contribution is made. If an amount is contributed to your traditional IRA between January 1 and April 15, you should tell the sponsor to which year (the current year or the previous year) the contribution is for. If you do not tell the sponsor which year it is for, the sponsor can assume, and report to the 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.

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

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 was 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 may be deductible as a miscellaneous itemized deduction on Schedule A (Form 1040). See chapter 30.

Brokers' commissions. Brokers' commissions are part of your IRA contribution and, as such, are deductible subject to the limits.

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 the lesser of:

1. $2,000 for 2001 ($3,000 for 2002 or $3,500 for 2002 if you are 50 or older), 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 for 2001 ($3,000 for 2002 or $3,500 for 2002 if 50 or older), 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 more compensation.

This limit is reduced by any contributions to a 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 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 was 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. See Nondeductible Contributions, later.

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 "Retirement 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.

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

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. 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.

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.

Defined benefit plan. 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.

A defined benefit plan is any plan that is not a defined contribution plan. Types of defined benefit plans include pension plans and annuity plans.

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 account or the accrual.

Situations in Which You Are Not Covered

Unless you are covered under 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 a 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

If either you or your spouse was 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 phaseout, you must determine your modified adjusted gross income (AGI) and your filing status. Then use Table 18-1 or 18-2 to determine if the phaseout applies.

Social security recipients. Instead of using Table 18-1 or 18-2, use 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 was covered by an employer retirement plan.

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

Deduction phaseout. If you were covered by an employer retirement plan, your IRA deduction may be reduced or eliminated depending on your filing status and modified AGI as shown in Table 18-1.

For 2002, 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:

• $34,000 and $44,000 for a single individual (or head of household),
• $54,000 and $64,000 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.

For all filing statuses other than married filing a separate return, the upper and lower limits of the phaseout range will increase by $1,000.

Table 18-1. Effect of Modified AGI ¹ on Deduction if Covered by Retirement Plan at Work

If you are covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction.

IF your filing status is ...	AND your modified adjusted gross income (modified AGI) is ...	THEN you can take ...
Single or Head of Household	Less than $33,000	A full deduction
	At least $33,000 but less than $43,000	A partial deduction
	$43,000 or more	No deduction
Married Filing Jointly or Qualifying Widow(er)	Less than $53,000	A full deduction
	At least $53,000 but less than $63,000	A partial deduction
	$63,000 or more	No deduction
Married Filing Separately 2	Less than $10,000	A partial deduction
	$10,000 or more	No deduction

1 Modified AGI (adjusted gross income). See Modified adjusted gross income. 2 If you did not live with your spouse at any time during the year, your filing status is considered Single for this purpose (therefore, your IRA deduction is determined under the "Single" column).

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 is reduced or eliminated entirely depending on your filing status and modified AGI as shown in Table 18-2.

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.

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.

Table 18-2. Effect of Modified AGI ¹ on Deduction if NOT Covered by Retirement Plan at Work

If you are not covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your deduction.

IF your filing status is ...	AND your modified adjusted gross income (modified AGI) is ...	THEN you can take ...
Single, Head of Household, or Qualifying Widow(er)	Any amount	A full deduction
Married Filing Jointly or Separately with a spouse who is not covered by a plan at work	Any amount	A full deduction
Married Filing Jointly with a spouse who is covered by a plan at work	Less than $150,000	A full deduction
	At least $150,000 but less than $160,000	A partial deduction
	$160,000 or more	No deduction
Married Filing Separately with a spouse who is covered by a plan at work 2	Less than $10,000	A partial deduction
	$10,000 or more	No deduction

1 Modified AGI (adjusted gross income). See Modified adjusted gross income. 2 You are entitled to the full deduction if you did not live with your spouse at any time during the year.

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 2001 and received a distribution from your IRA in 2001, see Publication 590.

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

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

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

This is your modified AGI.

Both contributions for 2001 and distributions in 2001. If all three of the following occurred, any IRA distributions you received in 2001 may be partly tax free and partly taxable.

1. You received distributions in 2001 from one or more traditional IRAs.
2. You made contributions to a traditional IRA for 2001.
3. Some of those contributions may be nondeductible contributions depending on whether your IRA deduction for 2001 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 Worksheet 1-1, Figuring the Taxable Part of Your IRA Distribution in Publication 590.

If at least one of the above did not occur, figure your modified AGI using Worksheet 18-1 in this chapter.

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 Form 1040 and Form 1040A include similar worksheets that you may be able to use instead.

Reporting Deductible Contributions

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

Worksheet 18-1. Figuring Your Modified AGI

Use this worksheet to figure your modified adjusted gross income for traditional IRA purposes.

