In this chapter the original IRA (sometimes called an ordinary or regular IRA) is referred to as the "traditional IRA." Two advantages of a traditional IRA are that you may be able to deduct some or all of your contributions to it, depending on your circumstances, and, generally, amounts in your IRA, including earnings and gains, are not taxed until they are distributed.

What Is a Traditional IRA?

A traditional IRA is any IRA that is not a Roth IRA, a SIMPLE IRA, or an education IRA.

Who Can Set Up a Traditional IRA?

You can set up and make contributions to a traditional IRA if you (or if you file a joint return, your spouse) received taxable compensation during the year and you were not age 70 1/2 by the end of the year.

What is compensation? Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans). Compensation also includes commissions and taxable alimony and separate maintenance payments.

Self-employment income. If you are self-employed (a sole proprietor or a partner), compensation is your net earnings from your trade or business (provided your personal services are a material income-producing factor) reduced by your deduction for contributions on your behalf to retirement plans and the deduction allowed for one-half of your self-employment taxes.

Compensation also includes earnings from self-employment that are not subject to self-employment tax because of your religious beliefs. See Publication 533, Self-Employment Tax, for more information.

What is not compensation? Compensation does not include any of the following items.

• Earnings and profits from property, such as rental income, interest income, and dividend income.
• Pension or annuity income.
• Deferred compensation received (compensation payments postponed from a past year).
• Foreign earned income and housing cost amounts that you exclude from income.
• Any other amounts that you exclude from income.

When and How Can a Traditional IRA Be Set Up?

You can set up a traditional IRA at any time. However, the time for making contributions for any year is limited. See When Can I Make Contributions?, later.

You can set up different kinds of IRAs with a variety of organizations. You can set up an IRA at a bank or other financial institution or with a mutual fund or life insurance company. You can also set up an IRA through your stockbroker. Any IRA must meet Internal Revenue Code requirements.

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

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

If you are a surviving spouse, you can elect to treat a traditional IRA inherited from your spouse as your own.

For more information, see the discussions of inherited IRAs under How Much Can I Contribute? and under Rollovers, later.

How Much Can I Contribute?

Contributions to a traditional IRA must be in the form of money (cash, check, or money order). You cannot contribute property.

There are limits and other rules that affect the amount you can contribute and the amount you can deduct. These rules are explained next.

General limit. The most that you can contribute for any year to your traditional IRA is the smaller of the following amounts:

1. Your compensation (defined earlier) that you must include in income for the year, or
2. $2,000.

This is the most you can contribute regardless of whether your contributions are to one or more traditional IRAs or whether all or part of your contributions are nondeductible. (See Nondeductible Contributions, later.)

Example 1. Betty, who is single, earns $24,000 in 1998. Her IRA contributions for 1998 are limited to $2,000.

Example 2. John, a college student working part time, earns $1,500 in 1998. His IRA contributions for 1998 are limited to $1,500, the amount of his compensation.

Spousal IRA limit. If you file a joint return and your taxable compensation is less than that of your spouse, the most that can be contributed for the year to your IRA is the smaller of the following amounts.

1. $2,000.
2. The total compensation includable in the gross income of both you and your spouse, reduced by the following amounts:
   1. Your spouse's IRA deduction for the year, and
   2. Any contribution to a Roth IRA on behalf of your spouse for the year.

This means that the total combined contributions that can be made for the year to your IRA and your spouse's IRA can be as much as $4,000.

Contributions you (or your spouse) make to your traditional IRAs reduce your (or your spouse's) limit for contributions to a Roth IRA (see Roth IRAs, later).

Age 70 1/2 rule. Contributions cannot be made to your traditional IRA for the year you reach age 70 1/2 or any later year.

Community property laws--effect on separate computations. Except as just discussed, each spouse figures his or her limit separately, using his or her own compensation. This is the rule even in states with community property laws.

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

Inherited IRAs. If you inherit a traditional IRA from your spouse, you can choose to treat it as your own by making contributions to it.

If, however, you inherit a traditional IRA and you are not the decedent's spouse, you cannot contribute to that IRA, because you cannot treat it as your own.

Trustees' fees. Trustees' administrative fees are not subject to the contribution limit. A trustee's administrative fees that are billed separately and paid in connection with your traditional IRA are deductible. They are deductible (if they are ordinary and necessary) as a miscellaneous deduction on Schedule A (Form 1040). The deduction is subject to the 2%-of-adjusted-gross-income limit (see chapter 30).

