If both you and your spouse have compensation and are under age 70½, each of you can set up an IRA. You cannot both participate in the same IRA.

Wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services are compensation. 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 IRA purposes only if shown in box 1 of Form W–2.

An amount you receive that is a percentage of profits or sales price is compensation.

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:

Compensation includes earnings from self-employment even if they are not subject to self-employment tax because of your religious beliefs.

When you have both self-employment income and salaries and wages, your compensation includes both amounts.

If you have a net loss from self-employment, do not subtract the loss from your salaries or wages when figuring your total compensation.

For IRA purposes, compensation includes any taxable alimony and separate maintenance payments you receive under a decree of divorce or separate maintenance.

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.

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 paid in connection with your traditional IRA are subject to the contribution limit. For information about whether you can deduct brokers' commissions, see Brokers' commissions, later under How Much Can You Deduct.

Trustees' administrative fees are not subject to the contribution limit. For information about whether you can deduct trustees' fees, see Trustees' fees, later under How Much Can You Deduct.

If you have more than one IRA, the limit applies to the total contributions made on your behalf to all your traditional IRAs for the year.

If you invest in an annuity or endowment contract under an individual retirement annuity, no more than $3,000 ($3,500 if 50 or older) can be contributed toward its cost for the tax year, including the cost of life insurance coverage. If more than this amount is contributed, the annuity or endowment contract is disqualified.

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 2003 must be made by April 15, 2004, and contributions for 2004 must be made by April 15, 2005.

Contributions cannot be made to your traditional IRA for the year in which you reach age 70½ or for any later year.

You attain age 70½ on the date that is six calendar months after the 70th anniversary of your birth. If you were born on June 30, 1933, the 70th anniversary of your birth is June 30, 2003, and you attained age 70½ on December 30, 2003. If you were born on July 1, 1933, the 70th anniversary of your birth was July 1, 2003, and you attained age 70½ on January 1, 2004.

If an amount is contributed to your traditional IRA between January 1 and April 15, you should tell the sponsor 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).

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.

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

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). For information about miscellaneous itemized deductions, see Publication 529, Miscellaneous Deductions.

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

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 of your traditional IRAs of up to the lesser of:

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

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:

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

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.

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

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

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. However, also see Situations in Which You Are Not Covered, later.

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

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

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:

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

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

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

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

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.

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.

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 the phaseout, you must determine your modified adjusted gross income (AGI) and your filing status, as explained later under Deduction Phaseout. Once you have determined your modified AGI and your filing status, you can use Table 1–2 or Table 1–3 to determine if the phaseout applies.

If you are covered by an employer retirement plan and you did not receive any social security retirement benefits, your IRA deduction may be reduced or eliminated depending on your filing status and modified AGI, as shown in Table 1–2.

If you are not covered by an employer retirement plan, but your spouse is, and you did not receive any social security benefits, your IRA deduction may be reduced or eliminated entirely depending on your filing status and modified AGI as shown in Table 1–3.

Your filing status depends primarily on your marital status. For this purpose you need to know if your filing status is single or head of household, married filing jointly or qualifying widow(er), or married filing separately. If you need more information on filing status, see Publication 501, Exemptions, Standard Deduction, and Filing Information.

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.

You can use Worksheet 1–1 to figure your modified AGI. If you made contributions to your IRA for 2003 and received a distribution from your IRA in 2003, see Both contributions for 2003 and distributions in 2003, later.

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

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

This is your modified AGI.

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

This is your modified AGI.

If you received distributions in 2003 from one or more traditional IRAs and your traditional IRAs include only deductible contributions, the distributions are fully taxable and are included in your modified AGI.

If all three of the following apply, any IRA distributions you received in 2003 may be partly tax free and partly taxable.

If this is your situation, 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 1–5, Figuring the Taxable Part of Your IRA Distribution.

If at least one of the above does not apply, figure your modified AGI using Worksheet 1–1.

If you are self-employed (a sole proprietor or partner) and have a SIMPLE IRA, enter your deduction for allowable plan contributions on line 30, Form 1040.

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

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

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

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.

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.

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.

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

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

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

If you inherit a traditional IRA from your spouse, you generally have the following three choices. You can:

You will be considered to have chosen to treat the IRA as your own if:

You will only be considered to have chosen to treat the IRA as your own if:

However, if you receive a distribution from your deceased spouse's IRA, you can roll that distribution over into your own IRA within the 60-day time limit, as long as the distribution is not a required distribution, even if you are not the sole beneficiary of your deceased spouse's IRA. For more information, see When Must You Withdraw Assets? (Required Minimum Distributions), later.

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 you cannot make any contributions to the IRA. It also means you cannot roll over any amounts into or out of the inherited IRA. However, you can make a trustee-to-trustee transfer as long as the IRA into which amounts are being moved is set up and maintained in the name of the deceased IRA owner for the benefit of you as beneficiary.

Like the original owner, you generally will not owe tax on the assets in the IRA until you receive distributions from it. You must begin receiving distributions from the IRA under the rules for distributions that apply to beneficiaries.

If you inherit a traditional IRA from a person who had a basis in the IRA because of nondeductible contributions, that basis remains with the IRA. Unless you are the decedent's spouse and choose to treat the IRA as your own, you cannot combine this basis with any basis you have in your own traditional IRA(s) or any basis in traditional IRA(s) you inherited from other decedents. If you take distributions from both an inherited IRA and your IRA, and each has basis, you must complete separate Forms 8606 to determine the taxable and nontaxable portions of those distributions.

A beneficiary may be able to claim a deduction for estate tax resulting from certain distributions from a traditional IRA. The beneficiary can deduct the estate tax paid on any part of a distribution that is income in respect of a decedent. He or she can take the deduction for the tax year the income is reported. For information on claiming this deduction, see Estate Tax Deduction under Other Tax Information in Publication 559, Survivors, Executors, and Administrators.