1.	Enter your adjusted gross income (AGI) shown on line 19, Form 1040A, or line 33, Form 1040 figured without taking into account line 16, Form 1040A, or line 23, Form 1040	1.
2.	Enter any Student loan interest deduction from line 17, Form 1040A, or line 24, Form 1040	2.
3.	Enter any Foreign earned income exclusion from line 18, Form 2555-EZ, or line 40, Form 2555	3.
4.	Enter any Foreign housing exclusion from line 34, Form 2555, or Foreign housing deduction from line 48, Form 2555	4.
5.	Enter any Excluded qualified savings bond interest shown on line 3, Schedule 1, Form 1040A, or line 3, Schedule B, Form 1040 (from line 14, Form 8815)	5.
6.	Enter any Exclusion of employer-paid adoption expenses shown on line 26, Form 8839	6.
7.	Add lines 1 through 6. This is your Modified AGI for traditional IRA purposes	7.

Nondeductible Contributions

Although your deduction for IRA contributions may be reduced or eliminated, contributions can be made to your IRA up to the general limit ($2,000 for 2001 ($3,000 for 2002 or $3,500 for 2002 if 50 or older) or 100% of compensation, whichever is less) or the spousal IRA limit (if it applies). The difference between your total permitted contributions and your IRA deduction, if any, is your nondeductible contribution.

Example. Martin Jones is single. In 2001, he was covered by a retirement plan at work. His salary was $52,312. His modified AGI was $55,000. Martin made a $2,000 IRA contribution for 2001. Because he was covered by a retirement plan and his modified AGI was over $43,000, he cannot deduct his $2,000 IRA contribution. However, he can choose to designate this contribution as a nondeductible contribution, as explained next.

Form 8606. To designate contributions as nondeductible, you must file Form 8606.

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.

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.

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. 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 cost basis is the sum of the nondeductible contributions to your IRA minus any withdrawals or distributions of nondeductible contributions.

Inherited IRAs

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

If you inherit a traditional IRA from your deceased spouse, you can choose to treat it as your own by making contributions (including rollover contributions) to it.

If you inherit a traditional IRA from anyone other than your deceased spouse, you cannot treat the inherited IRA as your own. This means that contributions (including rollover contributions) cannot be made to the IRA and you cannot roll over any amounts out of the inherited IRA.

If you inherit a traditional IRA from your deceased spouse, you can generally roll it over into another traditional IRA established for you or you can choose to treat the inherited IRA as your own.

For more information, see the discussion of inherited IRAs under Rollover From One IRA Into Another, later.

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 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 contribution to the second retirement plan is called a "rollover contribution."

Note. The amount you roll over tax free is generally taxable when the new plan distributes that amount to you or your beneficiary.

Kinds of rollovers to an IRA. There are two kinds of rollover contributions to a traditional IRA.

1. You put amounts you receive from one traditional IRA into the same or another traditional IRA.
2. You put amounts you receive from an employer's qualified retirement plan for its employees into a traditional IRA.

Distributions after December 31, 2001, can be rolled over into a traditional IRA from:

1. A deferred compensation plan of a state or local government (section 457 plan), or
2. A tax-sheltered annuity (section 403(b).

For more information, see Publication 553, Highlights of 2001 Tax Changes.

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.

Kinds of rollovers from an IRA. For distributions after December 31, 2001, you can roll over, tax free, a distribution from your IRA into a qualified plan, including a deferred compensation plan of a state or local government (section 457 plan) and a tax-sheltered annuity (section 403(b) plan). The part of the distribution that you can roll over is the part that would otherwise be taxable (includible in your income). Qualified plans may, but are not required to, accept such rollovers. Rules applicable to other rollovers, such as the 60-day time limit, apply. Time Limit for Making a Rollover Contribution

Time Limit for Making a Rollover Contribution. You, generally, 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.

For distributions made after December 31, 2001, the IRS may waive the 60-day requirement where the failure to do so would be against equity or good conscience, such as a casualty, disaster, or other event beyond your reasonable control.

Extension of rollover period. If an amount distributed to you from a traditional IRA or a qualified employer retirement plan is a frozen deposit at any time during the 60-day period allowed for a rollover, special rules extend 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 the same or another traditional IRA. Because this is a rollover, you cannot deduct the amount that you reinvest in an IRA.

Waiting period between rollovers. If you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same 1-year period, from the IRA into which you made the tax-free rollover.

The 1-year period begins on the date you receive the IRA distribution, not on the date you roll it over into an IRA.

Example. If you have two traditional IRAs, IRA-1 and IRA-2, and you make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3), you can also make a tax-free rollover of a distribution from IRA-2 into IRA-3 (or into any other traditional IRA) within 1 year of the distribution from IRA-1. These can both be tax-free rollovers because you have not received more than one distribution from either IRA within 1 year. However, you cannot, within the 1-year period, make a tax-free rollover of any distribution from IRA-3 into another traditional IRA.