Broker's commissions. Broker's commissions paid in connection with your traditional IRA are subject to the contribution limit. They are not deductible as a miscellaneous deduction on Schedule A (Form 1040).

When Can I Make Contributions?

You can make contributions to your traditional IRA for a year at any time during the year or by the due date for filing your return for that year, not including extensions. For most people, this means that contributions for 1998 must be made by April 15, 1999.

Designating year for which contribution is made. If you contribute an amount to your traditional IRA between January 1 and April 15, tell the sponsor (the trustee or issuer) to which year (the current year or the previous year) the contribution applies. If you do not tell the sponsor, the sponsor can assume, for reporting to IRS, that the contribution is for the current year.

Filing before making your contribution. You can file your return claiming a traditional IRA contribution before you actually make the contribution. You must, however, make the contribution by the due date of your return, not including extensions.

How Much Can I Deduct?

Generally, you can deduct the lesser of the contributions to your traditional IRA for the year or the general limit (or the spousal IRA limit, if it applies) on contributions (discussed earlier). However, if you or your spouse were covered by an employer retirement plan at any time during the year for which you made contributions, you may not be able to deduct all the contributions. Your deduction may be reduced or eliminated, depending on your filing status and the amount of your income, as discussed later under Deduction Limits. Any limit on the amount you can deduct does not affect the amount you can contribute. See Nondeductible Contributions, later.

Are You Covered by an Employer Plan?

The Form W-2, Wage and Tax Statement, you receive from your employer has a box used to indicate whether you were covered for the year. The "Pension Plan" box should have a mark in it if you were covered.

If you are not certain whether you were covered by your employer's retirement plan, you should ask your employer.

Table 18-1. Can You Take an IRA Deduction?

Employer plans. An employer retirement plan is one that an employer sets up for the benefit of the employees. For more information, see Publication 590.

When Are You Not Covered?

You are not covered by an employer plan in the following situations.

Social security or railroad retirement. Coverage under social security or railroad retirement (Tier I and Tier II) does not count as coverage under an employer retirement plan.

Benefits from a previous employer's plan. If you receive retirement benefits from a previous employer's plan and you are not covered under your current employer's plan, you are not considered covered.

Reservists. If the only reason you participate in a plan is because you are a member of a reserve unit of the armed forces, you may not be considered covered by the plan. You are not considered covered by the plan if both of the following conditions are met.

1. The plan you participate in is established for its employees by:
   1. The United States,
   2. A state or political subdivision of a state, or
   3. An instrumentality of either (a) or (b) above.
2. You did not serve more than 90 days on active duty during the year (not counting duty for training).

Volunteer firefighters. If the only reason you participate in a plan is because you are a volunteer firefighter, you may not be considered covered by the plan. You are not considered covered by the plan if both of the following conditions are met.

1. The plan you participate in is established for its employees by:
   1. The United States,
   2. A state or political subdivision of a state, or
   3. An instrumentality of either (a) or (b) above.
2. Your accrued retirement benefits at the beginning of the year will not provide more than $1,800 per year at retirement.

Social Security Recipients

If you received social security benefits, received taxable compensation, contributed to your traditional IRA, and you or your spouse were covered by an employer retirement plan, complete the worksheets in Appendix B of Publication 590. Use those worksheets to figure your IRA deduction and the taxable portion, if any, of your social security benefits.

Deduction Limits

As discussed under How Much Can I Deduct? 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 your filing status, as explained later under Reduced or no deduction.

Full deduction. If neither you nor your spouse was covered for any part of the year by an employer retirement plan, you can take a deduction for your total contributions to one or more traditional IRAs of up to $2,000, or 100% of your compensation, whichever is less. This limit is reduced by any contributions to a 501(c)(18) plan (generally, a plan created before June 25, 1959, funded entirely by employee contributions).

Spousal IRA. In the case of a married couple with unequal compensation who file a joint return, the deduction for contributions to the traditional IRA of the spouse with less compensation is limited to the smaller of the following amounts.

1. $2,000.
2. The total compensation includable in the income of both spouses, reduced by the following two amounts:
   1. Any deduction allowed for contributions to the traditional IRAs of the spouse with more compensation, and
   2. Any contribution to a Roth IRA on behalf of the spouse with more compensation.

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

Reduced or no deduction. If either you or your spouse was covered by an employer retirement plan, your deduction may be reduced or eliminated, depending on your income and your filing status. The deduction begins to decrease (phase out) when your income rises above a certain amount, and is eliminated altogether when it reaches a higher amount. The amounts vary depending on your filing status. See Table 18-1, Can I Take A Traditional IRA Deduction?, earlier.

