DEDUCTIBILITY OF CONTRIBUTIONS

<body topmargin=0 leftmargin=0 marginheight=0 marginwidth=0> <table cellpadding=0 cellspacing=0 border=0><tr> <td valign="top" colspan=2 height=90 BGCOLOR="#006699" TEXT="#080000" bgproperties="fixed" background="0be285a1erlcgo.gif"> <div> <FONT SIZE="5" COLOR="#FFCC66" FACE="Arial" ><B>INDIVIDUAL RETIREMENT ACCOUNTS</B></FONT><B>     |     </B><A HREF="index.htm" TARGET="_top" TITLE="INDIVIDUAL RETIREMENT ACCOUNTS"><U><B>home</B></U></A></div> <div> <A HREF="id22.htm" TARGET="_top" TITLE="TRADITIONAL IRAs"><U>TRADITIONAL  IRAs</U></A>   |   <A HREF="id23.htm" TARGET="_top" TITLE="ROTH IRAs"><U>ROTH IRAs</U></A>   |   <A HREF="id24.htm" TARGET="_top" TITLE="SIMPLIFIED EMPLOYEE PENSIONS (SEPIRAs)"><U>SIMPLIFIED EMPLOYEE PENSIONS (SEP-IRAs)</U></A>   |   <A HREF="id26.htm" TARGET="_top" TITLE="SIMPLE IRAs"><U>SIMPLE IRAs</U></A>   |   <A HREF="id25.htm" TARGET="_top" TITLE="IRA Custodians"><U>IRA Custodians</U></A>   |   <A HREF="id72.htm" TARGET="_top" TITLE="Savers Credit"><U>Saver's Credit</U></A>   |   <A HREF="id89.htm" TARGET="_top" TITLE="REVIEW QUESTIONS"><U>REVIEW QUESTIONS</U></A>   |   <A HREF="id50.htm" TARGET="_top" TITLE="PRINTABLE VERSION"><U>PRINTABLE VERSION</U></A></div> <div> </div> </td> </tr><tr> <td valign="top" width=210 BGCOLOR="#FFCC66" TEXT="#080000" background="0bdd2c00dkelyh.gif"> <div> <A HREF="http://www.wallstreetinstructors.com" TARGET="_top" TITLE="http://www.wallstreetinstructors.com"><U><IMG SRC="0caaf630.gif" border=0 width="175" height="99" ALIGN="BOTTOM" HSPACE="0" VSPACE="0"></U></A></div> <div> copyright © 2002-2007 Wall Street Instructors, Inc.  All rights reserved.  </div> <bR> <div> <TABLE BORDER="2" CELLPADDING="2" CELLSPACING="1" WIDTH="164" BORDERCOLORLIGHT="#C0C0C0" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#FFFFFF > <tR> <tD VALIGN=TOP HEIGHT= 20 ><NOBR><div> <A HREF="mailto:instructor@wallstreetinstructors.com" TARGET="_top" TITLE="mailto:instructor@wallstreetinstructors."><U><B>E-Mail An Instructor</B></U></A></div> </NOBR></tD> </tR> </TABLE></div> <bR> <DIV ALIGN="LEFT"></DIV> <div> <B>Module 1</B></div> <div> <B>TRADITIONAL IRAs</B></div> <div> <B>__________________</B></div> <bR> <div> <A HREF="id65.htm" TARGET="_top" TITLE="ESTABLISHING AN IRA"><U><B>ESTABLISHING AN IRA</B></U></A></div> <div> <A HREF="id67.htm" TARGET="_top" TITLE="IRA CONTRIBUTIONS"><U><B>IRA CONTRIBUTIONS</B></U></A></div> <div> <B>DEDUCTIBILITY OF CONTRIBUTIONS</B></div> <div> <A HREF="id66.htm" TARGET="_top" TITLE="IRA INVESTMENTS"><U><B>IRA INVESTMENTS</B></U></A></div> <div> <A HREF="id71.htm" TARGET="_top" TITLE="IRA BENEFICIARIES"><U><B>IRA BENEFICIARIES</B></U></A></div> <div> <A HREF="id69.htm" TARGET="_top" TITLE="IRA DISTRIBUTIONS"><U><B>IRA DISTRIBUTIONS</B></U></A></div> <div> <A HREF="id70.htm" TARGET="_top" TITLE="INDIVIDUAL RETIREMENT ANNUITIES"><U><B>INDIVIDUAL RETIREMENT ANNUITIES</B></U></A></div> <div> <A HREF="id91.htm" TARGET="_top" TITLE="Review Questions Module 1"><U><B>Review Questions Module 1</B></U></A></div> <bR> <bR> <bR> </td> <td valign="top" height=390 BGCOLOR="#FFFFFF" TEXT="#080000"> <div> <I>DEDUCTIBILITY OF CONTRIBUTIONS</I></div> <bR> <bR> <div> Generally speaking, individuals may contribute up to $4,000 or 100% of earnings to an IRA. All or part of that IRA contribution may be tax deductible, depending on the individual’s level of income and whether he or she participates in an employer-sponsored retirement plan.  </div> <bR> <div> An immediate tax deduction for contributions is a key advantage of an IRA.  Indeed, for many, the current tax deduction is the motivating factor for making a contribution. In 1986, the last year for which all IRA contributions were deductible, Americans deposited $38 billion into IRAs.  In 1987, when many depositors could no longer deduct their contributions, IRA deposits fell to $14 billion. </div> <bR> <bR> <bR> <bR> <div> <B> <A NAME="active_participation"><IMG BORDER="0" SRC="1x1.gif" HEIGHT="1" ALIGN="bottom" WIDTH="1" HSPACE="0" VSPACE="0" ></A></B><B>Active participation</B></div> <bR> <div> Contributors who are not covered by another qualified retirement plan during the year may deduct the full amount of any contributions made that year.  