Any taxable part of a distribution that is not income in respect of a decedent is a payment the beneficiary must include in income. However, the beneficiary cannot take any estate tax deduction for this part.

A surviving spouse can roll over the distribution to another traditional IRA and avoid including it in income for the year received.

For more information about rollovers, required distributions, and inherited IRAs, see:

Under certain conditions, you can move assets from a traditional IRA to a Roth IRA. For more information about these transfers, see Converting From Any Traditional IRA Into a Roth IRA, later, and Can You Move Amounts Into a Roth IRA? in chapter 2.

You can roll over amounts from the following plans into a traditional IRA:

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 Reporting rollovers from employer plans.

A written explanation of rollover treatment must be given to you by the plan (other than an IRA) making the distribution.

You may be able to roll over, tax free, a distribution from your traditional IRA into a qualified plan. These plans include the Federal Thrift Savings Fund (for federal employees), deferred compensation plans of state or local governments (section 457 plans), and tax-sheltered annuity plans (section 403(b) plans). 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.

If you roll over a distribution from an IRA into an eligible retirement plan (defined next) other than an IRA, the part of the distribution you roll over is considered to come first from amounts other than after-tax contributions in any of your traditional IRAs. This means that you can roll over a distribution from an IRA with nontaxable income into a qualified plan if you have enough taxable income in your other IRAs to cover the nontaxable part. The effect of this is to make the amount in your traditional IRAs that you can roll over to a qualified plan as large as possible.

The following are considered eligible retirement plans.

In the absence of a waiver, amounts not rolled over within the 60-day period do not qualify for tax-free rollover treatment. You must treat them as a taxable distribution from either your IRA or your employer's plan. These amounts are taxable in the year distributed, even if the 60-day period expires in the next year. You may also have to pay a 10% additional tax on early distributions as discussed later under Early Distributions.

Unless there is a waiver or an extension of the 60-day rollover period, any contribution you make to your IRA more than 60 days after the distribution is a regular contribution, not a rollover contribution.

The 60-day rollover requirement is waived automatically only if all of the following apply.

If you do not qualify for an automatic waiver, you can apply to the IRS for a waiver of the 60-day rollover requirement. You apply by following the procedures for applying for a letter ruling. Those procedures are stated in a revenue procedure generally published in the first Internal Revenue Bulletin of the year. You must also pay a user fee with the application. For how to get that revenue procedure, see chapter 5.

In determining whether to grant a waiver, the IRS will consider all relevant facts and circumstances, including:

The rules regarding the amount that can be rolled over within the 60-day time period also apply to the amount that can be deposited due to a waiver. For example, if you received $6,000 from your IRA, the most that you can deposit into an eligible retirement plan due to a waiver is $6,000.

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, two special rules extend the rollover period.

This is any deposit that cannot be withdrawn from a financial institution because of either of the following reasons.

Generally, 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.

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.

If property is distributed to you from an IRA and you complete the rollover by contributing property to an IRA, your rollover is tax free only if the property you contribute is the same property that was distributed to you.

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). The amount you keep may be subject to the 10% additional tax on early distributions discussed later under What Acts Result in Penalties or Additional Taxes.

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

If you inherit a traditional IRA from your spouse, you generally can roll it over, or you can choose to make the inherited IRA your own as discussed earlier under What If You Inherit an IRA.

If you inherited 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 When Must You Withdraw Assets, later.

Report any rollover from one traditional IRA to the same or another traditional IRA on lines 15a and 15b of Form 1040 or on lines 11a and 11b of Form 1040A.

Enter the total amount of the distribution on line 15a of Form 1040 or on line 11a of Form 1040A. If the total amount on line 15a of Form 1040 or on line 11a of Form 1040A was rolled over, enter zero on line 15b of Form 1040 or on line 11b of Form 1040A. If the total distribution was not rolled over, enter the taxable portion of the part that was not rolled over on line 15b of Form 1040 or on line 11b of Form 1040A. Put “Rollover” next to line 15b, Form 1040 or line 11b, Form 1040A. See the forms instructions.

If you rolled over the distribution in 2004 or from an IRA into a qualified plan (other than an IRA), attach a statement explaining what you did.

For information on how to figure the taxable portion, see Are Distributions Taxable, later.

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

Your rollover into a traditional IRA may include both amounts that would be taxable and amounts that would not be taxable if they were distributed to you, but not rolled over. To the extent the distribution is rolled over into a traditional IRA, it is not includible in your income.

Before making an eligible rollover distribution, the administrator of a qualified employer plan must provide you with a written explanation. It must tell you about all of the following.

The plan administrator must provide you with this written explanation no earlier than 90 days and no later than 30 days before the distribution is made.

However, you can choose to have a distribution made less than 30 days after the explanation is provided as long as both of the following requirements are met.

Contact the plan administrator if you have any questions regarding this information.

Generally, if an eligible rollover distribution is paid directly to you, the payer must withhold 20% of it. This applies even if you plan to roll over the distribution to a traditional IRA. You can avoid withholding by choosing the direct rollover option, discussed later.

The payer does not have to withhold from an eligible rollover distribution paid to you if either of the following conditions apply.

The 20% withholding requirement does not apply to distributions that are not eligible rollover distributions. However, other withholding rules apply to these distributions. The rules that apply depend on whether the distribution is a periodic distribution or a nonperiodic distribution. For either of these types of distributions, you can still choose not to have tax withheld. For more information, get Publication 575.

Your employer's qualified plan must give you the option to have any part of an eligible rollover distribution paid directly to a traditional IRA. The plan is not required to give you this option if your eligible rollover distributions are expected to total less than $200 for the year.

If you choose the direct rollover option, no tax is withheld from any part of the designated distribution that is directly paid to the trustee of the traditional IRA.

