Generally, compensation is what you earn from working. For a summary of what compensation does and does not include, see Table 1-1. Compensation includes the items discussed next.

An individual retirement account is a trust or custodial account set up in the United States for the exclusive benefit of you or your beneficiaries. The account is created by a written document. The document must show that the account meets all of the following requirements.

You can set up an individual retirement annuity by purchasing an annuity contract or an endowment contract from a life insurance company.

An individual retirement annuity must be issued in your name as the owner, and either you or your beneficiaries who survive you are the only ones who can receive the benefits or payments.

An individual retirement annuity must meet all the following requirements.

The sale of individual retirement bonds issued by the federal government was suspended after April 30, 1982. The bonds have the following features.

If you cash (redeem) the bonds before the year in which you reach age 59½, you may be subject to a 10% additional tax. See Age 59½ Rule under Early Distributions, later. You can roll over redemption proceeds into IRAs.

A simplified employee pension (SEP) is a written arrangement that allows your employer to make deductible contributions to a traditional IRA (a SEP-IRA) set up for you to receive such contributions. Generally, distributions from SEP IRAs are subject to the withdrawal and tax rules that apply to traditional IRAs. See Publication 560 for more information about SEPs.

Your employer or your labor union or other employee association can set up a trust to provide individual retirement accounts for employees or members. The requirements for individual retirement accounts apply to these traditional IRAs.

The trustee or issuer (sometimes called the sponsor) of your traditional IRA generally must give you a disclosure statement at least 7 days before you set up your IRA. However, the sponsor does not have to give you the statement until the date you set up (or purchase, if earlier) your IRA, provided you are given at least 7 days from that date to revoke the IRA.

The disclosure statement must explain certain items in plain language. For example, the statement should explain when and how you can revoke the IRA, and include the name, address, and telephone number of the person to receive the notice of cancellation. This explanation must appear at the beginning of the disclosure statement.

If you revoke your IRA within the revocation period, the sponsor must return to you the entire amount you paid. The sponsor must report on the appropriate IRS forms both your contribution to the IRA (unless it was made by a trustee-to-trustee transfer) and the amount returned to you. These requirements apply to all sponsors.

The most that can be contributed to your traditional IRA is the smaller of the following amounts:

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.)

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 two amounts:

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 $6,000 ($6,500 if only one of you is 50 or older or $7,000 if both of you are 50 or older). For 2005, combined total contributions can be as much as $8,000 ($8,500 if only one of you is 50 or older or $9,000 if both of you are 50 or older).

Generally, except as discussed earlier under Spousal IRA Limit, your filing status has no effect on the amount of allowable contributions to your traditional IRA. However, if during the year either you or your spouse was covered by a retirement plan at work, your deduction may be reduced or eliminated, depending on your filing status and income. See How Much Can You Deduct, later.

If contributions to your traditional IRA for a year were less than the limit, you cannot contribute more after the due date of your return for that year to make up the difference.

If contributions to your IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year. However, a penalty or additional tax may apply. See Excess Contributions, later under What Acts Result in Penalties or Additional Taxes.

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.

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

Deduction Phaseout

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

Covered by a retirement plan.   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.

For 2005, if you are covered by a retirement plan at work, your IRA deduction will not be reduced (phased out) unless your modified AGI is:

• More than $50,000 but less than $60,000 for a single individual (or head of household),

• More than $70,000 but less than $80,000 for a married couple filing a joint return (or a qualifying widow(er)), or

• Less than $10,000 for a married individual filing a separate return.

For all filing statuses other than married filing separately, the upper and lower limits of the phaseout range for 2005 will increase by $5,000 from the limit for 2004.

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

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

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

Modified adjusted gross income (AGI).   You can use Worksheet 1-1 to figure your modified AGI. If you made contributions to your IRA for 2004 and received a distribution from your IRA in 2004, see Both contributions for 2004 and distributions in 2004, later.

  

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

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

• IRA deduction.

• Student loan interest deduction.

• Tuition and fees deduction.

• Foreign earned income exclusion.

• Foreign housing exclusion or deduction.

• Exclusion of qualified savings bond interest shown on Form 8815.

• Exclusion of employer-provided adoption benefits shown on Form 8839.

This is your modified AGI.

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

• IRA deduction.

• Student loan interest deduction.

• Tuition and fees deduction.

• Exclusion of qualified bond interest shown on Form 8815.

• Exclusion of employer-provided adoption benefits shown on Form 8839.

This is your modified AGI.

Income from IRA distributions.   If you received distributions in 2004 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.

Both contributions for 2004 and distributions in 2004.   If all three of the following apply, any IRA distributions you received in 2004 may be partly tax free and partly taxable.

• You received distributions in 2004 from one or more traditional IRAs,

• You made contributions to a traditional IRA for 2004, and

• Some of those contributions may be nondeductible contributions. (See Nondeductible Contributions and Worksheet 1-2, later.)

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 file Form 1040, enter your IRA deduction on line 25 of that form. If you file Form 1040A, enter your IRA deduction on line 17 of that form. You cannot deduct IRA contributions on Form 1040EZ.

Although your deduction for IRA contributions may be reduced or eliminated, contributions can be made to your IRA of up to the general limit or, if it applies, the spousal IRA limit. The difference between your total permitted contributions and your IRA deduction, if any, is your nondeductible contribution.

Cost basis.   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.

The following examples illustrate the use of Worksheet 1-2, Figuring Your Reduced IRA Deduction for 2004.

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. This waiting period is discussed later under Rollover From One IRA Into Another.

For information about direct transfers from retirement programs other than traditional IRAs, see Direct rollover option, later.

Generally, a rollover is a tax-free distribution to you of cash or other assets from one retirement plan that you contribute to another retirement plan. The contribution to the second retirement plan is called a “rollover contribution.”

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.

You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the contribution. See Recharacterizations in this chapter for more information.

Waiting period between rollovers.   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.

Example.

You have two traditional IRAs, IRA-1 and IRA-2. You make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). You cannot, within 1 year of the distribution from IRA-1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional IRA.

However, the rollover from IRA-1 into IRA-3 does not prevent you from making a tax-free rollover from IRA-2 into any other traditional IRA. This is because you have not, within the last year, rolled over, tax-free, any distribution from IRA-2 or made a tax-free rollover into IRA-2.

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.

The same property must be rolled over.   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.

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). 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.

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, or you can choose to make the inherited IRA your own as discussed earlier under What If You Inherit an IRA.

Not inherited from spouse.   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.

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

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

  If you rolled over the distribution in 2005 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.

Rollover From Employer's Plan Into an IRA

You can roll over into a traditional IRA all or part of an eligible rollover distribution you receive from your (or your deceased spouse's):

• Employer's qualified pension, profit-sharing or stock bonus plan,

• Annuity plan,

• Tax-sheltered annuity plan (section 403(b) plan), or

• Governmental deferred compensation plan (section 457 plan).

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

Eligible rollover distribution.   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.

1. A required minimum distribution (explained later under When Must You Withdraw Assets? (Required Minimum Distributions)).

2. A hardship distribution.

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.

4. Corrective distributions of excess contributions or excess deferrals, and any income allocable to the excess, or of excess annual additions and any allocable gains.

5. A loan treated as a distribution because it does not satisfy certain requirements either when made or later (such as upon default), unless the participant's accrued benefits are reduced (offset) to repay the loan.

6. Dividends on employer securities.

7. The cost of life insurance coverage.

8. Generally, a distribution to the plan participant's beneficiary.

  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.