Exception. There is an exception to the rule that amounts rolled over tax free into an IRA cannot be rolled over tax free again within the 1-year period beginning on the date of the original distribution. The exception applies to a distribution which meets all three of the following requirements.

1. It is made from a failed financial institution by the Federal Deposit Insurance Corporation (FDIC) as receiver for the institution.
2. It was not initiated by either the custodial institution or the depositor.
3. It was made because:
   1. The custodial institution is insolvent, and
   2. The receiver is unable to find a buyer for the institution.

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

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, or you can choose to make the inherited IRA your own.

For distributions after December 31, 2001, your rollover options increase. You may still roll over your spouse's IRA into your traditional IRA, but to the extent a distribution is taxable, you can roll it over into your qualified plan, your qualified employee annuity (section 403(a) annuity), your tax-sheltered annuity (section 403(b) annuity), or your deferred compensation plan of your state or local government (section 457 plan).

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 the same or another traditional IRA on lines 15a and 15b, Form 1040 or lines 11a and 11b, Form 1040A.

Enter the total amount of the distribution on line 15a, Form 1040 or line 11a, Form 1040A. If the total amount on line 15a, Form 1040 or line 11a, Form 1040A was rolled over, enter zero on line 15b, Form 1040 or line 11b, Form 1040A. Otherwise, enter the taxable portion of the part that was not rolled over on line 15b, Form 1040 or line 11b, Form 1040A. Rollover From Employer's Plan Into an IRA

Rollover From Employer's Plan Into an IRA

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.

For distributions made after December 31, 2001, if you receive an eligible rollover distribution from your (or your deceased spouse's) governmental deferred compensation plan (section 457 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 minimum required distribution,
2. Hardship distributions from 401(k) plans and certain 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.

For distributions made after December 31, 2001, no hardship distribution is an eligible rollover distribution.

Maximum rollover. The most that you can roll over is the taxable part of any eligible rollover distribution (defined earlier). All of the distribution you receive generally will be 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 12a and 12b, Form 1040A. Do not use lines 15a or 15b, Form 1040, or lines 11a or 11b, Form 1040A.

More Information on Rollovers

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 use of your IRA assets and distributions from it. Violation of the rules generally results in additional taxes in the year of violation. See What Acts Result in Penalties.

Age 59 1/2 rule. Generally, if you are under age 59 1/2, you must pay a 10% additional tax on the distribution of any assets (money or other property) from your traditional IRA. Distributions before you are age 59 1/2 are called early distributions.

The 10% additional tax applies to the part of the distribution that you have to include in gross income. It is in addition to any regular income tax on that amount.

Exceptions. There are several exceptions to the age 59 1/2 rule. Even if you receive a distribution before you are age 59 1/2, you may not have to pay the 10% additional tax 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 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 therefore not subject to the 10% additional tax. (See Excess contributions withdrawn after due date of return, later.) This also applies to transfers incident to divorce, as discussed earlier.

Contributions returned before the due date. If you made IRA contributions for 2001, 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, for each contribution you withdraw, both of the following conditions apply.

• You did not take a deduction for the contribution.
• You also withdraw any interest or other income earned on the contribution. You can take into account any loss on the contribution while it was in the IRA when calculating the amount that must be withdrawn. If there was a loss, the net income earned on the contribution may be a negative amount.

Note. If the trustee of your IRA is unable to calculate the amount you must withdraw, get IRS Notice 2000-39. The notice explains the IRS-approved method of calculating the amount you must withdraw. This notice can be found in many libraries and IRS offices.

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 contributions, not in the year in which you withdraw them.

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.

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

When Must I Withdraw IRA Assets? (Required Distributions)

You cannot keep funds in your traditional IRA indefinitely. Eventually they must be distributed. If there are no distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required. See Excess Accumulations (Insufficient Distributions), later. The requirements for distributing IRA funds differ depending on whether you are the IRA owner or the beneficiary of a decedent's IRA.

Required distributions not eligible for rollover. Amounts that must be distributed (required distributions) during a particular year are not eligible for rollover treatment.

IRA owners. If you are the owner of a traditional IRA, by April 1 of the year following the year in which you reach age 70 1/2, you must either:

1. Receive the entire balance in your IRA, or
2. Start receiving periodic distributions from your IRA.

April 1 of the year following the year in which you reach age 70 1/2 is referred to as the required beginning date.