If any part is paid to you, the payer must withhold 20% of that part's taxable amount.

Table 1–4 may help you decide which distribution option to choose. Carefully compare the effects of each option.

You can roll over a distribution of voluntary deductible employee contributions (DECs) you made to your employer's plan. Prior to January 1, 1987, employees could make and deduct these contributions to certain qualified employers' plans and government plans. These are not the same as an employee's elective contributions to a 401(k) plan, which are not deductible by the employee.

If you receive a distribution from your employer's qualified plan of any part of the balance of your DECs and the earnings from them, you can roll over any part of the distribution.

The once-a-year limit on IRA-to-IRA rollovers does not apply to eligible rollover distributions from an employer plan. You can roll over more than one distribution from the same employer plan within a year.

If you receive an eligible rollover distribution from your employer's plan, you can roll over part or all of it into one or more conduit IRAs. You can later roll over those assets into a new employer's plan. You can use a traditional IRA as a conduit IRA. The conduit IRA must be made up of only the eligible rollover distribution from your employer's plan, plus gains and earnings on the assets making up that distribution. A conduit IRA will no longer qualify if you mix regular contributions or funds from other sources with the rollover distribution from your employer's plan.

If you receive both property and cash in an eligible rollover distribution, you can roll over part or all of the property, part or all of the cash, or any combination of the two that you choose.

If you receive property in an eligible rollover distribution from a qualified retirement plan you cannot keep the property and contribute cash to a traditional IRA in place of the property. You must either roll over the property or sell it and roll over the proceeds, as explained next.

Instead of rolling over a distribution of property other than cash, you can sell all or part of the property and roll over the amount you receive from the sale (the proceeds) into a traditional IRA. You cannot keep the property and substitute your own funds for property you received.

If you sell the distributed property and roll over all the proceeds into a traditional IRA, no gain or loss is recognized. The sale proceeds (including any increase in value) are treated as part of the distribution and are not included in your gross income.

If you received both cash and property, or just property, but did not roll over the entire distribution, see Rollovers in Publication 575.

You cannot roll over a life insurance contract from a qualified plan into a traditional IRA.

If you receive an eligible rollover distribution (defined earlier) from your deceased spouse's eligible retirement plan (defined earlier), you can roll over part or all of it into a traditional IRA. You can also roll over all or any part of a distribution of deductible employee contributions (DECs).

If you are the spouse or former spouse of an employee and you receive a distribution from a qualified employer plan as a result of divorce or similar proceedings, you may be able to roll over all or part of it into a traditional IRA. To qualify, the distribution must be:

A domestic relations order is a judgment, decree, or order (including approval of a property settlement agreement) that is issued under the domestic relations law of a state. A “qualified domestic relations order” gives to an alternate payee (a spouse, former spouse, child, or dependent of a participant in a retirement plan) the right to receive all or part of the benefits that would be payable to a participant under the plan. The order requires certain specific information, and it cannot alter the amount or form of the benefits of the plan.

Any part of an eligible rollover distribution that you keep is taxable in the year you receive it. If you do not roll over any of it, special rules for lump-sum distributions may apply. See Publication 575. The 10% additional tax on early distributions, discussed later under What Acts Result in Penalties or Additional Taxes, does not apply.

If you are self-employed, you are generally treated as an employee for rollover purposes. Consequently, if you receive an eligible rollover distribution from a Keogh plan (a qualified plan with at least one self-employed participant), you can roll over all or part of the distribution (including a lump-sum distribution) into a traditional IRA. For information on lump-sum distributions, see Publication 575.

For more information about Keogh plans, get Publication 560.

If you receive an eligible rollover distribution from a tax-sheltered annuity plan (section 403(b) plan), you can roll it over into a traditional IRA.

If you receive property other than money, you can sell the property and roll over the proceeds as discussed earlier.

If you redeem retirement bonds that were distributed to you under a qualified bond purchase plan, you can roll over tax free into a traditional IRA the part of the amount you receive that is more than your basis in the retirement bonds.

Enter the total distribution (before income tax or other deductions were withheld) on line 16a of Form 1040 or line 12a of Form 1040A. This amount should be shown in box 1 of Form 1099–R. From this amount, subtract any contributions (usually shown in box 5 of Form 1099–R) that were taxable to you when made. From that result, subtract the amount that was rolled over either directly or within 60 days of receiving the distribution. Enter the remaining amount, even if zero, on line 16b of Form 1040 or line 12b of Form 1040A. Also, enter "Rollover" next to line 16b on Form 1040 or line 12b of Form 1040A.

There are two commonly-used methods of transferring IRA assets to a spouse or former spouse. The methods are:

If all the assets are to be transferred, you can make the transfer by changing the name on the IRA from your name to the name of your spouse or former spouse.

Under this method, you direct the trustee of the traditional IRA to transfer the affected assets directly to the trustee of a new or existing traditional IRA set up in the name of your spouse or former spouse.

If your spouse or former spouse is allowed to keep his or her portion of the IRA assets in your existing IRA, you can direct the trustee to transfer the assets you are permitted to keep directly to a new or existing traditional IRA set up in your name. The name on the IRA containing your spouse's or former spouse's portion of the assets would then be changed to show his or her ownership.

You can withdraw all or part of the assets from a traditional IRA and reinvest them (within 60 days) in a Roth IRA. The amount that you withdraw and timely contribute (convert) to the Roth IRA is called a conversion contribution. If properly (and timely) rolled over, the 10% additional tax on early distributions will not apply.

You must roll over into the Roth IRA the same property you received from the traditional IRA. You can roll over part of the withdrawal into a Roth IRA 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. See When Can You Withdraw or Use Assets, later for more information on distributions from traditional IRAs and Early Distributions, later, for more information on the tax on early distributions.