Written explanation to recipients.   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.

• Your right to have the distribution paid tax free directly to a traditional IRA or another eligible retirement plan.

• The requirement to withhold tax from the distribution if it is not paid directly to a traditional IRA or another eligible retirement plan.

• The tax treatment of any part of the distribution that you roll over to a traditional IRA or another eligible retirement plan within 60 days after you receive the distribution.

• Other qualified employer plan rules, if they apply, including those for lump-sum distributions, alternate payees, and cash or deferred arrangements.

• How the plan receiving the distribution differs from the plan making the distribution in its restrictions and tax consequences.

  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.

• You are given at least 30 days after the notice is provided to consider whether you want to elect a direct rollover.

• You are given information that clearly states that you have this 30-day period to make the decision.

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

Withholding requirement.   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.

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

• The distribution and all previous eligible rollover distributions you received during your tax year from the same plan (or, at the payer's option, from all your employer's plans) total less than $200.

• The distribution consists solely of employer securities, plus cash of $200 or less in lieu of fractional shares.

The amount withheld is part of the distribution. If you roll over less than the full amount of the distribution, you may have to include in your income the amount you do not roll over. However, you can make up the amount withheld with funds from other sources.

Other withholding rules.   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, see Publication 575.

Direct rollover option.   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.

Withholding.   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.

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

Table 1-4. Comparison of Payment to You Versus Direct Rollover

Affected item	Result of a payment to you	Result of a direct rollover
withholding	The payer must withhold 20% of the taxable part.	There is no withholding.
additional tax	If you are under age 59½, a 10% additional tax may apply to the taxable part (including an amount equal to the tax withheld) that is not rolled over.	There is no 10% additional tax. See Early Distributions.
when to report as income	Any taxable part (including the taxable part of any amount withheld) not rolled over is income to you in the year paid.	Any taxable part is not income to you until later distributed to you from the IRA.

If you decide to roll over any part of a distribution, the direct rollover option will generally be to your advantage. This is because you will not have 20% withholding or be subject to the 10% additional tax under that option.

If you have a lump-sum distribution and do not plan to roll over any part of it, the distribution may be eligible for special tax treatment that could lower your tax for the distribution year. In that case, you may want to see Publication 575 and Form 4972, Tax on Lump-Sum Distributions, and its instructions to determine whether your distribution qualifies for special tax treatment and, if so, to figure your tax under the special methods.

You can then compare any advantages from using Form 4972 to figure your tax on the lump-sum distribution with any advantages from rolling over all or part of the distribution. However, if you roll over any part of the lump-sum distribution, you cannot use the Form 4972 special tax treatment for any part of the distribution.

Contributions you made to your employer's plan.   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.

No waiting period between rollovers.   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.

IRA as a holding account (conduit IRA) for rollovers to other eligible plans.   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. You can roll over part or all of the conduit IRA to a qualified plan, even if you make regular contributions to it or add funds from sources other than your employer's plan. However, if you make regular contributions to the conduit IRA or add funds from other sources, the qualified plan into which you move funds will not be eligible for any optional tax treatment for which it might have otherwise qualified.

Property and cash received in a distribution.   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.

The same property (or sales proceeds) must be rolled over.   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.

Sale of property received in a distribution from a qualified plan.   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.

Example.

You receive a total distribution from your employer's plan consisting of $10,000 cash and $15,000 worth of property. You decide to keep the property. You can roll over to a traditional IRA the $10,000 cash received, but you cannot roll over an additional $15,000 representing the value of the property you choose not to sell.

Treatment of gain or loss.   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.

Example.

On September 2, Mike received a lump-sum distribution from his employer's retirement plan of $50,000 in cash and $50,000 in stock. The stock was not stock of his employer. On September 24, he sold the stock for $60,000. On October 4, he rolled over $110,000 in cash ($50,000 from the original distribution and $60,000 from the sale of stock). Mike does not include the $10,000 gain from the sale of stock as part of his income because he rolled over the entire amount into a traditional IRA.

Note.

Special rules may apply to distributions of employer securities. For more information, see Publication 575.

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

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

Distributions received by a surviving spouse.   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).

Distributions under divorce or similar proceedings (alternate payees).   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:

• One that would have been an eligible rollover distribution (defined earlier) if it had been made to the employee, and

• Made under a qualified domestic relations order.

Qualified domestic relations order.   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.

Tax treatment if all of an eligible distribution is not rolled over.   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.

Keogh plans and rollovers.   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.

More information.   For more information about Keogh plans, see Publication 560.

Distribution from a tax-sheltered annuity.   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.

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

Rollover from bond purchase plan.   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.

Reporting rollovers from employer plans.    Enter the total distribution (before income tax or other deductions were withheld) on Form 1040, line 16a, or Form 1040A, line 12a. 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 Form 1040, line 16b, or Form 1040A, line 12b. Also, enter "Rollover" next to line 16b on Form 1040 or line 12b of Form 1040A.

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 information about transfers of interests in employer plans, see Distributions under divorce or similar proceedings (alternate payees) under Rollover From Employer's Plan Into an IRA, earlier.

You can convert amounts from a traditional IRA into a Roth IRA if, for the tax year you make the withdrawal from the traditional IRA, both of the following requirements are met.

Income.   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 may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the contribution.

To recharacterize a contribution, you generally must have the contribution transferred from the first IRA (the one to which it was made) to the second IRA in a trustee-to-trustee transfer. If the transfer is made by the due date (including extensions) for your tax return for the year during which the contribution was made, you can elect to treat the contribution as having been originally made to the second IRA instead of to the first IRA. If you recharacterize your contribution, you must do all three of the following.

How Do You Recharacterize a Contribution?

To recharacterize a contribution, you must notify both the trustee of the first IRA (the one to which the contribution was actually made) and the trustee of the second IRA (the one to which the contribution is being moved) that you have elected to treat the contribution as having been made to the second IRA rather than the first. You must make the notifications by the date of the transfer. Only one notification is required if both IRAs are maintained by the same trustee. The notification(s) must include all of the following information.

• The type and amount of the contribution to the first IRA that is to be recharacterized.

• The date on which the contribution was made to the first IRA and the year for which it was made.

• A direction to the trustee of the first IRA to transfer in a trustee-to-trustee transfer the amount of the contribution and any net income (or loss) allocable to the contribution to the trustee of the second IRA.

• The name of the trustee of the first IRA and the name of the trustee of the second IRA.

• Any additional information needed to make the transfer.

In most cases, the net income you must transfer is determined by your IRA trustee or custodian. If you need to determine the applicable net income on IRA contributions made after 2003 that are recharacterized, use Worksheet 1-3. See Regulations section 1.408A-5 for more information.

Worksheet 1-3. Determining the Amount of Net Income Due To an IRA Contribution and Total Amount To Be Recharacterized

1.	Enter the amount of your IRA contribution for 2005 to be recharacterized.	1.
2.	Enter the fair market value of the IRA immediately prior to the recharacterization (include any distributions, transfers, or recharacterization made while the contribution was in the account).	2.
3.	Enter the fair market value of the IRA immediately prior to the time the contribution being recharacterized was made, including the amount of such contribution and any other contributions, transfers, or recharacterizations made while the contribution was in the account	3.
4.	Subtract line 3 from line 2	4.
5.	Divide line 4 by line 3. Enter the result as a decimal (rounded to at least three places).	5.
6.	Multiply line 1 by line 5. This is the net income attributable to the contribution to be recharacterized..	6.
7.	Add lines 1 and 6. This is the amount of the IRA contribution plus the net income attributable to it to be recharacterized.	7.