If the individual is an active participant in an qualified plan, he or she may make a deductible contribution to an IRA — depending on his or her level of income. At certain income “thresholds” the deduction is phased out and eventually eliminated. For purposes of these rules, an employee is an “active participant” if he or she is eligible to be covered by a: </div> <bR> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.gif" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">qualified pension, profit-sharing, or stock bonus plan, including 401(k)s,</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.gif" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">qualified annuity plan,</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.gif" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">tax-sheltered annuity plan,</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.gif" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">simplified employee pension (SEP), </div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.gif" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">a SIMPLE plan, or</div> <div> <IMG BORDER="0" SRC="Symb075c00b700f000000000.gif" HEIGHT="16" WIDTH="24" ALIGN="bottom" HSPACE="0" VSPACE="0">a plan established by local, state or federal government or agency.</div> <bR> <div> Contributors should review their status each year.  Individuals who were active participants in previous years may not be so in the future due to changes in employment, changes in existing employer plans, etc.  To be considered an active participant, the employee must be eligible to be covered by the plan at any time during the year.</div> <bR> <div> Active participant status does not depend on whether an individual's rights under the plan are nonforfeitable (“vested”).  Nor does an active participant's status depend on whether monies were contributed to the plan on behalf of the employee.  </div> <bR> <bR> <DIV ALIGN="LEFT"></DIV> <div> <TABLE BORDER="2" CELLPADDING="8" CELLSPACING="4" WIDTH="489" BORDERCOLORLIGHT="#FFCC66" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#006699 > <tR> <tD VALIGN=TOP HEIGHT= 107 WIDTH="459"><div> <B>Example: </B></div> <bR> <div> <B>Shannon is a participant in her employer's 401(k) plan. Shannon is only 40% vested in the plan. She makes no contribution to the plan this year.  However, she is considered an "active participant" in the 401(k) plan for IRA deductibility purposes.</B></div> </tD> </tR> </TABLE></div> <bR> <div> <TABLE BORDER="2" CELLPADDING="8" CELLSPACING="4" WIDTH="489" BORDERCOLORLIGHT="#FFCC66" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#006699 > <tR> <tD VALIGN=TOP HEIGHT= 90 WIDTH="459"><div> <B>Example: Leroy qualifies for his employer's profit-sharing  plan.  Due to financial difficulties, Leroy's employer elects not to make SEP contributions this year.  Leroy is still considered an "active participant" in the profit-sharing plan when deciding if his IRA contributions this year are deductible.</B></div> </tD> </tR> </TABLE></div> <bR> <div> An individual’s employer (or former employer) will report on the employee’s W-2 form whether the employee is considered an active participant for the tax year.</div> <bR> <div> The active participant status of one spouse is not attributed to the other spouse.   Special income “phase-out” rules apply in situations where an individual is not an active participant, but whose spouse is an active participant (these are discussed below).</div> <bR> <div> If an IRA holder is receiving retirement benefits from a previous employer’s plan, but is not eligible under his or her current employer’s plan, the IRA holder is not considered to be an active participant in any employer’s plan — i.e., the holder may fully deduct any IRA contributions. </div> <bR> <bR> <div> <B> <A NAME="income_thresholds"><IMG BORDER="0" SRC="1x1.gif" HEIGHT="1" ALIGN="bottom" WIDTH="1" HSPACE="0" VSPACE="0" ></A></B><B>Income thresholds</B></div> <bR> <div> If an individual is not an active plan participant for any part of the year, the individual can take a full deduction for all IRA contributions that year, regardless of income. However, if an individual is an active participant, the individual may be able to take a full deduction, a partial deduction or no deduction at all, depending income (which includes taxable Social Security benefits).</div> <bR> <div> Individuals who are below the so-called the “threshold level” can make fully deductible IRA contributions.  