Adjusted gross income limit. The effect of income on your deduction, as just described, is sometimes called the adjusted gross income limitation (AGI limit). To compute your reduced traditional IRA deduction, you must first determine your modified adjusted gross income and your filing status as explained later.

Deduction phaseout--If you are covered. If you are covered by an employer retirement plan, your IRA deduction is reduced or eliminated depending on your filing status and modified AGI as follows:

Table 1.

If your filing status is:	Your deduction is reduced if your modified AGI is between:	Your deduction is eliminated if your modified AGI is:
Single, or Head of household	$30,000 and $40,000	$40,000 or more
Married--joint return, or Qualifying widow(er)	$50,000 and $60,000	$60,000 or more
Married-- separate return	$-0- and $10,000	$10,000 or more

See Married filing separately exception, under Filing status, later.

For 1999, if you are covered by a retirement plan at work, your IRA deduction will not be reduced (phased out) unless your modified adjusted gross income (AGI) is between:

• $31,000 (a $1,000 increase) and $41,000 for a single individual (or head of household),
• $51,000 (a $1,000 increase) and $61,000 for a married couple (or a qualifying widow(er)) filing a joint return, or
• $-0- (no increase) and $10,000 for a married individual filing a separate return.

If you are not covered, but your spouse is. If you are not covered by an employer retirement plan, but your spouse is, your IRA deduction is reduced or eliminated depending on your filing status and modified AGI as follows:

Table 2.

If your filing status is:	Your deduction is reduced if your modified AGI is between:	Your deduction is eliminated if your modified AGI is:
Married--joint return, or Qualifying widow(er)	$150,000 and $160,000	$160,000 or more
Married-- separate return	$-0- and $10,000	$10,000 or more

See Married filing separately exception, under Filing status, next. Also, see Table 18-1 earlier.

Filing status. Your filing status depends primarily on your marital status. For this purpose, you need to know if your filing status is single or head of household, married filing jointly or qualifying widow(er), or married filing separately. If you need more information on filing status, see chapter 2.

Married filing separately exception. If you did not live with your spouse at any time during the year and you file a separate return, you are not treated as married and your filing status is considered, for this purpose, as single.

Modified adjusted gross income. Your modified adjusted gross income (modified AGI) is:

1. If you file Form 1040 -- the amount on the page 1 "adjusted gross income" line, but modified (changed) by figuring it without taking into account any:
   1. IRA deduction,
   2. Student loan interest deduction,
   3. Foreign earned income exclusion,
   4. Foreign housing exclusion or deduction,
   5. Exclusion of qualified bond interest shown on Form 8815, Exclusion of Interest From Series EE U.S. Savings Bonds Issued After 1989, or
   6. Exclusion of employer-paid adoption expenses shown on Form 8839, Qualified Adoption Expenses.
2. If you file Form 1040A -- the amount on the page 1 "adjusted gross income" line, but modified by figuring it without any IRA deduction, student loan interest deduction, or any exclusion of qualified bond interest shown on Form 8815, or any exclusion of employer-paid adoption expenses shown on Form 8839.

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

How to figure your reduced IRA deduction.

You can figure your reduced IRA deduction for either Form 1040 or Form 1040A by using the worksheets in Chapter 1 of Publication 590. Also, the instructions for these tax forms include similar worksheets.

Note. If you were divorced or legally separated (and did not remarry) before the end of the year, you cannot deduct any contributions you made to your spouse's IRA. You can deduct only the contributions you made to your own IRA, and your deductions are subject to the adjusted gross income limit rules for single individuals.

Reporting Deductible Contributions

You do not have to itemize deductions to claim your deduction for IRA contributions. If you file Form 1040, deduct your IRA contributions for 1998 on line 23 and, if you file a joint return, also deduct your spouse's IRA contributions on line 23.

If you file Form 1040A, deduct your contributions on line 15 and, if you file a joint return, also deduct contributions to your spouse's IRA on line 15.

Form 1040EZ does not provide for IRA deductions.

Form 5498. You should receive by June 1, 1999, Form 5498, Individual Retirement Arrangement Information, or similar statement, from plan sponsors, showing all the contributions made to your IRA for 1998.