Example.

On March 1, 2005, when her Roth IRA is worth $80,000, Allison makes a $160,000 conversion contribution to the Roth IRA. Subsequently, Allison discovers that she was ineligible to make a Roth conversion contribution in 2005 and so she requests that the $160,000 be recharacterized to a traditional IRA. Pursuant to this request, on March 1, 2006, when the IRA is worth $225,000, the Roth IRA trustee transfers to a traditional IRA the $160,000 plus allocable net income. No other contributions have been made to the Roth IRA and no distributions have been made.

The adjusted opening balance is $240,000 ($80,000 + $160,000) and the adjusted closing balance is $225,000. Thus the net income allocable to the $160,000 is ($10,000) ($160,000 x (($225,000 – $240,000) ÷ $240,000). Therefore in order to recharacterize the March 1, 2005, $160,000 conversion contribution on March 1, 2006, the Roth IRA trustee must transfer from Allison's Roth IRA to her traditional IRA $150,000 ($160,000 – $10,000). This is shown on the following worksheet.

Worksheet 1-3. Example—Illustrated

1.	Enter the amount of your IRA contribution for 2005 to be recharacterized.	1.	160,000
2.	Enter the fair market value of the IRA immediately prior to the recharacterization (include any distributions, transfers, or recharacterization made while the contribution was in the account).	2.	225,000
3.	Enter the fair market value of the IRA immediately prior to the time the contribution being recharacterized was made, including the amount of such contribution and any other contributions, transfers, or recharacterizations made while the contribution was in the account	3.	240,000
4.	Subtract line 3 from line 2.	4.	(15,000)
5.	Divide line 4 by line 3. Enter the result as a decimal (rounded to at least three places)..	5.	(.0625)
6.	Multiply line 1 by line 5. This is the net income attributable to the contribution to be recharacterized.	6.	(10,000)
7.	Add lines 1 and 6. This is the amount of the IRA contribution plus the net income attributable to it to be recharacterized.	7.	150,000

Timing.   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.

Extension.   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:

• Your return was timely filed for the year the choice should have been made, and

• You take appropriate corrective action within 6 months from the due date of your return excluding extensions. For returns due April 15, 2005, this period ends on October 15, 2005.

  Appropriate corrective action consists of:

• Notifying the trustee(s) of your intent to recharacterize,

• Providing the trustee with all necessary information, and

• Having the trustee transfer the contribution.

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.

Decedent.   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.

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

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

Reporting a Recharacterization

If you elect to recharacterize a contribution to one IRA as a contribution to another IRA, you must report the recharacterization on your tax return as directed by Form 8606 and its instructions. You must treat the contribution as having been made to the second IRA.

Example.

On June 1, 2004, Christine properly and timely converted her traditional IRAs to a Roth IRA. At the time, she and her husband, Lyle, expected to have modified AGI of less than $100,000 for 2004. In December, Lyle received an unexpected bonus that increased his and Christine's modified AGI to more than $100,000. In January 2005, to make the necessary adjustment to remove the unallowable conversion, Christine set up a traditional IRA with the same trustee. Also in January 2005, she instructed the trustee of the Roth IRA to make a trustee-to-trustee transfer of the conversion contribution made to the Roth IRA (including net income allocable to it since the conversion) to the new traditional IRA. She also notified the trustee that she was electing to recharacterize the contribution to the Roth IRA and treat it as if it had been contributed to the new traditional IRA. Because of the recharacterization, Lyle and Christine have no taxable income from the conversion to report for 2004, and the resulting rollover to a traditional IRA is not treated as a rollover for purposes of the one-rollover-per-year rule.

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

When Can You Withdraw or Use Assets?

You can withdraw or use your traditional IRA assets at any time. However, a 10% additional tax generally applies if you withdraw or use IRA assets before you are age 59½. This is explained under Age 59½ Rule under Early Distributions, later.

You generally can make a tax-free withdrawal of contributions if you do it before the due date for filing your tax return for the year in which you made them. This means that, even if you are under age 59½, the 10% additional tax may not apply. These withdrawals are explained next.

Contributions Returned Before Due Date of Return

If you made IRA contributions in 2004, 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 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.

In most cases, the net income you must withdraw is determined by the IRA trustee or custodian. If you need to determine the applicable net income on IRA contributions made after 2004 that are returned to you, use Worksheet 1-4. See Regulations section 1.408-11 for more information.

Worksheet 1-4. Determining the Amount of Net Income Due To an IRA Contribution and Total Amount To Be Withdrawn From the IRA

1.	Enter the amount of your IRA contribution for 2005 to be returned to you.	1.
2.	Enter the fair market value of the IRA immediately prior to the removal of the contribution, plus the amount of any distributions, transfers, and recharacterizations made while the contribution was in the IRA.	2.
3.	Enter the fair market value of the IRA immediately before the contribution was made, plus the amount of such contribution and any other contributions, transfers, and recharacterizations made while the contribution was in the IRA	3.
4.	Subtract line 3 from line 2.	4.
5.	Divide line 4 by line 3. Enter the result as a decimal (rounded to at least three places)..	5.
6.	Multiply line 1 by line 5. This is the net income attributable to the contribution to be returned.	6.
7.	Add lines 1 and 6. This is the amount of the IRA contribution plus the net income attributable to it to be returned to you.	7.

Example.

On May 1, 2005, when her IRA is worth $4,800, Cathy makes a $1,600 regular contribution to her IRA. Cathy requests that $400 of the May 1, 2005, contribution be returned to her. On February 1, 2006, when the IRA is worth $7,600, the IRA trustee distributes to Cathy the $400 plus net income attributable to the contribution. No other contributions have been made to the IRA for 2005 and no distributions have been made.

The adjusted opening balance is $6,400 ($4,800 + $1,600) and the adjusted closing balance is $7,600. The net income due to the May 1, 2005, contribution is $75 ($400 x ($7,600 – $6,400) ÷ $6,400). Therefore, the total to be distributed on February 1, 2006, is $475. This is shown on the following worksheet.

Worksheet 1-4. Example—Illustrated

1.	Enter the amount of your IRA contribution for 2005 to be returned to you.	1.	400
2.	Enter the fair market value of the IRA immediately prior to the removal of the contribution, plus the amount of any distributions, transfers, and recharacterizations made while the contribution was in the IRA.	2.	7,600
3.	Enter the fair market value of the IRA immediately before the contribution was made, plus the amount of such contribution and any other contributions, transfers, and recharacterizations made while the contribution was in the IRA	3.	6,400
4.	Subtract line 3 from line 2.	4.	1,200
5.	Divide line 4 by line 3. Enter the result as a decimal (rounded to at least three places).	5.	.1875
6.	Multiply line 1 by line 5. This is the net income attributable to the contribution to be returned.	6.	75
7.	Add lines 1 and 6. This is the amount of the IRA contribution plus the net income attributable to it to be returned to you.	7.	475

Last-in first-out rule.   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.

Earnings Includible in Income

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 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. Excess contributions can also be recovered tax free as discussed under What Acts Result in Penalties or Additional Taxes, later.

Early Distributions Tax

The 10% additional tax on distributions made before you reach age 59½ 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 59½ rule, it will be subject to this tax. See Early Distributions under What Acts Result in Penalties or Additional Taxes, later.