In 2007, the threshold level for single persons is $50,000 and for married persons who file jointly the threshold is $80,000. For individuals who are married and file a separate tax return, the threshold level was zero.  These levels are adjusted annually for inflation.</div> <bR> <div> If an IRA contributor's modified adjusted gross income exceeds the threshold level, the contribution may be partially deductible.  The “phase-out range” for single taxpayers is $50,000 to $60,000.  For married taxpayers filing jointly the “phase-out range’ is $80,000 to $100,000.   The partial deduction is found by comparing the taxpayer’s income with the threshold amount.  The deduction is reduced by 40¢ for every dollar the taxpayer’s income exceeds the threshold —  for those over age 50, the deduction is reduced by 50¢ for every dollar the taxpayer’s income exceeds the threshold (these apply in 2006 and 2007.  In 2008 the disallowance increases to 50¢ for every dollar of excess income, and 60¢ for those age 50 and older.)</div> <bR> <div>  </div> <bR> <DIV ALIGN="LEFT"></DIV> <div> <TABLE BORDER="2" CELLPADDING="8" CELLSPACING="4" WIDTH="489" BORDERCOLORLIGHT="#FFCC66" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#006699 > <tR> <tD VALIGN=TOP HEIGHT= 283 WIDTH="459"><div> <B>Example: </B></div> <bR> <div> <B>Jim Jones is a 37-year-old active participant in his company’s 401(k) plan.  He contributes $4,000 to his IRA in 2007.  He files an individual return with an adjusted gross income of $57,000.  Since his income exceeds the $50,000 threshold by $7,000, his deduction is reduced by $7,000 x 0.40 or $2,800.  Jim is able to claim an IRA deduction of $1,200 for 2007 ($4,000 contribution — $2,800 disallowance).</B></div> <bR> <div> <B>If Jim were age 50 or older, he could contribute $5,000.  Assuming he contributed the maximum, his deduction is reduced by 50¢ for every dollar of income over the threshold, so the reduction would be $7,000 x 0.50 or $3,500 — and $1,500 would be deductible ($5,000 contribution — $3,500 disallowance).</B></div> <bR> </tD> </tR> </TABLE></div> <div>      </div> <bR> <div> If an active participant’s income exceeds the phase-out range, the individual may not deduct the IRA contribution, although the individual is still able to make a contribution. </div> <bR> <bR> <div> <I><B> <A NAME="_deductions_for_spousal_iras"><IMG BORDER="0" SRC="1x1.gif" HEIGHT="1" ALIGN="bottom" WIDTH="1" HSPACE="0" VSPACE="0" ></A></B></I><I><B> </B></I><FONT SIZE="3" COLOR="#006699" FACE="Arial" ><B>Deductions for Spousal IRAs</B></FONT></div> <bR> <div> An individual will not be considered an active participant in an employer-sponsored plan merely because the individual’s spouse is an active participant for any part of a plan year. </div> <bR> <div> Deductions for IRA contributions by an individual who is not an active participant, but whose spouse is, are phased out at adjusted gross incomes between $150,000 and $160,000.  In other words, “non-participant” spouses may take a full deduction for their IRA contributions, if their joint income is under $150,000. (This phase-out rule does not apply to married individuals who file separately and live apart at all times during the tax year.  For these filers, contributions of an active participant’s spouse are always non-deductible.)</div> <bR> <div>               </div> <DIV ALIGN="LEFT"></DIV> <div> <TABLE BORDER="2" CELLPADDING="8" CELLSPACING="4" WIDTH="489" BORDERCOLORLIGHT="#FFCC66" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#006699 > <tR> <tD VALIGN=TOP HEIGHT= 177 WIDTH="459"><div> <B>Example: </B></div> <bR> <div> <B>Norton is covered by a 401(k) plan at work. His wife, Trixie, is a full-time homemaker. They file a joint return in 2007 with an adjusted gross income  of $180,000 and contribute $4,000 to each of their IRAs. Neither Norton nor Trixie is entitled to make deductible contributions to an IRA for the year because they exceed the upper income threshold of $160,000.</B></div> <div> <B>            </B></div> <bR> </tD> </tR> <tR> <tD VALIGN=TOP HEIGHT= 178 WIDTH="459"><bR> <div> <B>Assume Norton and Trixie's joint income is $125,000.  Trixie can make a deductible contribution to the IRA for the year because she is not an active participant, and their combined income is below the $150,000 threshold. But Norton cannot make a deductible contribution because he is an active participant and his income exceeds the threshold for active participants ($100,000 for married couples filing jointly).   