Nondeductible Contributions

Although your deduction for IRA contributions may be reduced or eliminated because of the adjusted gross income limit (see Deduction Limits, earlier), you can still make contributions of up to $2,000 or 100% of compensation, whichever is less. For a spousal IRA, see Spousal IRA limit, under How Much Can I Contribute?, earlier. Often, the difference between your total permitted contributions and your total deductible contributions, if any, is your nondeductible contribution.

Example. Sonny Jones is single. In 1998, he is covered by a retirement plan at work. His salary is $52,312. His modified AGI is $55,000. Sonny makes a $2,000 IRA contribution for that year. Because he is covered by a retirement plan and his modified AGI is over $40,000, he cannot deduct his $2,000 IRA contribution. However, he can choose to either:

1. Designate this contribution as a nondeductible contribution by reporting it on his tax return, as explained later under Reporting Nondeductible Contributions, or
2. Withdraw the contribution as explained later under Tax-free withdrawal of contributions under When Can I Withdraw or Use IRA Assets?, later.

As long as your contributions are within the contribution limits, none of the earnings on those contributions (deductible or nondeductible) or gains will be taxed until they are distributed. See When Can I Withdraw or Use IRA Assets?, later.

Cost basis. You will have a cost basis in your IRA if you make nondeductible contributions. Your basis is the sum of the nondeductible amounts you have contributed to your IRA less any distributions of those amounts. When you withdraw (or receive distributions of) those amounts, as discussed later under Are Distributions Taxable?, you can do so tax free.

Reporting Nondeductible Contributions

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

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

Form 8606. You must file Form 8606 if either of the following applies.

• You made nondeductible contributions to your traditional IRA for 1998, or
• You received IRA distributions in 1998 and you have ever made nondeductible contributions to any of your traditional IRAs.

Also, see Roth IRAs, later.

Contribution and distribution in the same year. If you receive a distribution from an IRA in the same year that you make an IRA contribution that may be partly nondeductible, use the worksheet in chapter 1 of Publication 590 to figure the taxable portion of the distribution. Then you can figure the amount of nondeductible contributions to report on Form 8606.

Failure to report nondeductible contributions. If you do not report nondeductible contributions, all of your traditional IRA contributions will be treated as deductible. When you make withdrawals from your IRA, they will be taxed unless you can show, with satisfactory evidence, that nondeductible contributions were made.

Penalty for overstatement. If you overstate nondeductible contributions on your Form 8606, you must pay a penalty of $100 for each overstatement, unless it was due to reasonable cause.

Penalty for failure to file Form 8606. You will have to pay a $50 penalty if you do not file a required Form 8606, unless you can prove that the failure was due to reasonable cause.

Can I Move Retirement Plan Assets?

Traditional IRA rules permit you to transfer, tax free, assets (money or property) from other retirement plans (including traditional IRAs) to a traditional IRA. The rules permit the following kinds of transfers:

• Transfers from one trustee to another,
• Rollovers, and
• Transfers incident to a divorce.

Transfers to Roth IRAs. Under certain conditions, you can move assets from a traditional IRA to a Roth IRA. See Can I Move Amounts Into a Roth IRA?, under Roth IRAs, later.

Trustee-to-Trustee Transfer

A transfer of funds in your traditional IRA from one trustee directly to another, either at your request or at the trustee's request, is not a rollover. Because there is no distribution to you, the transfer is tax free. Because it is not a rollover, it is not affected by the one-year waiting period that is required between rollovers, discussed next. For information about direct transfers to IRAs from retirement plans other than IRAs, see Publication 590.

Rollovers

Generally, a rollover is a tax free distribution to you of cash or other assets from one retirement plan that you contribute (roll over) to another retirement plan. The amount you roll over tax free, however, is generally taxable later when the new plan pays that amount to you or your beneficiary.

Kinds of rollovers to an IRA. There are two kinds of rollover contributions to a traditional IRA. In one, you put amounts you receive from one traditional IRA into another. In the other, you put amounts from an employer's qualified retirement plan for its employees into a traditional IRA.

Treatment of rollovers. You cannot deduct a rollover contribution but you must report the rollover distribution on your tax return as discussed later under Reporting rollovers from IRAs, and under Reporting rollovers from employer plans, later.

Time limit for making a rollover contribution. You must make the rollover contribution by the 60th day after the day you receive the distribution from your traditional IRA or your employer's plan.

Extension of rollover period. If the amount distributed to you from a traditional IRA or a qualified employer retirement plan becomes a frozen deposit in a financial institution during the 60-day period allowed for a rollover, a special rule extends the rollover period. For more information, get Publication 590.