Excess Contributions Tax

If any part of these contributions is an excess contribution for 2003, it is subject to a 6% excise tax. You will not have to pay the 6% tax if any 2003 excess contribution was withdrawn by April 15, 2004 (plus extensions), and if any 2004 excess contribution is withdrawn by April 15, 2005 (plus extensions). See Excess Contributions under What Acts Result in Penalties or Additional Taxes, later.

You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the contribution. See Recharacterizations earlier for more information.

When Must You Withdraw Assets? (Required Minimum Distributions)

You cannot keep funds in a 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, later under What Acts Result in Penalties or Additional Taxes. The requirements for distributing IRA funds differ, depending on whether you are the IRA owner or the beneficiary of a decedent's IRA.

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

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

IRA Owners

If you are the owner of a traditional IRA, you must start receiving distributions from your IRA by April 1 of the year following the year in which you reach age 70½. April 1 of the year following the year in which you reach age 70½ is referred to as the required beginning date.

Distributions by the required beginning date.   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.

Even if you begin receiving distributions before you reach age 70½, you must begin calculating and receiving required minimum distributions by your required beginning date.

More than minimum received.   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.

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

Example.

You reach age 70½ on August 20, 2004. For 2004, you must receive the required minimum distribution from your IRA by April 1, 2005. You must receive the required minimum distribution for 2005 by December 31, 2005.

If you do not receive your required minimum distribution for 2004 until 2005, both your 2004 and your 2005 distributions will be includible on your 2005 return.

Distributions from individual retirement account.   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.

Distributions from individual retirement annuities.   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, see Regulations section 1.401(a)(9)-6. These regulations can be read in many libraries and IRS offices.

Change in marital status.   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.

Change of beneficiary.   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.

Figuring the Owner's Required Minimum Distribution

Figure your required minimum distribution for each year by dividing the IRA account balance (defined next) as of the close of business on December 31 of the preceding year by the applicable distribution period or life expectancy.

IRA account balance.   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.   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.

Outstanding rollovers and recharacterizations.   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.   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.

Example 1.

Laura was born on October 1, 1934. She is an unmarried participant in a qualified defined contribution plan. She reaches age 70½ in 2005. Her required beginning date is April 1, 2006. As of December 31, 2004, her account balance was $26,500. No rollover or recharacterization amounts were outstanding. Using Table III in Appendix C, the applicable distribution period for someone her age (71) is 26.5 years. Her required minimum distribution for 2005 is $1,000 ($26,500 ÷ 26.5). That amount is distributed to her on April 1, 2006.

Example 2.

Joe, born October 1, 1933, reached 70½ in 2004. His wife (his beneficiary) turned 56 in September 2004. He must begin receiving distributions by April 1, 2005. Joe's IRA account balance as of December 31, 2003, is $30,100. Because Joe's wife is more than 10 years younger than Joe and is the sole beneficiary of his IRA, Joe uses Table II in Appendix C. Based on their ages at year end (December 31, 2004), the joint life expectancy for Joe (age 71) and his wife (age 56) is 30.1 years. The required minimum distribution for 2004, Joe's first distribution year (his 701/ year), is $1,000 ($30,100 ÷ 30.1). This amount is distributed to Joe on April 1, 2005.

Distribution period.   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.

Life expectancy.   If you must use Table I, your life expectancy for 2005 is listed in the table next to your age as of your birthday in 2005. If you use Table II, your life expectancy is listed where the row or column containing your age as of your birthday in 2005 intersects with the row or column containing your spouse's age as of his or her birthday in 2005. Both Table I and Table II are in Appendix C.

Distributions during your lifetime.   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 2005, divide your account balance at the end of 2004 by the distribution period from the table. This is the distribution period listed next to your age (as of your birthday in 2005) 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.

Example.

You own a traditional IRA. Your account balance at the end of 2004 was $100,000. You are married and your spouse, who is the sole beneficiary of your IRA, is 6 years younger than you. You turn 75 years old in 2005. You use Table III. Your distribution period is 22.9. Your required minimum distribution for 2005 is $4,367 ($100,000 ÷ 22.9).

Sole beneficiary spouse who is more than 10 years younger.   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 2005 intersects with the row or column containing your spouse's age as of his or her birthday in 2005.

  You figure your required minimum distribution for 2005 by dividing your account balance at the end of 2004 by the life expectancy from Table II (Joint Life and Last Survivor Expectancy) in Appendix C.

Example.

You own a traditional IRA. Your account balance at the end of 2004 was $100,000. You are married and your spouse, who is the sole beneficiary of your IRA, is 11 years younger than you. You turn 75 in 2005 and your spouse turns 64. You use Table II. Your joint life and last survivor expectancy is 23.6. Your required minimum distribution for 2005 is $4,237 ($100,000 ÷ 23.6).

Distributions in the year of the owner's death.   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).

Note.

You figure the required minimum distribution for the year in which an IRA owner dies as if the owner lived for the entire year.

IRA Beneficiaries

The rules for determining required minimum distributions for beneficiaries depend on whether the beneficiary is an individual. The rules for individuals are explained below. If the owner's beneficiary is not an individual (for example, if the beneficiary is the owner's estate), see Beneficiary not an individual, later.

Surviving spouse.   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).

Taking balance within 5 years.   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.

Owner Died On or After Required Beginning Date

If the owner died on or after his or her required beginning date, and you are the designated beneficiary, you generally must base required minimum distributions for years after the year of the owner's death on the longer of:

• Your single life expectancy as shown on Table I, or

• The owner's life expectancy as determined under Death on or after required beginning date, under Beneficiary not an individual, later.

Owner Died Before Required Beginning Date

If the owner died before his or her required beginning date, base required minimum distributions for years after the year of the owner's death generally on your single life expectancy.

If the owner's beneficiary is not an individual (for example, if the beneficiary is the owner's estate), see Beneficiary not an individual, later.

Date the designated beneficiary is determined.   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.

Death of a 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.

Death of surviving spouse.   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.

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

Figuring the Beneficiary's Required Minimum Distribution

How you figure the required minimum distribution depends on whether the beneficiary is an individual or some other entity, such as a trust or estate.

Beneficiary an individual.   If the beneficiary is an individual, to figure the required minimum distribution for 2005, divide the account balance at the end of 2004 by the appropriate life expectancy from Table I (Single Life Expectancy) in Appendix C. Determine the appropriate life expectancy as follows.

• Spouse as sole designated beneficiary. Use the life expectancy listed in the table next to the spouse's age (as of the spouse's birthday in 2005). If the owner died before the year in which he or she reached age 70½, distributions to the spouse do not need to begin until the year in which the owner would have reached age 70½.

• Other designated beneficiary. Use the life expectancy listed in the table next to the beneficiary's age as of his or her birthday in the year following the year of the owner's death, reduced by one for each year since the year following the owner's death.

Example.

Your father died in 2004. You are the designated beneficiary of your father's traditional IRA. You are 53 years old in 2005. You use Table I and see that your life expectancy in 2005 is 31.4. If the IRA was worth $100,000 at the end of 2004, your required minimum distribution for 2005 is $3,185 ($100,000 ÷ 31.4). If the value of the IRA at the end of 2005 was again $100,000, your required minimum distribution for 2006 would be $3,289 ($100,000 ÷ 30.4). Instead of taking yearly distributions, you could choose to take the entire distribution in 2009 or earlier.

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

• Death on or after required beginning date. Divide the account balance at the end of 2003 by the appropriate life expectancy from Table I (Single Life Expectancy) in Appendix C. Use the life expectancy listed next to the owner's age as of his or her birthday in the year of death, reduced by one for each year since the year of death.