If you have started taking substantially equal periodic payments from a traditional IRA, you can convert the amounts in the traditional IRA to a Roth IRA and then continue the periodic payments. The 10% additional tax on early distributions will not apply even if the distributions are not qualified distributions (as long as they are part of a series of substantially equal periodic payments).

You cannot convert amounts that must be distributed from your traditional IRA for a particular year (including the calendar year in which you reach age 70½) under the required distribution rules (discussed in this chapter).

If you inherited a traditional IRA from someone other than your spouse, you cannot convert it to a Roth IRA.

You must include in your gross income distributions from a traditional IRA that you would have had to include in income if you had not converted them into a Roth IRA. You do not include in gross income any part of a distribution from a traditional IRA that is a return of your basis, as discussed under Are Distributions Taxable, later in this chapter.

If you must include any amount in your gross income, you may have to increase your withholding or make estimated tax payments. See Publication 505, Tax Withholding and Estimated Tax.

You cannot deduct the contribution to the first IRA. Any net income you transfer with the recharacterized contribution is treated as earned in the second IRA. The contribution will not be treated as having been made to the second IRA to the extent any deduction was allowed for the contribution to the first IRA.

For recharacterization purposes, if you receive a distribution from a traditional IRA in one tax year and roll it over into a Roth IRA in the next year, but still within 60 days of the distribution from the traditional IRA, treat it as a contribution to the Roth IRA in the year of the distribution from the traditional IRA.

If an amount has been moved from one IRA to another in a tax-free transfer, such as a rollover, you generally cannot recharacterize the amount that was transferred. However, see Traditional IRA mistakenly moved to SIMPLE IRA, later.

Roth IRA conversion contributions from a SEP-IRA or SIMPLE IRA can be recharacterized to a SEP-IRA or SIMPLE IRA (including the original SEP-IRA or SIMPLE IRA).

If you mistakenly roll over or transfer an amount from a traditional IRA to a SIMPLE IRA, you can later recharacterize the amount as a contribution to another traditional IRA.

You can recharacterize only actual contributions. If you are applying excess contributions for prior years as current contributions, you can recharacterize them only if the recharacterization would still be timely with respect to the tax year for which the applied contributions were actually made.

You cannot recharacterize employer contributions (including elective deferrals) under a SEP or SIMPLE plan as contributions to another IRA. SEPs are discussed in Publication 560. SIMPLE plans are discussed in chapter 3.

The recharacterization of a contribution is not treated as a rollover for purposes of the 1-year waiting period described earlier in this chapter under Rollover From One IRA Into Another. This is true even if the contribution would have been treated as a rollover contribution by the second IRA if it had been made directly to the second IRA rather than as a result of a recharacterization of a contribution to the first IRA.

The election to recharacterize and the transfer must both take place on or before the due date (including extensions) for filing your tax return for the year for which the contribution was made to the first IRA.

Ordinarily you must choose to recharacterize a contribution by the due date of the return or the due date plus extensions. However, if you miss this deadline, you can still recharacterize a contribution if:

Appropriate corrective action consists of:

Once this is done, you must amend your return to show the recharacterization. You have until the regular due date for amending a return to do this. Report the recharacterization on the amended return and write “Filed pursuant to section 301.9100–2” on the return. File the amended return at the same address you filed the original return.

The election to recharacterize can be made on behalf of a deceased IRA owner by the executor, administrator, or other person responsible for filing the decedent's final income tax return.

After the transfer has taken place, you cannot change your election to recharacterize.

Recharacterizations made with the same trustee can be made by redesignating the first IRA as the second IRA, rather than transferring the account balance.

If you have more than one IRA, figure the amount to be recharacterized only on the account from which you withdraw the contribution.

If you made more than one regular contribution for the year, your last contribution is considered to be the one that is returned to you first.

The amount that must be distributed each year is referred to as the required minimum distribution.

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

You must receive at least a minimum amount for each year starting with the year you reach age 70½ (your 70½ year). If you do not (or did not) receive that minimum amount in your 70½ year, then you must receive distributions for your 70½ year by April 1 of the next year.

If an IRA owner dies after reaching age 70½, but before April 1 of the next year, no minimum distribution is required because death occurred before the required beginning date.

If, in any year, you receive more than the required minimum distribution for that year, you will not receive credit for the additional amount when determining the minimum required distributions for future years. This does not mean that you do not reduce your IRA account balance. It means that if you receive more than your required minimum distribution in one year, you cannot treat the excess (the amount that is more than the required minimum distribution) as part of your required minimum distribution for any later year. However, any amount distributed in your 70½ year will be credited toward the amount that must be distributed by April 1 of the following year.

The required minimum distribution for any year after the year you turn 70½ must be made by December 31 of that later year.

If you are the owner of a traditional IRA that is an individual retirement account, you or your trustee must figure the required minimum distribution for each year. See Figuring the Owner's Required Minimum Distribution, later.

If your traditional IRA is an individual retirement annuity, special rules apply to figuring the required minimum distribution. For more information on rules for annuities, get section 1.401(a)(9)–6T of the regulations. These temporary regulations can be read in many libraries and IRS offices.

For purposes of figuring your required minimum distribution, your marital status is determined as of January 1 of each year. If you are married on January 1, but get divorced or your spouse dies during the year, your spouse as of January 1 remains your sole beneficiary for that year. For purposes of determining your distribution period, a change in beneficiary is effective in the year following the year of death or divorce.

If your spouse is the sole beneficiary of your IRA, and he or she dies before you, your spouse will not fail to be your sole beneficiary for the year that he or she died solely because someone other than your spouse is named a beneficiary for the rest of that year. However, if you get divorced during the year and change the beneficiary designation on the IRA during that same year, your former spouse will not be treated as the sole beneficiary for that year.

The IRA account balance is the amount in the IRA at the end of the year preceding the year for which the required minimum distribution is being figured.