Rollover From One IRA Into Another

You can withdraw, tax free, all or part of the assets from one traditional IRA if you reinvest them within 60 days in another traditional IRA.

Waiting period between rollovers. You can take (receive) a distribution from a particular traditional IRA and make a rollover contribution to another traditional IRA only once in any one-year period. The one-year period begins on the date you receive the IRA distribution, not on the date you roll it over into another IRA.

This rule applies separately to each IRA you own. For example, if you have two traditional IRAs, IRA-1 and IRA-2, and you roll over assets of IRA-1 into a new traditional IRA (IRA-3), you may also make a rollover from IRA-2 into IRA-3, or into any other traditional IRA, within one year after the rollover distribution from IRA-1. These are both allowable rollovers because you have not received more than one distribution from either IRA within one year. However, you cannot, within the one-year period, again roll over the assets you rolled over into IRA-3 into any other traditional IRA.

Exception. There is an exception to this one-year waiting period rule for distributions from certain failed financial institutions. Get Publication 590 for more information.

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

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

Inherited IRAs. If you inherit a traditional IRA from your spouse, you generally can roll it over into a traditional IRA established for you.

Not inherited from spouse. If you inherit a traditional IRA from someone other than your spouse, you cannot roll it over or allow it to receive a rollover contribution. You must withdraw the IRA assets within a certain period. For more information, see Publication 590.

Reporting rollovers from IRAs. Report any rollover from one traditional IRA to another traditional IRA on lines 15a and 15b, Form 1040, or lines 10a and 10b, Form 1040A. Enter the total amount of the distribution on line 15a, Form 1040, or line 10a, Form 1040A. If the total amount on line 15a, Form 1040, or line 10a, Form 1040A, was rolled over, enter zero on line 15b, Form 1040, or line 10b, Form 1040A. Otherwise, enter the taxable portion of the part that was not rolled over on line 15b, Form 1040, or line 10b, Form 1040A.

Rollover From Employer's Plan Into an IRA

Special rules apply to distributions made from qualified employer plans that are rolled over or transferred to traditional IRAs. The rules primarily relate to requirements affecting rollovers, income tax withholding, and notices to recipients. See Publication 590 for more information.

Generally, if you receive an eligible rollover distribution from your (or your deceased spouse's) employer's qualified pension, profit-sharing or stock bonus plan, annuity plan, or tax-sheltered annuity plan (403(b) plan), you can roll over all or part of it into a traditional IRA.

Eligible rollover distribution. Generally, an eligible rollover distribution is the taxable part of any distribution of all or part of the balance to your credit as the employee-participant in a qualified retirement plan except:

1. A required minimum distribution, or
2. Any of a series of substantially equal periodic distributions paid at least once a year over:
   1. Your lifetime or life expectancy,
   2. The lifetimes or life expectancies of you and your beneficiary, or
   3. A period of 10 years or more.

The taxable parts of most other distributions from qualified retirement plans are eligible rollover distributions. See Publication 575, Pension and Annuity Income, for additional exceptions.

Maximum rollover. The most that you can roll over is the taxable part of any eligible rollover distribution from your employer's qualified plan. The distribution you receive generally will be all taxable unless you have made nondeductible employee contributions to the plan.

Reporting rollovers from employer plans. To report a rollover from an employer retirement plan to a traditional IRA, use lines 16a and 16b, Form 1040, or lines 11a and 11b, Form 1040A. Do not use lines 15a or 15b, Form 1040, or lines 10a or 10b, Form 1040A.

For more information on rollovers, get Publication 590.

Transfers Incident to Divorce

If an interest in a traditional IRA is transferred from your spouse or former spouse to you by a decree of divorce or separate maintenance, or a written document related to such a decree, the interest in the IRA, starting from the date of the transfer, is treated as your IRA. The transfer is tax free. For detailed information, see Publication 590.

When Can I Withdraw or Use IRA Assets?

There are rules limiting the withdrawal and use of your IRA assets. Violation of the rules generally results in additional taxes in the year of violation. See Prohibited Transactions, Premature Distributions (Early Withdrawals), and Excess Accumulations (Insufficient Distributions), later.

Note. These rules also apply to SIMPLE IRAs. See Publication 590.

Distributions (withdrawals)--general rule. If during a year you receive distributions from a traditional IRA, you must generally include them in your gross income for the year.