• Death before required beginning date. The entire account must be distributed by the end of the fifth year following the year of the owner's death. No distribution is required for any year before that fifth year.

Example.

The owner died in 2004 at the age of 80. The owner's traditional IRA went to his estate. The account balance at the end of 2004 was $100,000. In 2005, the required minimum distribution was $10,870 ($100,000 ÷ 9.2). (The owner's life expectancy in the year of death, 10.2, reduced by one.) If the owner had died in 2004 at the age of 70, the entire account would have to be distributed by the end of 2009.

Which Table Do You Use To Determine Your Required Minimum Distribution?

There are three different tables. You use only one of them to determine your required minimum distribution for each traditional IRA. Determine which one to use as follows.

Reminder.

In using the tables for lifetime distributions, marital status is determined as of January 1 each year. Divorce or death after January 1 is generally disregarded until the next year. However, if you divorce and change the beneficiary designation in the same year, your former spouse cannot be considered your sole beneficiary for that year.

Table I (Single Life Expectancy).   Use Table I for years after the year of the owner's death if either of the following apply.

• You are an individual and a designated beneficiary, but not both the owner's surviving spouse and sole designated beneficiary.

• You are not an individual and the owner died on or after the required beginning date.

Surviving spouse.   If you are the owner's surviving spouse and sole designated beneficiary, and the owner had not reached age 70½ when he or she died, and you do not elect to be treated as the owner of the IRA, you do not have to take distributions (and use Table I) until the year in which the owner would have reached age 70½.

Table II (Joint Life and Last Survivor Expectancy).   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.

Note.

Use this table in the year of the owner's death if the owner died after the required beginning date and this is the table that would have been used had he or she not died.

Table III (Uniform Lifetime).   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.

Note.

Use this table in the year of the owner's death if the owner died after the required beginning date and this is the table that would have been used had he or she not died.

No table.   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.

5-year rule.   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.

What Age(s) Do You Use With the Table(s)?

The age or ages to use with each table are explained below.

Table I (Single Life Expectancy).   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.

Example.

You are the owner's designated beneficiary figuring your first required minimum distribution. Distributions must begin in 2005. You become 57 years old in 2005. You use Table I. Your distribution period for 2005 is 27.9 years. Your distribution period for 2006 is 26.9 (27.9 - 1). Your distribution period for 2007 is 25.9 (27.9 - 2).

No designated beneficiary.   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.

Table II (Joint Life and Last Survivor Expectancy).   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 2005, use your ages as of your birthdays in 2005. For each subsequent year, use your and your spouse's ages as of your birthdays in the subsequent year.

Table III (Uniform Lifetime).   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 2005, use your age as of your birthday in 2005. For each subsequent year, use your age as of your birthday in the subsequent year.

Miscellaneous Rules for Required Minimum Distributions

The following rules may apply to you.

Installments allowed.   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.

More than one IRA.   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.

Example.

Sara, born August 1, 1933, became 70½ on February 1, 2004. She has two traditional IRAs. She must begin receiving her IRA distributions by April 1, 2005. On December 31, 2003, Sara's account balance from IRA A was $10,000; her account balance from IRA B was $20,000. Sara's brother, age 64 as of his birthday in 2004, is the beneficiary of IRA A. Her husband, age 78 as of his birthday in 2004, is the beneficiary of IRA B.

Sara's required minimum distribution from IRA A is $377 ($10,000 ÷ 26.5 (the distribution period for age 71 per Table III)). The amount of the required minimum distribution from IRA B is $755 ($20,000 ÷ 26.5). The amount that must be withdrawn by Sara from her IRA accounts by April 1, 2005, is $1,132 ($377 + $755).

More than minimum received.   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.

Example.

Justin became 70½ on December 15, 2004. Justin's IRA account balance on December 31, 2003, was $38,400. He figured his required minimum distribution for 2004 was $1,401 ($38,400 ÷ 27.4). By December 31, 2004, he had actually received distributions totaling $3,600, $2,199 more than was required. Justin cannot use that $2,199 to reduce the amount he is required to withdraw for 2005, but his IRA account balance is reduced by the full $3,600 to figure his required minimum distribution for 2005. Justin's reduced IRA account balance on December 31, 2004, was $34,800. Justin figured his required minimum distribution for 2005 is $1,313 ($34,800 ÷ 26.5). During 2005, he must receive distributions of at least that amount.

Multiple individual beneficiaries.   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.

• All of the beneficiaries are individuals, and

• The account or benefit has not been divided into separate accounts or shares for each beneficiary.

Separate accounts.   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.

Trust as beneficiary.   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.

1. The trust is a valid trust under state law, or would be but for the fact that there is no corpus.

2. The trust is irrevocable or will, by its terms, become irrevocable upon the death of the owner.

3. The beneficiaries of the trust who are beneficiaries with respect to the trust's interest in the owner's benefit are identifiable from the trust instrument.

4. The IRA trustee, custodian, or issuer has been provided with either a copy of the trust instrument with the agreement that if the trust instrument is amended, the administrator will be provided with a copy of the amendment within a reasonable time, or all of the following.

   1. A list of all of the beneficiaries of the trust (including contingent and remaindermen beneficiaries with a description of the conditions on their entitlement).

   2. Certification that, to the best of the owner's knowledge, the list is correct and complete and that the requirements of (1), (2), and (3) above, are met.

   3. An agreement that, if the trust instrument is amended at any time in the future, the owner will, within a reasonable time, provide to the IRA trustee, custodian, or issuer corrected certifications to the extent that the amendment changes any information previously certified.

   4. An agreement to provide a copy of the trust instrument to the IRA trustee, custodian, or issuer upon demand.

  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.

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

Are Distributions Taxable?

In general, distributions from a traditional IRA are taxable in the year you receive them.

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

• Rollovers,

• 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 rule that distributions from a traditional IRA are taxable in the year you receive them. Conversion distributions are includible in your gross income subject to this rule and the special rules for conversions explained earlier and in chapter 2.

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 and Withholding Requirements for Taxable Amounts, 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 2004, and your total IRA basis for 2004 and earlier years. See the illustrated Forms 8606 in this chapter.

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. Complete Form 8606, sign it, and send it to the IRS at the time and place you would otherwise file an income tax return.

Figuring the Nontaxable and Taxable Amounts

If your traditional IRA includes nondeductible contributions and you received a distribution from it in 2004, you must use Form 8606 to figure how much of your 2004 IRA distribution is tax free.

Contribution and distribution in the same year.   If you received a distribution in 2004 from a traditional IRA and you also made contributions to a traditional IRA for 2004 that may not be fully deductible because of the income limits, you can use Worksheet 1-5 to figure how much of your 2004 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.

Reporting your nontaxable distribution on Form 8606.   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.

• Use the IRA Deduction Worksheet in the Form 1040 or 1040A instructions to figure your deductible contributions to traditional IRAs to report on line 25 of Form 1040 or line 17 of Form 1040A.

• After you complete the IRA deduction worksheet in the form instructions, enter your nondeductible contributions to traditional IRAs on line 1 of Form 8606.

• Complete lines 2 through 5 of Form 8606.

• If line 5 of Form 8606 is less than line 8 of Worksheet 1-5, complete lines 6 through 15 of Form 8606 and stop here.

• If line 5 of Form 8606 is equal to or greater than line 8 of Worksheet 1-5, follow instructions 6 and 7, next. Do not complete lines 6 through 12 of Form 8606.