Contributions increase the account balance in the year they are made. If a contribution for last year is not made until after December 31 of last year, it increases the account balance for this year, but not for last year. Disregard contributions made after December 31 of last year in determining your required minimum distribution for this year.

The IRA account balance is adjusted by outstanding rollovers and recharacterizations of Roth IRA conversions that are not in any account at the end of the preceding year.

For a rollover from a qualified plan or another IRA that was not in any account at the end of the preceding year, increase the account balance of the receiving IRA by the rollover amount valued as of the date of receipt.

If a conversion contribution or failed conversion contribution is contributed to a Roth IRA and that amount (plus net income allocable to it) is transferred to another IRA in a subsequent year as a recharacterized contribution, increase the account balance of the receiving IRA by the recharacterized contribution (plus allocable net income) for the year in which the conversion or failed conversion occurred.

Distributions reduce the account balance in the year they are made. If a distribution for last year is not made until after December 31 of last year, it reduces the account balance for this year, but not for last year. Disregard distributions made after December 31 of last year in determining your required minimum distribution for this year.

This is the maximum number of years over which you are allowed to take distributions from the IRA. The period to use for 2004 is listed next to your age as of your birthday in 2004 in Table III in Appendix C.

If you must use Table I, your life expectancy for 2004 is listed in the table next to your age as of your birthday in 2004. If you use Table II, your life expectancy is listed where the row or column containing your age as of your birthday in 2004 intersects with the row or column containing your spouse's age as of his or her birthday in 2004. Both Table I and Table II are in Appendix C.

Required minimum distributions during your lifetime are based on a distribution period that generally is determined using Table III (Uniform Lifetime) in Appendix C. However, if the sole beneficiary of your IRA is your spouse who is more than 10 years younger than you, see Sole beneficiary spouse who is more than 10 years younger, later.

To figure the required minimum distribution for 2004, divide your account balance at the end of 2003 by the distribution period from the table. This is the distribution period listed next to your age (as of your birthday in 2004) in Table III in Appendix C, unless the sole beneficiary of your IRA is your spouse who is more than 10 years younger than you.

If the sole beneficiary of your IRA is your spouse and your spouse is more than 10 years younger than you, use the life expectancy from Table II (Joint Life and Last Survivor Expectancy).

The life expectancy to use is the joint life and last survivor expectancy listed where the row or column containing your age as of your birthday in 2004 intersects with the row or column containing your spouse's age as of his or her birthday in 2004.

You figure your required minimum distribution for 2004 by dividing your account balance at the end of 2003 by the life expectancy from Table II (Joint Life and Last Survivor Expectancy) in Appendix C.

The required minimum distribution for the year of the owner's death depends on whether the owner died before the required beginning date.

If the owner died before the required beginning date, see Owner Died Before Required Beginning Date, later under IRA Beneficiaries.

If the owner died on or after the required beginning date, the required minimum distribution for the year of death generally is based on Table III (Uniform Lifetime) in Appendix C. However, if the sole beneficiary of the IRA is the owner's spouse who is more than 10 years younger than the owner, use the life expectancy from Table II (Joint Life and Last Survivor Expectancy).

If you are a surviving spouse who is the sole beneficiary of your deceased spouse's IRA, you may elect to be treated as the owner and not as the beneficiary. If you elect to be treated as the owner, you determine the required minimum distribution (if any) as if you were the owner beginning with the year you elect or are deemed to be the owner. However, if you become the owner in the year your deceased spouse died, you are not required to determine the required minimum distribution for that year using your life; rather, you can take the deceased owner's required minimum distribution for that year (to the extent it was not already distributed to the owner before his or her death).

A beneficiary who is an individual may be required to take the entire account by the end of the fifth year following the year of the owner's death. If this rule applies, no distribution is required for any year before that fifth year.

Generally, the designated beneficiary is determined on September 30 of the calendar year following the calendar year of the IRA owner's death. In order to be a designated beneficiary, an individual must be a beneficiary as of the date of death. Any person who was a beneficiary on the date of the owner's death, but is not a beneficiary on September 30 of the calendar year following the calendar year of the owner's death (because, for example, he or she disclaimed entitlement or received his or her entire benefit), will not be taken into account in determining the designated beneficiary.

If a person who is a beneficiary as of the owner's date of death dies before September 30 of the year following the year of the owner's death without disclaiming entitlement to benefits, that individual, rather than his or her successor beneficiary, continues to be treated as a beneficiary for determining the distribution period.

If the designated beneficiary is the owner's surviving spouse, and he or she dies before he or she was required to begin receiving distributions, the surviving spouse will be treated as if he or she were the owner of the IRA. However, this rule does not apply to the surviving spouse of a surviving spouse.

If an IRA has more than one beneficiary or a trust is named as beneficiary, see Miscellaneous Rules for Required Minimum Distributions, later.

If the beneficiary is an individual, to figure the required minimum distribution for 2004, divide the account balance at the end of 2003 by the appropriate life expectancy from Table I (Single Life Expectancy) in Appendix C. Determine the appropriate life expectancy as follows.

If the beneficiary is not an individual, determine the required minimum distribution for 2004 as follows.

Use Table I for years after the year of the owner's death if either of the following apply.

Use Table II if you are the IRA owner and your spouse is both your sole designated beneficiary and more than 10 years younger than you.

Use Table III if you are the IRA owner and your spouse is not both the sole designated beneficiary of your IRA and more than 10 years younger than you.

Do not use any of the tables if the designated beneficiary is not an individual and the owner died before the required beginning date. In this case, the entire distribution must be made by the end of the fifth year following the year of the IRA owner's death.

This rule also applies if there is no designated beneficiary named by September 30 of the year following the year of the IRA owner's death.

If you are an individual, you can elect to take the entire account by the end of the fifth year following the year of the owner's death. If you make this election, do not use a table.