Age 59 1/2 rule. Generally, until you reach the age of 59 1/2, you must pay a 10% additional tax if you withdraw assets (money or other property) from your traditional IRA. However, there are a number of exceptions to that rule.

Exceptions. The exceptions to the age 59 1/2 rule for distributions from traditional IRAs are in part designed to provide relief from hardship situations such as:

• Significant unreimbursed medical expenses,
• Paying medical insurance premiums after losing your job,
• Disability, and
• Death.

But there are also exceptions for distributions:

• That are a part of a series of substantially equal payments (annuity exception),
• That are not more than qualified higher education expenses,
• To pay certain qualified first-time homebuyer amounts.

Distributions that are rolled over, as discussed earlier, are not subject to regular income tax or the 10% additional tax. Certain withdrawals of contributions are also tax-free and not subject to the 10% additional tax (see Tax-free withdrawal of contributions, next).

Tax-free withdrawal of contributions. If you made IRA contributions for 1998, 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 both the following apply.

• You did not take a deduction for the contributions you withdraw.
• You also withdraw any interest or other income earned on the contributions. 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 withdrawn contributions.

Generally, except for any part of a withdrawal that is a return of nondeductible contributions (basis), any withdrawal of your contributions after the due date (or extended due date) of your return will be treated as a taxable distribution. Another exception is the return of an excess contribution as discussed later under What Acts Result in Penalties?, later.

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

Excess contributions tax. If any part of these contributions is an excess contribution for 1997, it is subject to a 6% excise tax. You will not have to pay the 6% tax if any 1997 excess contribution was withdrawn by April 15, 1998 (plus extensions), and if any 1998 excess contribution is withdrawn by April 15, 1999. See Excess Contributions under What Acts Result in Penalties?, later.

When Must I Withdraw IRA Assets? (Required Distributions)

You cannot keep funds in your traditional IRA indefinitely. Eventually you must withdraw them. If you do not make any withdrawals, or if you do not withdraw enough, you may have to pay a 50% excise tax on the amount not withdrawn as required. See Excess Accumulations (Insufficient Distributions), later. The requirements for withdrawing IRA funds differ depending on whether you are the IRA owner or the beneficiary of a decedent's IRA.

IRA owners. If you are the owner of a traditional IRA, you must choose to withdraw the balance in your IRA in one of the following two ways:

1. By withdrawing the entire balance in your IRA by the required beginning date (defined below), or
2. By withdrawing periodic distributions of the balance in your IRA starting no later than the required beginning date.

Required beginning date (RBD)--Age 70 1/2 rule. You must withdraw the entire balance in your traditional IRA or begin receiving periodic distributions by April 1 of the year following the year in which you reach age 70 1/2.

Periodic distributions. If you choose to receive periodic distributions, you must receive at least a minimum amount for each year starting with the year you reach age 70 1/2 (your 70 1/2 year). If you do not (or did not) receive the minimum in your 70 1/2 year, then you must receive distributions for your 70 1/2 year that reach the minimum amount by April 1 of the next year.

Distributions after the RBD. The required minimum distribution for any year after your 70 1/2 year must be made by December 31 of that later year.

Beneficiaries. If you are the beneficiary of a decedent's traditional IRA, the requirements you must satisfy for withdrawing funds from that IRA depend on whether distributions have begun that satisfy the minimum distribution requirement.

More information. For more information, including how to figure your required minimum distribution each year and how to figure your required distribution if you are a beneficiary of a decedent's IRA, see Publication 590.

Are Distributions Taxable?

In general, include traditional IRA distributions in your gross income in the year you receive them.

Exceptions to this general rule are rollovers and tax-free withdrawals of contributions, discussed earlier, and the return of nondeductible contributions, discussed later under Distributions Fully or Partly Taxable.

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

No special treatment. In figuring your tax, you cannot use the special averaging 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) since it was set up, you have no basis in your IRA. Because you have no basis in your IRA, any distributions are fully taxable when received. See Reporting taxable distributions on your return, later.

Partly taxable. If you made nondeductible contributions to any of your traditional IRAs, you have a cost basis (investment in the contract) equal to the amount of those contributions. These nondeductible contributions are not taxed when they are distributed to you. They are a return of your investment in your IRA.

When distributions are made from a traditional IRA, special rules apply in figuring the tax on the distributions if:

• Only nondeductible IRA contributions were made and there are earnings or gains, or
• Both deductible and nondeductible IRA contributions were made.

