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 $8,000 ($8,500 if only one of you is age 50 or older or $9,000 if both of you are age 50 or older). For 2006, combined total contributions can be as much as $8,000 ($9,000 if only one of you is age 50 or older or $10,000 if both of you are age 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 2006, 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 $75,000 but less than $85,000 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.

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 2005 and received a distribution from your IRA in 2005, see Both contributions for 2005 and distributions in 2005, 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.

• Domestic production activities 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 2005 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 2005 and distributions in 2005.   If all three of the following apply, any IRA distributions you received in 2005 may be partly tax free and partly taxable.

• You received distributions in 2005 from one or more traditional IRAs,

• You made contributions to a traditional IRA for 2005, 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 32 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 2005.

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 2006 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.

If you made IRA contributions in 2005, 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.

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 2005 that are returned to you, use Worksheet 1-4. See Regulations section 1.408-11 for more information.

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.

Excess Contributions Tax

If any part of these contributions is an excess contribution for 2004, it is subject to a 6% excise tax. You will not have to pay the 6% tax if any 2004 excess contribution was withdrawn by April 15, 2005 (plus extensions), and if any 2005 excess contribution is withdrawn by April 17, 2006 (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.

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.

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.

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.

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

The following rules may apply to you.

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

If your traditional IRA includes nondeductible contributions and you received a distribution from it in 2005, you must use Form 8606 to figure how much of your 2005 IRA distribution is tax free.

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.

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. Any such losses are added back to taxable income for purposes of calculating the alternative minimum tax.

Two other special IRA distribution situations are discussed below.

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 2a of Form 1099-R. A number or letter code in box 7 tells you what type of distribution you received from your IRA.

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.

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.

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

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.

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.

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 38, 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 6. 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 up to $10,000 of 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, total qualifying 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.

Hurricane relief.   If you received a distribution to buy, build, or rebuild a first home, but did not buy, build, or rebuild the home because of Hurricane Katrina, Rita, or Wilma, you may be able to repay the distribution and not pay income tax or the 10% additional tax on early distributions. See Repayment of a Qualified Distribution for the Purchase or Construction of a Main Home in chapter 4.

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.

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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).

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.

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.