• Enter the amount from line 8 of Worksheet 1-5 on lines 13 and 17 of Form 8606.

• Complete line 14 of Form 8606.

• Enter the amount from line 9 of Worksheet 1-5 (or, if you entered an amount on line 11, the amount from that line) on line 15 of Form 8606.

Example.

Rose Green has made the following contributions to her traditional IRAs.

Year	Deductible	Nondeductible
1997	$2,000	–0–
1998	2,000	–0–
1999	2,000	–0–
2000	1,000	–0–
2001	1,000	–0–
2002	1,000	–0–
2003	700	$ 300
Totals	$9,700	$ 300

In 2004, Rose, whose IRA deduction for that year may be reduced or eliminated, makes a $2,000 contribution that may be partly nondeductible. She also receives a distribution of $5,000 for conversion to a Roth IRA. She completed the conversion before December 31, 2004, and did not recharacterize any contributions. At the end of 2004, the fair market values of her accounts, including earnings, total $20,000. She did not receive any tax-free distributions in earlier years. The amount she includes in income for 2004 is figured on Worksheet 1-5, Figuring the Taxable Part of Your IRA Distribution—Illustrated.

The Form 8606 for Rose, illustrated, shows the information required when you need to use Worksheet 1-5 to figure your nontaxable distribution. Assume that the $500 entered on Form 8606, line 1 is the amount Rose figured using instructions 1 and 2 given earlier under Reporting your nontaxable distribution on Form 8606.

Recognizing Losses on Traditional IRA Investments

If you have a loss on your traditional IRA investment, you can recognize (include) the loss on your income tax return, but only when all the amounts in all your traditional IRA accounts have been distributed to you and the total distributions are less than your unrecovered basis, if any. Your basis is the total amount of the nondeductible contributions in your traditional IRAs. You claim the loss as a miscellaneous itemized deduction, subject to the 2%-of-adjusted-gross-income limit that applies to certain miscellaneous itemized deductions on Schedule A, Form 1040.

Example.

Bill King has made nondeductible contributions to a traditional IRA totaling $2,000, giving him a basis at the end of 2003 of $2,000. By the end of 2004, his IRA earns $400 in interest income. In that year, Bill receives a distribution of $600 ($500 basis + $100 interest), reducing the value of his IRA to $1,800 ($2,000 + 400 - 600) at year's end. Bill figures the taxable part of the distribution and his remaining basis on Form 8606 (illustrated).

In 2005, Bill's IRA has a loss of $500. At the end of that year, Bill's IRA balance is $1,300 ($1,800 - 500). Bill's remaining basis in his IRA is $1,500 ($2,000 - 500). Bill receives the $1,300 balance remaining in the IRA. He can claim a loss for 2005 of $200 (the $1,500 basis minus the $1,300 distribution of the IRA balance).

Other Special IRA Distribution Situations

Two other special IRA distribution situations are discussed below.

Distribution of an annuity contract from your IRA account.   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.

Tax treatment.   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.

Cashing in retirement bonds.   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.

Reporting and Withholding Requirements for Taxable Amounts

If you receive a distribution from your traditional IRA, you will receive Form 1099-R, 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.

Number codes.   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 2004.

If code 1, 5, or 8 appears on your Form 1099-R, you are probably subject to a penalty or additional tax. If code 1 appears, see Early Distributions, later. If code 5 appears, see Prohibited Transactions, later. If code 8 appears, see Excess Contributions, later.

Letter codes.   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 2002.

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.

N—Recharacterized IRA contribution made for 2004 and recharacterized in 2004.

P—Excess contributions plus earnings/ excess deferrals taxable in 2003.

Q—Roth IRA qualified distribution.

R—Recharacterized IRA contribution made for 2003 and recharacterized in 2004.

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.”

If code D, J, P, or S appears on your Form 1099-R, you are probably subject to a penalty or additional tax. If code D appears, see Excess Contributions, later. If code J appears, see Early Distributions, later. If code P appears, see Excess Contributions, later. If code S appears, see Additional Tax on Early Distributions in chapter 3.

Withholding.   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.

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.

  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.

More information.   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.

Reporting taxable distributions on your return.   Report fully taxable distributions, including early distributions, on Form 1040, line 15b (no entry is required on line 15a), or Form 1040A, line 11b. If only part of the distribution is taxable, enter the total amount on Form 1040, line 15a (or Form 1040A, line 11a), and the taxable part on line 15b (or line 11b). You cannot report distributions on Form 1040EZ.

Estate tax.   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.

Form 8606 - Rose Green

Form 8606 - Page 2 - Rose Green

Worksheet 1-5. Figuring the Taxable Part of Your IRA Distribution Use only if you made contributions to a traditional IRA for 2004 and have to figure the taxable part of your 2004 distributions to determine your modified AGI. See Limit If Covered By Employer Plan. Form 8606 and the related instructions will be needed when using this worksheet. Note. When used in this worksheet, the term outstanding rollover refers to an amount distributed from a traditional IRA as part of a rollover that, as of December 31, 2004, had not yet been reinvested in another traditional IRA, but was still eligible to be rolled over tax free.

1.	Enter the basis in your traditional IRA(s) as of December 31, 2003	1.
2.	Enter the total of all contributions made to your traditional IRAs during 2004 and all contributions made during 2005 that were for 2004, whether or not deductible. Do not include rollover contributions properly rolled over into IRAs. Also, do not include certain returned contributions described in the instructions for line 7, Part I, of Form 8606.	2.
3.	Add lines 1 and 2	3.
4.	Enter the value of all your traditional IRA(s) as of December 31, 2004 (include any outstanding rollovers from traditional IRAs to other traditional IRAs)	4.
5.	Enter the total distributions from traditional IRAs (including amounts converted to Roth IRAs that will be shown on line 16 of Form 8606) received in 2004. (Do not include outstanding rollovers included on line 4 or any rollovers between traditional IRAs completed by December 31, 2004. Also, do not include certain returned contributions described in the instructions for line 7, Part I, of Form 8606.)	5.
6.	Add lines 4 and 5	6.
7.	Divide line 3 by line 6. Enter the result as a decimal (rounded to at least three places). If the result is 1.000 or more, enter 1.000	7.
8.	Nontaxable portion of the distribution. Multiply line 5 by line 7. Enter the result here and on lines 13 and 17 of Form 8606	8.
9.	Taxable portion of the distribution (before adjustment for conversions). Subtract line 8 from line 5. Enter the result here and if there are no amounts converted to Roth IRAs, stop here and enter the result on line 15 of Form 8606	9.
10.	Enter the amount included on line 9 that is allocable to amounts converted to Roth IRAs by December 31, 2004. (See Note at the end of this worksheet.) Enter here and on line 18 of Form 8606	10.
11.	Taxable portion of the distribution (after adjustments for conversions). Subtract line 10 from line 9. Enter the result here and on line 15 of Form 8606	11.
Note.If the amount on line 5 of this worksheet includes an amount converted to a Roth IRA by December 31, 2004, you must determine the percentage of the distribution allocable to the conversion. To figure the percentage, divide the amount converted (from line 16 of Form 8606) by the total distributions shown on line 5. To figure the amounts to include on line 10 of this worksheet and on line 18, Part II of Form 8606, multiply line 9 of the worksheet by the percentage you figured.