If you are a designated beneficiary figuring your first distribution, use your age as of your birthday in the year distributions must begin. This is usually the calendar year immediately following the calendar year of the owner's death. If you are the owner's surviving spouse and the sole designated beneficiary, this is the year in which the owner would have reached age 70½. After the first distribution year, reduce your life expectancy by one for each subsequent year.

In some cases, you need to use the owner's life expectancy. You need to use it when the owner dies on or after the required beginning date and there is no designated beneficiary as of September 30 of the year following the year of the owner's death. In this case, use the owner's life expectancy for his or her age as of the owner's birthday in the year of death and reduce it by one for each subsequent year.

For your first distribution by the required beginning date, use your age and the age of your designated beneficiary as of your birthdays in the year you become age 70½. Your combined life expectancy is at the intersection of your ages.

If you are figuring your required minimum distribution for 2004, use your ages as of your birthdays in 2004. For each subsequent year, use your and your spouse's ages as of your birthdays in the subsequent year.

For your first distribution by your required beginning date, use your age as of your birthday in the year you become age 70½.

If you are figuring your required minimum distribution for 2004, use your age as of your birthday in 2004. For each subsequent year, use your age as of your birthday in the subsequent year.

The yearly required minimum distribution can be taken in a series of installments (monthly, quarterly, etc.) as long as the total distributions for the year are at least as much as the minimum required amount.

If you have more than one traditional IRA, you must determine a separate required minimum distribution for each IRA. However, you can total these minimum amounts and take the total from any one or more of the IRAs.

If, in any year, you receive more than the required minimum amount for that year, you will not receive credit for the additional amount when determining the minimum required amounts for future years. This does not mean that you do not reduce your IRA account balance. It means that if you receive more than your required minimum distribution in one year, you cannot treat the excess (the amount that is more than the required minimum distribution) as part of your required minimum distribution for any later year. However, any amount distributed in your 70½ year will be credited toward the amount that must be distributed by April 1 of the following year.

If as of September 30 of the year following the year in which the owner dies there is more than one beneficiary, the beneficiary with the shortest life expectancy will be the designated beneficiary if both of the following apply.

Separate accounts with separate beneficiaries can be set up at any time, either before or after the owner's required beginning date. If separate accounts with separate beneficiaries are set up, the separate accounts are not combined for required minimum distribution purposes until the year after the separate accounts are established, or if later, the date of death. As a general rule, the required minimum distribution rules separately apply to each account. However, the distribution period for an account is separately determined (disregarding beneficiaries of the other account(s)) only if the account was set up by the end of the year following the year of the owner's death.

The separate account rules cannot be used by beneficiaries of a trust.

A trust cannot be a designated beneficiary even if it is a named beneficiary. However, the beneficiaries of a trust will be treated as having been designated as beneficiaries if all of the following are true.

The deadline for providing the beneficiary documentation to the IRA trustee, custodian, or issuer is October 31 of the year following the year of the owner's death.

If the beneficiary of the trust is another trust and the above requirements for both trusts are met, the beneficiaries of the other trust will be treated as having been designated as beneficiaries for purposes of determining the distribution period.

The separate account rules cannot be used by beneficiaries of a trust.

Special rules apply if you receive distributions from your traditional IRA as an annuity purchased from an insurance company. See sections 1.401(a)(9)–6T and 54.4974–2 of the regulations. These regulations can be found in many libraries and IRS offices.

Distributions from a traditional IRA are taxable in the year you receive them even if they are made without your consent by a state agency as receiver of an insolvent savings institution. This means you must include such distributions in your gross income unless you roll them over. For an exception to the 1-year waiting period rule for rollovers of certain distributions from failed financial institutions, see Exception under Rollover From One IRA Into Another, earlier.

Exceptions to distributions from traditional IRAs being taxable in the year you receive them are:

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

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.

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 and Withholding Requirements for Taxable Amounts, later.

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.

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 2003, and your total IRA basis for 2003 and earlier years. See the illustrated Forms 8606 in this chapter.

If you received a distribution in 2003 from a traditional IRA and you also made contributions to a traditional IRA for 2003 that may not be fully deductible because of the income limits, you can use Worksheet 1–5 to figure how much of your 2003 IRA distribution is tax free and how much is taxable. Then you can figure the amount of nondeductible contributions to report on Form 8606. Follow the instructions under Reporting your nontaxable distribution on Form 8606, next, to figure your remaining basis after the distribution.

To report your nontaxable distribution and to figure the remaining basis in your traditional IRA after distributions, you must complete Worksheet 1–5 before completing Form 8606. Then follow these steps to complete Form 8606.

You can tell the trustee or custodian of your traditional IRA account to use the amount in the account to buy an annuity contract for you. You are not taxed when you receive the annuity contract. You are taxed when you start receiving payments under that annuity contract.

If only deductible contributions were made to your traditional IRA since it was set up (this includes all your traditional IRAs, if you have more than one), the annuity payments are fully taxable.

If any of your traditional IRAs include both deductible and nondeductible contributions, the annuity payments are taxed as explained earlier under Distributions Fully or Partly Taxable.

When you cash in retirement bonds, you are taxed on the entire amount you receive. Unless you have already cashed them in, you will be taxed on the entire value of your bonds in the year in which you reach age 70½. The value of the bonds is the amount you would have received if you had cashed them in at the end of that year. When you later cash in the bonds, you will not be taxed again.

Some of the number codes are explained below. All of the codes are explained in the instructions for recipients on Form 1099–R.

1—Early distribution, no known exception.

2—Early distribution, exception applies.

3—Disability.

4—Death.

5—Prohibited transaction.

7—Normal distribution.

8—Excess contributions plus earnings/ excess deferrals (and/or earnings) taxable in 2003.

Some of the letter codes are explained below. All of the codes are explained in the instructions for recipients on Form 1099–R.