Periodic distributions. If you do not receive the entire balance in your traditional IRA by the required beginning date, you must start to receive periodic distributions over one of the following periods:

1. Your life,
2. The lives of you and your designated beneficiary,
3. A period that does not extend beyond your life expectancy, or
4. A period that does not extend beyond the joint life and last survivor expectancy of you and your designated beneficiary.

Distributions after the required beginning date. The minimum required 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 distributions 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 minimum required 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, distributions from a traditional IRA are taxable 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.

Although a conversion of a traditional IRA is considered a rollover for Roth IRA purposes, it is not an exception to the general rule for distributions from a traditional IRA. Conversion distributions are includable in your gross income subject to these rules and the special rules for conversions explained in chapter 2 of Publication 590.

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 10-year tax option 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), 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 2001 and your total IRA basis for 2001 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 early distributions, on line 15b, Form 1040 (no entry is required on line 15a), or line 11b, Form 1040A. If only part of the distribution is taxable, enter the total amount on line 15a, Form 1040, or line 11a, Form 1040A, and the taxable part on line 15b, Form 1040, or line 11b, 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.
• Taking early distributions.
• Allowing excess amounts to accumulate (failing to take required distributions).

There are penalties for overstating the amount of nondeductible contributions and for failure to file a Form 8606, if required.

Prohibited Transactions

Generally, a prohibited transaction is any improper use of your traditional IRA by you, your beneficiary, or any disqualified person.

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.
• Selling property to it.
• Receiving unreasonable compensation for managing it.
• Using it as security for a loan.
• Buying property for personal use (present or future) with IRA funds.

Effect on an IRA account. Generally, if you or your beneficiary engages in a prohibited transaction in connection with your traditional IRA account at any time during the year, the account stops being an IRA as of the first day of that 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 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 early 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 early distributions, discussed later.

Collectibles. These include:

• Art works,
• Rugs,
• Antiques,
• Metals,
• Gems,
• Stamps,
• Coins,
• Alcoholic beverages, and
• Certain other tangible personal property.

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 for 2001 ($3,000 for 2002 or $3,500 for 2002 if 50 or older).

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. You must complete your withdrawal by the date your tax 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.

You can take into account any loss on the contribution while it was in the IRA when calculating the amount that must be withdrawn. If there was a loss, the net income earned on the contribution may be a negative amount.

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 distributions, discussed later.

Excess contributions withdrawn after due date of return. In general, you must include all distributions (withdrawals) from your traditional IRA in your gross income. However, if the following conditions are met, you can withdraw excess contributions from your IRA and not include the amount withdrawn in your gross income.

1. Total contributions (other than rollover contributions) for 2001 to your IRA were not more than $2,000.
2. You did not take a deduction for the excess contribution being withdrawn.

The withdrawal can take place at any time, even after the due date, including extensions, for filing your tax return for the year.

Excess contribution deducted in an earlier year. If you deducted an excess contribution in an earlier year for which the total contributions were $2,000 or less, you can still remove the excess from your traditional IRA and not include it in your gross income. To do this, file Form 1040X, Amended U.S. Individual Income Tax Return, for that year and do not deduct the excess contribution on the amended return. Generally, you can file an amended return within 3 years after you filed your return, or 2 years from the time the tax was paid, whichever is later.

Excess due to incorrect rollover information. If an excess contribution in your traditional IRA is the result of a rollover and the excess occurred because the information the plan was required to give you was incorrect, you can withdraw the excess contribution. The limits mentioned above are increased by the amount of the excess that is due to the incorrect information. You will have to amend your return for the year in which the excess occurred to correct the reporting of the rollover amounts in that year. Do not include in your gross income the part of the excess contribution caused by the incorrect information.

Early Distributions

You must include early distributions of taxable amounts from your traditional IRA in your gross income. 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.

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

Exceptions. In certain situations, you may not have to pay the 10% additional tax even if amounts are distributed from your IRA before you are age 59 1/2. These situations are listed below.

• 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 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 are also tax free and not subject to the 10% additional tax (as explained earlier under Excess Contributions). This also applies to transfers incident to divorce, as discussed under Can I Move Retirement Plan Assets, earlier.

Additional 10% tax. The additional tax on early distributions is 10% of the amount of the early 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 early 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 early 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 minimum required 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 minimum required 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.

If you believe you qualify for this relief, do the following.

1. File Form 5329 with your Form 1040.
2. Pay any tax you owe on excess accumulations.
3. Attach a letter of explanation.

If the IRS approves your request, it will refund the excess accumulations tax you paid.

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, early (premature) 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 55, 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 the 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 and date 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 "2001 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. If you do not owe any other additional tax on a distribution, multiply the taxable part of the early distribution by 10% and enter the result on line 55 of Form 1040. Write "No" next to line 55 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 do not have to 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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