Worksheet 1-5. Figuring the Taxable Part of Your IRA Distribution—Illustrated Use only if you made contributions to a traditional IRA for 2004 and have to figure the taxable part of your 2004 distributions to determine your modified AGI. See Limit If Covered By Employer Plan. Form 8606 and the related instructions will be needed when using this worksheet. Note. When used in this worksheet, the term outstanding rollover refers to an amount distributed from a traditional IRA as part of a rollover that, as of December 31, 2004, had not yet been reinvested in another traditional IRA, but was still eligible to be rolled over tax free.

1.	Enter the basis in your traditional IRA(s) as of December 31, 2003	1.	300
2.	Enter the total of all contributions made to your traditional IRAs during 2004 and all contributions made during 2005 that were for 2004, whether or not deductible. Do not include rollover contributions properly rolled over into IRAs. Also, do not include certain returned contributions described in the instructions for line 7, Part I, of Form 8606.	2.	2,000
3.	Add lines 1 and 2	3.	2,300
4.	Enter the value of all your traditional IRA(s) as of December 31, 2004 (include any outstanding rollovers from traditional IRAs to other traditional IRAs)	4.	20,000
5.	Enter the total distributions from traditional IRAs (including amounts converted to Roth IRAs that will be shown on line 16 of Form 8606) received in 2004. (Do not include outstanding rollovers included on line 4 or any rollovers between traditional IRAs completed by December 31, 2004. Also, do not include certain returned contributions described in the instructions for line 7, Part I, of Form 8606.)	5.	5,000
6.	Add lines 4 and 5	6.	25,000
7.	Divide line 3 by line 6. Enter the result as a decimal (rounded to at least three places). If the result is 1.000 or more, enter 1.000	7.	.092
8.	Nontaxable portion of the distribution. Multiply line 5 by line 7. Enter the result here and on lines 13 and 17 of Form 8606	8.	460
9.	Taxable portion of the distribution (before adjustment for conversions). Subtract line 8 from line 5. Enter the result here and if there are no amounts converted to Roth IRAs, stop here and enter the result on line 15 of Form 8606	9.	4,540
10.	Enter the amount included on line 9 that is allocable to amounts converted to Roth IRAs by December 31, 2004. (See Note at the end of this worksheet.) Enter here and on line 18 of Form 8606	10.	4,540
11.	Taxable portion of the distribution (after adjustments for conversions). Subtract line 10 from line 9. Enter the result here and on line 15 of Form 8606	11.	0
Note. If the amount on line 5 of this worksheet includes an amount converted to a Roth IRA by December 31, 2004, you must determine the percentage of the distribution allocable to the conversion. To figure the percentage, divide the amount converted (from line 16 of Form 8606) by the total distributions shown on line 5. To figure the amounts to include on line 10 of this worksheet and on line 18, Part II of Form 8606, multiply line 9 of the worksheet by the percentage you figured.

Form 8606 - Bill King $100

What Acts Result in Penalties or Additional Taxes?

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. 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 Form 8606, if required.

This chapter discusses those acts that you should avoid and the additional taxes and other costs, including loss of IRA status, that apply if you do not avoid those acts.

Prohibited Transactions

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

Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).

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.

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

• Exercises any discretionary authority or discretionary control in managing your IRA or exercises any authority or control in managing or disposing of its assets.

• Provides investment advice to your IRA for a fee, or has any authority or responsibility to do so.

• Has any discretionary authority or discretionary responsibility in administering your IRA.

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 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.

Borrowing on an annuity contract.   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.

Pledging an account as security.   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.

Trust account set up by an employer or an employee association.   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.

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

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.

Loss of IRA status.   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.

Exempt Transactions

The following two types of transactions are not prohibited transactions if they meet the requirements that follow.

• Payments of cash, property, or other consideration by the sponsor of your traditional IRA to you (or members of your family).

• Your receipt of services at reduced or no cost from the bank where your traditional IRA is established or maintained.

Payments of cash, property, or other consideration.   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.

1. The payments are for establishing a traditional IRA or for making additional contributions to it.

2. The IRA is established solely to benefit you, your spouse, and your or your spouse's beneficiaries.

3. During the year, the total fair market value of the payments you receive is not more than:

   1. $10 for IRA deposits of less than $5,000, or

   2. $20 for IRA deposits of $5,000 or more.

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.

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

• The traditional IRA qualifying you to receive the services is established and maintained for the benefit of you, your spouse, and your or your spouse's beneficiaries.

• The bank itself can legally offer the services.

• The services are provided in the ordinary course of business by the bank (or a bank affiliate) to customers who qualify but do not maintain an IRA (or a Keogh plan).

• The determination, for a traditional IRA, of who qualifies for these services is based on an IRA (or a Keogh plan) deposit balance equal to the lowest qualifying balance for any other type of account.

• The rate of return on a traditional IRA investment that qualifies is not less than the return on an identical investment that could have been made at the same time at the same branch of the bank by a customer who is not eligible for (or does not receive) these services.

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 IRAs for the year that is more than the smaller of:

• $3,000 ($3,500 if 50 or older), or

• Your taxable compensation for the year.

The taxable compensation limit applies whether your contributions are deductible or nondeductible.

Contributions for the year you reach age 70½ and any later year are also excess contributions.

An excess contribution could be the result of your contribution, your spouse's contribution, your employer's contribution, or an improper rollover contribution. If your employer makes contributions on your behalf to a SEP-IRA, see Publication 560.

Tax on Excess Contributions

In general, if the excess contributions for a year 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.

The additional tax is figured on Form 5329. For information on filing Form 5329, see Reporting Additional Taxes, later.

Example.

For 2004, Paul Jones is 45 years old and single, his compensation is $31,000, and he contributed $3,500 to his traditional IRA. Paul has made an excess contribution to his IRA of $500 ($3,500 minus the $3,000 limit). The contribution earned $5 interest in 2004 and $6 interest in 2005 before the due date of the return, including extensions. He does not withdraw the $500 or the interest it earned by the due date of his return, including extensions.

Paul figures his additional tax for 2004 by multiplying the excess contribution ($500) shown on Form 5329, line 16, by .06, giving him an additional tax liability of $30. He enters the tax on Form 5329, line 17, and on Form 1040, line 59. See Paul's filled-in Form 5329.

Form 5329, page 1 Paul Jones

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 any 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 of the following conditions are met.

• No deduction was allowed for the excess contribution.

• 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 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.

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.

Form 1099-R.   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.

Example.

Maria, age 35, made an excess contribution in 2004 of $1,000, which she withdrew by April 15, 2005, the due date of her return. At the same time, she also withdrew the $50 income that was earned on the $1,000. She must include the $50 in her gross income for 2004 (the year in which the excess contribution was made). She must also pay an additional tax of $5 (the 10% additional tax on early distributions because she is not yet 59½ years old), but she does not have to report the excess contribution as income or pay the 6% excise tax. Maria receives a Form 1099-R showing that the earnings are taxable for 2004.

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.

• Total contributions (other than rollover contributions) for 2004 to your IRA were not more than $3,000 ($3,500 if 50 or older).

• 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 not more than the maximum deductible amount for that year ($2,000 for 2001 and earlier years, $3,000 for 2002 and 2003 ($3,500 for 2002 and 2003 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.

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.

Deducting an Excess Contribution in a Later Year

You cannot apply an excess contribution to an earlier year even if you contributed less than the maximum amount allowable for the earlier year. However, you may be able to apply it to a later year if the contributions for that later year are less than the maximum allowed for that year.

You can deduct excess contributions for previous years that are still in your traditional IRA. The amount you can deduct this year is the lesser of the following two amounts.

• Your maximum IRA deduction for this year minus any amounts contributed to your traditional IRAs for this year.