D—Excess contributions plus earnings/ excess deferrals taxable in 2001.

G—Direct rollover to a qualified plan, a tax-sheltered annuity, a governmental 457(b) plan, or an IRA. May also include a transfer from a conduit IRA to a qualified plan.

J—Early distribution from a Roth IRA, no known exception.

N—Recharacterized IRA contribution made for 2003 and recharacterized in 2003.

P—Excess contributions plus earnings/ excess deferrals taxable in 2002.

Q—Roth IRA qualified distribution.

R—Recharacterized IRA contribution made for 2002 and recharacterized in 2003.

S—Early distributions from a SIMPLE IRA in first 2 years, no known exception.

T—Roth IRA distribution, exception applies.

If the distribution shown on Form 1099–R is from your IRA, SEP-IRA, or SIMPLE IRA, the small box in box 7 (labeled IRA/SEP/SIMPLE) should be marked with an “X.”

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

The amount of tax withheld from an annuity or a similar periodic payment is based on your marital status and the number of withholding allowances you claim on your withholding certificate (Form W–4P). If you have not filed a certificate, tax will be withheld as if you are a married individual claiming three withholding allowances.

Generally, tax will be withheld at a 10% rate on nonperiodic distributions.

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.

To choose exemption from withholding, you must certify to the payer under penalties of perjury that you are not a U.S. citizen, a resident alien of the United States, or a tax-avoidance expatriate.

Even if this election is made, the payer must withhold tax at the rates prescribed for nonresident aliens.

For more information on withholding on pensions and annuities, see Pensions and Annuities in chapter 1 of Publication 505, Tax Withholding and Estimated Tax. For more information on withholding on nonresident aliens and foreign entities, see Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities.

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 (or 11b). You cannot report distributions on Form 1040EZ.

Generally, the value of an annuity or other payment receivable by any beneficiary of a decedent's traditional IRA that represents the part of the purchase price contributed by the decedent (or by his or her former employer(s)), must be included in the decedent's gross estate. For more information, see the instructions for Schedule I, Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return.

For these purposes, a fiduciary includes anyone who does any of the following.

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.

If your account stops being an IRA because you or your beneficiary engaged in a prohibited transaction, the account is treated as distributing all its assets to you at their fair market values on the first day of the year. If the total of those values is more than your basis in the IRA, you will have a taxable gain that is includible in your income. For information on figuring your gain and reporting it in income, see Are Distributions Taxable, earlier. The distribution may be subject to additional taxes or penalties.

If you borrow money against your traditional IRA annuity contract, you must include in your gross income the fair market value of the annuity contract as of the first day of your tax year. You may have to pay the 10% additional tax on early distributions, discussed later.

If you use a part of your traditional IRA account as security for a loan, that part is treated as a distribution and is included in your gross income. You may have to pay the 10% additional tax on early distributions, discussed later.

Your account or annuity does not lose its IRA treatment if your employer or the employee association with whom you have your traditional IRA engages in a prohibited transaction.

If you participate in the prohibited transaction with your employer or the association, your account is no longer treated as an IRA.

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.

If the traditional IRA ceases to be an IRA because of a prohibited transaction by you or your beneficiary, you or your beneficiary are not liable for these excise taxes. However, you or your beneficiary may have to pay other taxes as discussed under Effect on you or your beneficiary, earlier.

Even if a sponsor makes payments to you or your family, there is no prohibited transaction if all three of the following requirements are met.

If the consideration is group term life insurance, requirements (1) and (3) do not apply if no more than $5,000 of the face value of the insurance is based on a dollar-for-dollar basis on the assets in your IRA.

Even if a sponsor provides services at reduced or no cost, there is no prohibited transaction if all five of the following requirements are met.

These include:

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.

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 of the following conditions are met.

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 you must withdraw may be a negative amount.

In most cases, the net income you must transfer will be determined by your IRA trustee or custodian. If you need to determine the applicable net income you need to withdraw, you can use the same method that was used in Worksheet 1–3, earlier.

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.

You will receive Form 1099–R indicating the amount of the withdrawal. If the excess contribution was made in a previous tax year, the form will indicate the year in which the earnings are taxable.

If you deducted an excess contribution in an earlier year for which the total contributions were not more than the maximum deductible amount for that year ($2,000 for 2001 and earlier years, $3,000 for 2002 ($3,500 for 2002 if 50 or older)), 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.

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.

A special rule applies if you incorrectly deducted part of the excess contribution in a closed tax year (one for which the period to assess a tax deficiency has expired). The amount allowable as a traditional IRA deduction for a later correction year (the year you contribute less than the allowable amount) must be reduced by the amount of the excess contribution deducted in the closed year.

To figure the amount of excess contributions for previous years that you can deduct this year if you incorrectly deducted part of the excess contribution in a closed tax year, see Worksheet 1–7.

Worksheet 1–7. Excess Contributions Deductible This Year if Any Were Deducted in a Closed Tax Year

Use this worksheet to figure the amount of excess contributions for prior years that you can deduct this year if you incorrectly deducted excess contributions in a closed tax year.

Early distributions generally are amounts distributed from your traditional IRA account or annuity before you are age 59½, or amounts you receive when you cash in retirement bonds before you are age 59½.

After you reach age 59½, you can receive distributions without having to pay the 10% additional tax. Even though you can receive distributions after you reach age 59½, distributions are not required until you reach age 70½. See When Must You Withdraw Assets? (Required Minimum Distributions), earlier.

Even if you are under age 59½, you do not have to pay the 10% additional tax on distributions that are not more than:

You can only take into account unreimbursed medical expenses that you would be able to include in figuring a deduction for medical expenses on Schedule A, Form 1040. You do not have to itemize your deductions to take advantage of this exception to the 10% additional tax.

This is the amount on Form 1040, line 35, or Form 1040A, line 22.