He may contribute to his IRA, but cannot deduct the contribution.</B></div> <bR> </tD> </tR> <tR> <tD VALIGN=TOP HEIGHT= 107 WIDTH="459"><bR> <div> <B>If their joint income had been $155,000, Trixie would have been entitled to a partial deduction for her contribution (their income is in the phaseout range of $150,000 - $160,000), Norton's contribution would still be non-deductible.</B></div> <bR> </tD> </tR> </TABLE></div> <bR> <bR> <bR> <bR> <bR> <div> <B> <A NAME="nondeductible_contributions"><IMG BORDER="0" SRC="1x1.gif" HEIGHT="1" ALIGN="bottom" WIDTH="1" HSPACE="0" VSPACE="0" ></A></B><B>Nondeductible Contributions</B></div> <bR> <div> While not as advantageous as a deductible contribution, individuals may make nondeductible contributions to a traditional IRA.  This is an option for individuals whose IRA deductions are reduced or eliminated because of the phase-out described above  (or are unable to contribute to a Roth IRA because of income restrictions). </div> <bR> <div> Since distributions from an non-deductible IRA will be partially taxed as earnings and partially tax-free return of contribution, the contributor must maintain records of his or her “cost basis”.  Form 8606 is used to report nondeductible IRA contributions to the IRS — this form is filed with the contributor’s tax return.  The taxpayer may designate an IRA contribution as nondeductible or revoke the designation at any time up to the filing date for the tax year. This allows an individual to make a contribution to an IRA at any time during the year without having to know how much will ultimately be deductible. Taxpayers  calculate how much is deductible when they fill out their tax return.</div> <bR> <div> Moreover, an individual is not required to report the nondeductible status of the contribution to the bank or institution holding the IRA. So, both deductible and nondeductible contributions may be made to a single IRA.</div> <div>  </div> <div> Individuals may also be able to make nondeductible contributions to Roth IRAs.  The ability to contribute to a Roth IRA is phased out for single taxpayers with adjusted gross incomes exceeding $95,000 and joint filers with AGI exceeding $150,000 (these limits will be adjusted for inflation beginning in 2008).  Investments in a Roth IRA grow tax-deferred and distributions from a Roth IRA may be taken tax-free under certain circumstances. This makes a Roth IRA a better opportunity for the taxpayer than a non-deductible, traditional IRA. (see <A HREF="id23.htm" TARGET="_top" TITLE="ROTH IRAs"><U>Roth IRAs</U></A>.)  Still, individuals who cannot (or do not) make contributions to a deductible IRA or a Roth IRA may choose to make contributions to a nondeductible IRA.</div> <bR> <div> It is important to note that there are a number of disadvantages involved in nondeductible IRA contributions. There is paperwork involved in keeping track of nondeductible contributions. Also, the fact that the contributions do not reduce taxable income makes other investment vehicles possibly more attractive, especially in light of the fact that IRA contributions are subject to early withdrawal penalties.  </div> <bR> <div> Taxpayers who fail to file Form 8606 are subject to a penalty of $50. Individuals who overstate the amount of nondeductible contributions (and consequently inflate the amount of tax-free distribution when the funds are withdrawn) must pay a $100 penalty.  If a taxpayer fails to file Form 8606 when nondeductible contributions are made, the IRS will fully tax all distributions from those contributions.  For taxpayers in this situation, it may make sense to file the delinquent forms and pay the penalties before taking a distribution.  This will establish a cost basis in account — and then only the earnings portion of the distribution, not the entire amount, will be taxed </div> <div> (see discussion of<A HREF="id69.htm" TARGET="_top" TITLE="IRA DISTRIBUTIONS"><U> Distributions</U></A>).  </div> <div>         </div> <bR> <DIV ALIGN="LEFT"></DIV> <div> <TABLE BORDER="2" CELLPADDING="2" CELLSPACING="1" WIDTH="76" BORDERCOLORLIGHT="#C0C0C0" BORDERCOLORDARK="#808080" FRAME="BOX" RULES="ALL" ALIGN="BOTTOM" HSPACE="0" VSPACE="0" BGCOLOR=#FFCC66 > <tR> <tD VALIGN=TOP HEIGHT= 23 WIDTH="64"><div> <A HREF="id66.htm" TARGET="_top" TITLE="IRA INVESTMENTS"><U><B>NEXT</B></U></A></div> </tD> </tR> </TABLE></div> <div> <I><B>  </B></I></div> <bR> </td> </tr></table></body>