• The total excess contributions in your IRAs at the beginning of this year.

This method lets you avoid making a withdrawal. It does not, however, let you avoid the 6% tax on any excess contributions remaining at the end of a tax year.

To figure the amount of excess contributions for previous years that you can deduct this year, see Worksheet 1-6.

Worksheet 1-6. Excess Contributions Deductible This Year

Use this worksheet to figure the amount of excess contributions from prior years you can deduct this year.

1.	Maximum IRA deduction for the current year	1.
2.	IRA contributions for the current year	2.
3.	Subtract line 2 from line 1. If zero (0) or less, enter zero	3.
4.	Excess contributions in IRA at beginning of year	4.
5.	Enter the lesser of line 3 or line 4. This is the amount of excess contributions for previous years that you can deduct this year	5.

Example.

Teri was entitled to contribute to her traditional IRA and deduct $1,000 in 2003 and $1,500 in 2004 (the amounts of her taxable compensation for these years). For 2003, she actually contributed $1,400 but could deduct only $1,000. In 2003, $400 is an excess contribution subject to the 6% tax. However, she would not have to pay the 6% tax if she withdrew the excess (including any earnings) before the due date of her 2003 return. Because Teri did not withdraw the excess, she owes excise tax of $24 for 2003. To avoid the excise tax for 2004, she can correct the $400 excess amount from 2003 in 2004 if her actual contributions are only $1,100 for 2004 (the allowable deductible contribution of $1,500 minus the $400 excess from 2003 she wants to treat as a deductible contribution in 2004). Teri can deduct $1,500 in 2004 (the $1,100 actually contributed plus the $400 excess contribution from 2003). This is shown on the following worksheet.

Worksheet 1-6. Example—Illustrated

Use this worksheet to figure the amount of excess contributions from prior years you can deduct this year.

1.	Maximum IRA deduction for the current year	1.	1,500
2.	IRA contributions for the current year	2.	1,100
3.	Subtract line 2 from line 1. If zero (0) or less, enter zero	3.	400
4.	Excess contributions in IRA at beginning of year	4.	400
5.	Enter the lesser of line 3 or line 4. This is the amount of excess contributions for previous years that you can deduct this year	5.	400

Closed tax year.   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.

1.	Maximum IRA deduction for the current year	1.
2.	IRA contributions for the current year	2.
3.	If line 2 is less than line 1, enter any excess contributions that were deducted in a closed tax year. Otherwise, enter zero (0)	3.
4.	Subtract line 3 from line 1	4.
5.	Subtract line 2 from line 4. If zero (0) or less, enter zero	5.
6.	Excess contributions in IRA at beginning of year	6.
7.	Enter the lesser of line 5 or line 6. This is the amount of excess contributions for previous years that you can deduct this year	7.

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, as discussed later.

Early distributions defined.   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.

Age 59½ Rule

Generally, if you are under age 59½, 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 59½ 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.

A number of exceptions to this rule are discussed below under Exceptions. Also see Contributions Returned Before Due Date of Return, earlier.

You may have to pay a 25%, rather than 10%, additional tax if you receive distributions from a SIMPLE IRA before you are age 59½. See Additional Tax on Early Distributions under When Can You Withdraw or Use Assets? in chapter 3.

After age 59½ and before age 70½.   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.

Exceptions

There are several exceptions to the age 59½ rule. Even if you receive a distribution before you are age 59½, 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 below.

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, earlier.) This also applies to transfers incident to divorce, as discussed earlier under Can You Move Retirement Plan Assets.

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

• The amount you paid for unreimbursed medical expenses during the year of the distribution, minus

• 7.5% of your adjusted gross income (defined later) for the year of the distribution.

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.

Adjusted gross income.   This is the amount on Form 1040, line 37, or Form 1040A, line 22.

Medical insurance.   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 of the following conditions apply.

• You lost your job.

• You received unemployment compensation paid under any federal or state law for 12 consecutive weeks because you lost your job.

• You receive the distributions during either the year you received the unemployment compensation or the following year.

• You receive the distributions no later than 60 days after you have been reemployed.

Disabled.   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.

Beneficiary.   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.

Annuity.   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.

One-time switch.   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.

Higher education expenses.   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.

• Payment for services, such as wages.

• A loan.

• A gift.

• An inheritance given to either the student or the individual making the withdrawal.

• A withdrawal from personal savings (including savings from a qualified tuition program).

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

• Tax-free distributions from a Coverdell education savings account.

• Tax-free part of scholarships and fellowships.

• Pell grants.

• Employer-provided educational assistance.

• Veterans' educational assistance.

• Any other tax-free payment (other than a gift or inheritance) received as educational assistance.

Qualified higher education expenses.   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.

Eligible educational institution.   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.

First home.   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.

1. It must be used to pay qualified acquisition costs (defined later) before the close of the 120th day after the day you received it.

2. It must be used to pay qualified acquisition costs for the main home of a first-time homebuyer (defined later) who is any of the following.

   1. Yourself.

   2. Your spouse.

   3. Your or your spouse's child.

   4. Your or your spouse's grandchild.

   5. Your or your spouse's parent or other ancestor.

3. When added to all your prior qualified first-time homebuyer distributions, if any, the total distributions cannot be more than $10,000.

  

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.   Qualified acquisition costs include the following items.

• Costs of buying, building, or rebuilding a home.

• Any usual or reasonable settlement, financing, or other closing costs.

First-time homebuyer.   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.

Date of acquisition.   The date of acquisition is the date that:

• You enter into a binding contract to buy the main home for which the distribution is being used, or

• The building or rebuilding of the main home for which the distribution is being used begins.

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. (See Excess Contributions Withdrawn by Due Date of Return, and Excess Contributions Withdrawn After Due Date of Return, earlier.) This also applies to transfers incident to divorce, as discussed under Can You Move Retirement Plan Assets, earlier.

Receivership distributions.   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.

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.

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

Example.

Tom Jones, who is 35 years old, receives a $3,000 distribution from his traditional IRA account. Tom does not meet any of the exceptions to the 10% additional tax, so the $3,000 is an early distribution. Tom never made any nondeductible contributions to his IRA. He must include the $3,000 in his gross income for the year of the distribution and pay income tax on it. Tom must also pay an additional tax of $300 (10% × $3,000). He files Form 5329. See the filled-in Form 5329.

Form 5329, page 1 Tom Jones

Early distributions of funds from a SIMPLE retirement account made within 2 years of beginning participation in the SIMPLE are subject to a 25%, rather than 10%, early distributions tax.

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).

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

Tax on excess.   If distributions are less than the required minimum distribution for the year, 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.

Reporting the tax.   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.

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.

• File Form 5329 with your Form 1040.

• Pay any tax you owe on excess accumulations.

• 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 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.

Conditions.   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 defined.   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.

Requirements.   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.

Available portion.   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.

Make up of shortfall in distribution.   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.

Reporting Additional Taxes

Generally, you must use Form 5329 to report the tax on excess contributions, early distributions, and excess accumulations. If you must file Form 5329, you cannot use Form 1040A or Form 1040EZ.

Filing a tax return.   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 Form 1040, line 59.

Not filing a tax return.   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 “2004 Form 5329” on your check or money order.

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

• Distribution code 1 (early distribution) is correctly 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 Form 1040, line 59. Put “No” to the left of line 59 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.

• If you rolled over part or all of a distribution from a qualified retirement plan, the part rolled over is not subject to the tax on early distributions.

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