Even if you are under age 59½, you may not have to pay the 10% additional tax on distributions during the year that are not more than the amount you paid during the year for medical insurance for yourself, your spouse, and your dependents. You will not have to pay the tax on these amounts if all four of the following conditions apply.

If you become disabled before you reach age 59½, any distributions from your traditional IRA because of your disability are not subject to the 10% additional tax.

You are considered disabled if you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long, continued, and indefinite duration.

If you die before reaching age 59½, the assets in your traditional IRA can be distributed to your beneficiary or to your estate without either having to pay the 10% additional tax.

However, if you inherit a traditional IRA from your deceased spouse and elect to treat it as your own (as discussed under What If You Inherit an IRA, earlier), any distribution you later receive before you reach age 59½ may be subject to the 10% additional tax.

You can receive distributions from your traditional IRA that are part of a series of substantially equal payments over your life (or your life expectancy), or over the lives (or the joint life expectancies) of you and your beneficiary, without having to pay the 10% additional tax, even if you receive such distributions before you are age 59½. You must use an IRS-approved distribution method and you must take at least one distribution annually for this exception to apply. The “required minimum distribution method,” when used for this purpose, results in the exact amount required to be distributed, not the minimum amount.

There are two other IRS-approved distribution methods that you can use. They are generally referred to as the “fixed amortization method” and the “fixed annuitization method.” These two methods are not discussed in this publication because they are more complex and generally require professional assistance. See Revenue Ruling 2002–62 in Internal Revenue Bulletin 2002–42 for more information on these two methods. To obtain a copy of this revenue ruling, see Mail in chapter 5. This revenue ruling can also be found in many libraries and IRS offices.

The payments under this exception must generally continue until at least 5 years after the date of the first payment, or until you reach age 591/, whichever is later. If a change from an approved distribution method is made before the end of the appropriate period, any payments you receive before you reach age 59½ will be subject to the 10% additional tax. This is true even if the change is made after you reach age 59½. The payments will not be subject to the 10% additional tax if another exception applies or if the change is made because of your death or disability.

If you are receiving a series of substantially equal periodic payments, you can make a one-time switch to the required minimum distribution method at any time without incurring the additional tax. Once a change is made, you must follow the required minimum distribution method in all subsequent years.

Even if you are under age 59½, if you paid expenses for higher education during the year, part (or all) of any distribution may not be subject to the 10% additional tax. The part not subject to the tax is generally the amount that is not more than the qualified higher education expenses (defined later) for the year for education furnished at an eligible educational institution (defined later). The education must be for you, your spouse, or the children or grandchildren of you or your spouse.

When determining the amount of the distribution that is not subject to the 10% additional tax, include qualified higher education expenses paid with any of the following funds.

Do not include expenses paid with any of the following funds.

Qualified higher education expenses are tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance. In addition, if the individual is at least a half-time student, room and board are qualified higher education expenses.

This is any college, university, vocational school, or other postsecondary educational institution eligible to participate in the student aid programs administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

Even if you are under age 59½, you do not have to pay the 10% additional tax on distributions you receive to buy, build, or rebuild a first home. To qualify for treatment as a first-time homebuyer distribution, the distribution must meet all the following requirements.

If both you and your spouse are first-time homebuyers (defined later), each of you can receive distributions up to $10,000 for a first home without having to pay the 10% additional tax.

Qualified acquisition costs include the following items.

Generally, you are a first-time homebuyer if you had no present interest in a main home during the 2-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild. If you are married, your spouse must also meet this no-ownership requirement.

The date of acquisition is the date that:

Early distributions (with or without your consent) from savings institutions placed in receivership are subject to this tax unless one of the above exceptions applies. This is true even if the distribution is from a receiver that is a state agency.

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

If distributions are less than the required minimum distribution for the year, discussed earlier under When Must You Withdraw Assets? (Required Minimum Distributions), you may have to pay a 50% excise tax for that year on the amount not distributed as required.

Use Form 5329 to report the tax on excess accumulations. See the discussion of Form 5329, later, under Reporting Additional Taxes, for more information on filing the form.

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.

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

If you are unable to take 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. Those conditions and requirements are summarized below. Revenue Procedure 92–10 is in Cumulative Bulletin 1992–1. To obtain a copy of this revenue procedure, see Mail in chapter 5. You can also read the revenue procedure at most IRS offices and at many public libraries.

To qualify for exemption from the tax, the assets in your traditional IRA must include an affected investment. Also, the amount of your required distribution must be determined as discussed earlier under When Must You Withdraw Assets.

Affected investment means an annuity contract or a guaranteed investment contract (with an insurance company) for which payments under the terms of the contract have been reduced or suspended because of state insurer delinquency proceedings against the contracting insurance company.

If your traditional IRA (or IRAs) includes assets other than your affected investment, all traditional IRA assets, including the available portion of your affected investment, must be used to satisfy as much as possible of your IRA distribution requirement. If the affected investment is the only asset in your IRA, as much as possible of the required distribution must come from the available portion, if any, of your affected investment.

The available portion of your affected investment is the amount of payments remaining after they have been reduced or suspended because of state insurer delinquency proceedings.

If the payments to you under the contract increase because all or part of the reduction or suspension is canceled, you must make up the amount of any shortfall in a prior distribution because of the proceedings. You make up (reduce or eliminate) the shortfall with the increased payments you receive.

You must make up the shortfall by December 31 of the calendar year following the year that you receive increased payments.

If you must file an individual income tax return, complete Form 5329 and attach it to your Form 1040. Enter the total additional taxes due on line 57, Form 1040.

If you do not have to file a return, but do have to pay one of the additional taxes mentioned earlier, file the completed Form 5329 with the IRS at the time and place you would have filed 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 “2003 Form 5329” on your check or money order.

You do not have to use Form 5329 if either of the following situations exist.