Only the part of the distribution that represents nondeductible contributions (your cost basis) is not taxable. If nondeductible contributions have been made, distributions consist partly of nondeductible contributions (basis) and partly of deductible contributions, earnings, and gains (if any). Until you run out of basis, each distribution is partly nontaxable and partly taxable.

Form 8606. You must complete, and attach to your return, Form 8606 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 1998, and your total IRA basis for 1998 and earlier years.

Distributions reported on Form 1099-R. If you receive a distribution from your traditional IRA, you will receive Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, Etc., or similar statement. IRA distributions are shown in boxes 1 and 2 of Form 1099-R. A number or letter code in box 7 tells you what type of distribution you received from your IRA.

Withholding. Federal income tax is withheld from distributions out of traditional IRAs unless you choose not to have tax withheld. See chapter 5.

IRA distributions delivered outside the United States. In general, if you are a U.S. citizen or resident alien and your home address is outside the United States or its possessions, you cannot choose exemption from withholding on distributions from your traditional IRA.

Reporting taxable distributions on your return. Report fully taxable distributions, including taxable premature distributions, on line 15b, Form 1040 (no entry is required on line 15a), or line 10b, Form 1040A. If only part of the distribution is taxable, enter the total amount on line 15a, Form 1040 (or line 10a, Form 1040A), and the taxable part on line 15b, Form 1040 (or line 10b, Form 1040A). You cannot report distributions on Form 1040EZ.

What Acts Result in Penalties?

The tax advantages of using traditional IRAs for retirement savings can be offset by additional taxes and penalties if you do not follow the rules. For example, there are additions to the regular tax for using your IRA funds in prohibited transactions. There are also additional taxes for:

• Investing in collectibles,
• Making excess contributions,
• Making early withdrawals (taking premature distributions), and
• Allowing excess amounts to accumulate (failing to make required withdrawals).

There are penalties for overstating the amount of nondeductible contributions and for failure to file a required Form 8606. See Reporting Nondeductible Contributions, earlier.

Prohibited Transactions

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

Examples of disqualified persons include your fiduciary, and members of your family (a spouse, ancestor, lineal descendent, and any spouse of a lineal descendent).

Some examples of prohibited transactions with a traditional IRA are:

• Borrowing money from it,
• Buying property for personal use (present or future) with IRA funds,
• Selling property to it,
• Receiving unreasonable compensation for managing it, or
• Using the IRA as collateral for a loan.

Effect on an IRA account. Generally, if you or your beneficiary engage in a prohibited transaction at any time during the year with your IRA account, the account stops being an IRA as of the first day of the year.

Effect on you (or your beneficiary). If you (or your beneficiary) engage in a prohibited transaction with your traditional IRA account at any time during the year, you (or your beneficiary) must include the fair market value of all (or part, in certain cases) of the IRA assets in your gross income for that year. The fair market value is the price at which the IRA assets would change hands between a willing buyer and a willing seller, when neither has any need to buy or sell, and both have reasonable knowledge of the relevant facts.

You must use the fair market value of the assets as of the first day of the year you engaged in the prohibited transaction. You may have to pay the 10% additional tax on premature distributions, discussed later.

Taxes on prohibited transactions. If someone other than the owner or beneficiary of a traditional IRA engages in a prohibited transaction, that person may be liable for certain taxes. In general, there is a 15% tax on the amount of the prohibited transaction and a 100% additional tax if the transaction is not corrected.

More information. For more information on prohibited transactions, get Publication 590.

Investment in Collectibles

If your traditional IRA invests in collectibles, the amount invested is considered distributed to you in the year invested. You may have to pay the 10% additional tax on premature distributions, discussed later.

Collectibles. These include art works, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages, and other tangible personal property if specified by the IRS.

Exception. Your IRA can invest in one, one-half, one-quarter, or one-tenth ounce U.S. gold coins, or one ounce silver coins minted by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion.

Excess Contributions

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

• Your taxable compensation for the year, or
• $2,000.

Tax on excess contributions. In general, if the excess contribution for a year and any earnings on it are not withdrawn by the date your return for the year is due (including extensions), as explained later, you are subject to a 6% tax. You must pay the 6% tax each year on excess amounts that remain in your IRA at the end of your tax year. The tax cannot be more than 6% of the value of your IRA as of the end of your tax year.

Excess contributions withdrawn by due date of return. You will not have to pay the 6% tax if you withdraw an excess contribution made during a tax year and you also withdraw interest or other income earned on the excess contribution by the date your return for that year is due, including extensions.

Do not include in your gross income an excess contribution that you withdraw from your traditional IRA before your tax return is due if both the following conditions are met.

1. No deduction was allowed for the excess contribution.
2. The interest or other income earned on the excess was also withdrawn.

You must include in your gross income any interest or other income earned on the excess contribution (whether a deductible or nondeductible 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 withdrawals, discussed later.

Excess contributions withdrawn after due date of return. In general, you must include all withdrawals from your traditional IRA in your gross income. However, if the total contributions (other than rollover contributions) for the year were $2,000 or less and there were no employer contributions, you can withdraw any excess contribution after the due date for filing your return for that year, including extensions. You do not include the withdrawn contribution in your income. This exclusion from income applies only to the part of the withdrawn excess contribution for which you did not take a deduction.

Premature Distributions (Early Withdrawals)

You must include premature distributions of taxable amounts from your traditional IRA in your gross income. Premature distributions (sometimes called early withdrawals or early distributions) are also subject to an additional 10% tax. See the discussion of Form 5329 under Reporting Additional Taxes, later, to figure and report the tax.

Premature distributions defined. Premature distributions are amounts you withdraw from your traditional IRA before you are age 59 1/2.

Exceptions. In certain circumstances, the additional tax does not apply to distributions from your traditional IRA even if they are made before you are age 59 1/2. There are exceptions for:

• Certain higher education expenses,
• Certain first-time homebuyer payments,
• Certain medical expenses,
• Death,
• Disability, and
• Annuity distributions.

Additional tax. The additional tax on premature distributions is 10% of the amount of the premature distribution that you must include in your gross income. This tax is in addition to any regular income tax resulting from including the distribution in income.

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

Rollovers. Distributions that are rolled over as discussed under Rollovers, earlier, can be made without having to pay the regular income tax or the 10% additional tax.

More information. For more information on premature distributions, see Publication 590.

Table 18-2. You Can Contribute to a Roth IRA

Excess Accumulations (Insufficient Distributions)

You cannot keep amounts in your traditional IRA indefinitely. Generally, you must begin receiving distributions by April 1 of the year following the year in which you reach age 70 1/2.

Tax on excess. If distributions are less than the required minimum distribution for the year, you may have to pay a 50% excise tax for that year on the amount not distributed as required.

Request to excuse the tax. If the excess accumulation is due to reasonable error and you have taken, or are taking, steps to remedy the insufficient distribution, you can request that the tax be excused.

Exemption from tax. If you are unable to make required distributions because you have a traditional IRA invested in a contract issued by an insurance company that is in state insurer delinquency proceedings, the 50% excise tax does not apply if the conditions and requirements of Revenue Procedure 92-10 are satisfied.

More information. For more information on excess accumulations, see Publication 590.

Reporting Additional Taxes

Generally, you must use Form 5329 to report the tax on excess contributions, premature (early) distributions, and excess accumulations.

Filing Form 1040. If you file Form 1040, complete Form 5329 and attach it to your Form 1040. Enter the total amount of IRA tax due on line 53, Form 1040.

Note: If you have to file an individual income tax return and Form 5329, you must use Form 1040.

Not filing Form 1040. If you do not have to file a Form 1040 but do have to pay one of the IRA taxes mentioned earlier, file the completed Form 5329 with IRS at the time and place you would have filed your Form 1040. Be sure to include your address on page 1 and your signature on page 2. Enclose, but do not attach, a check or money order payable to the Department of Treasury for the tax you owe, as shown on Form 5329. Write your social security number and "1998 Form 5329" on your check or money order.

Form 5329 not required. You do not have to use Form 5329 if any of the following conditions exist.

• Distribution code 1 (early distribution) is shown in box 7 of Form 1099-R. Instead, multiply the taxable part of the distribution by 10% and enter the result on line 53 of Form 1040. Write "No" next to line 53 to indicate that you do not have to file Form 5329. However, if you owe this tax and also owe any other additional tax on a distribution, do not enter this 10% additional tax directly on your Form 1040. You must file Form 5329 to report your additional taxes.
• You qualify for an exception to the additional tax on early distributions. You need not report the exception if distribution code 2, 3, or 4 is shown in box 7 of Form 1099-R. However, if one of those codes is not shown, or the code shown is incorrect, you must file Form 5329 to report the exception.
• You properly rolled over all distributions you received during the year.

Previous | First | Next

Publication 17 | 1998 Tax Year Archives | Tax Help Archives | Home