Publication 17
Your Federal Income Tax

For Individuals

For use in preparing 2002 Returns

Part Four - Adjustments to Income

The three chapters in this part discuss three of the adjustments to income that you can deduct in figuring your adjusted gross income. These chapters cover:

• Contributions you make to traditional individual retirement arrangements (IRAs) - chapter 18,
• Moving expenses you pay - chapter 19, and
• Alimony you pay - chapter 20.

Other adjustments to income are discussed in other parts of this publication or in other publications and instructions. They are deductions for:

• Educator expenses - instruction for Form 1040 line 23, Form 1040A line 16,
• Interest paid on student loans - Publication 970,
• Tuition and fees deduction - Publication 970,
• Contributions to an Archer MSA - chapter 23,
• Self-employment tax - chapter 24,
• Self-employed health insurance - chapter 23,
• Payments to self-employed SEP, SIMPLE, and qualified plans - Publication 560, Retirement Plans for Small Business,
• Penalty on early withdrawal of savings - chapter 8,
• Amortization of the costs of reforestation - chapter 9 of Publication 535, Business Expenses,
• Contributions to Internal Revenue Code section 501(c)(18) pension plans - Publication 525, Taxable and Nontaxable Income,
• Expenses from the rental of personal property - chapter 13,
• Expenses of fee-basis officials or certain performing artists - chapter 28,
• Certain required repayments of supplemental unemployment benefits (sub-pay) - chapter 13,
• Foreign housing deduction - chapter 4 of Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad,
• Jury duty pay given to your employer - chapter 13,
• Part of the cost of qualified clean-fuel vehicle property - chapter 12 of Publication 535, Business Expenses, and
• Contributions by certain chaplains to Internal Revenue Code section 403(b) plans - Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers.

18. Individual Retirement Arrangements (IRAs)

Important Changes for 2002

Increased traditional IRA contribution and deduction limit.   Unless you reached age 50 before 2003, the most that can be contributed to your traditional IRA for 2002 is the smaller of the following amounts:

• Your compensation that you must include in income for the year, or
• $3,000 (up from $2,000).

If you reached age 50 before 2003, the most that can be contributed to your traditional IRA for 2002 is the smaller of the following amounts:

• Your compensation that you must include in income for the year, or
• $3,500 (up from $2,000).

For more information, see How Much Can Be Contributed? under Traditional IRAs.

Besides being able to contribute a larger amount for 2002, you may be able to deduct a larger amount. See How Much Can I Deduct? under Traditional IRAs.

Modified AGI limit for traditional IRA contributions increased.   For 2002, if you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA will be reduced (phased out) if your modified adjusted gross income (AGI) is between:

• $54,000 and $64,000 for a married couple filing a joint return or a qualifying widow(er),
• $34,000 and $44,000 for a single individual or head of household, or
• $-0- and $10,000 for a married individual filing a separate return.

For all filing statuses other than married filing separately, the upper and lower limits of the phaseout range increased by $1,000. See How Much Can I Deduct? under Traditional IRAs.

Credit for IRA contributions.   For tax years beginning after 2001, if you are an eligible individual, you may be able to claim a credit for a percentage of your qualified retirement savings contributions, such as contributions to your traditional or Roth IRA. To be eligible, you must be at least 18 years old as of the end of the year, and you cannot be a student or an individual for whom someone else claims a personal exemption. Also, your adjusted gross income (AGI) must be below a certain amount.

For more information, see chapter 38.

Rollovers of distributions from employer plans.   For distributions after 2001, you can roll over both the taxable and nontaxable part of a distribution from a qualified plan into a traditional IRA. If you have both deductible and nondeductible contributions in your IRA, you will have to keep track of your basis so you will be able to determine the taxable amount once distributions from the IRA begin.

For more information, see Can I Move Retirement Plan Assets? under Traditional IRAs.

Kinds of rollovers from a traditional IRA.   For distributions after 2001, you can roll over, tax free, a distribution from your traditional IRA into a qualified plan, including a deferred compensation plan of a state or local government (section 457 plan), and a tax-sheltered annuity (section 403(b) plan). The part of the distribution that you can roll over is the part that would otherwise be taxable (includible in your income). Qualified plans may, but are not required to, accept such rollovers. For more information, see Rollovers under Can I Move Retirement Plan Assets.

Rollovers of deferred compensation plans of state and local governments (section 457 plans) into traditional IRAs.   Before 2002, you could not roll over, tax free, an eligible rollover distribution from a governmental deferred compensation plan into a traditional IRA.

Beginning with distributions after 2001, if you participate in an eligible deferred compensation plan of a state or local government, you may be able to roll over part or all of your account tax free into an eligible retirement plan such as a traditional IRA. The most that you can roll over is the amount that qualifies as an eligible rollover distribution. The rollover may be either direct or indirect.

For more information, see Kinds of rollovers to a traditional IRA under Rollovers.

Participants born before 1936.   If you were born before 1936, you may be able to use capital gain and averaging treatment on certain lump-sum distributions from qualified plans, but you will lose the opportunity to use capital gain or averaging treatment on distributions from a qualified plan if you roll over IRA contributions to that plan. You can retain such treatment if the rollover is from a conduit IRA. For more information on conduit IRAs, see IRA as a holding account (conduit IRA) for rollovers to other eligible plans under Rollover From Employer's Plan Into an IRA in chapter 1 of Publication 590.

No rollovers of hardship distributions into IRAs.   For distributions made after 2001, no hardship distribution can be rolled over into an IRA. For more information about what can be rolled over, see Rollover From Employer's Plan Into an IRA under Can I Move Retirement Plan Assets.

Hardship exception to the 60-day rollover rule.   Generally, a rollover is tax free only if you make the rollover contribution by the 60th day after the day you receive the distribution. Beginning with distributions after 2001, the IRS may waive the 60-day requirement where it would be against equity or good conscience not to do so.

For more information, see Time limit for making a rollover contribution under Rollovers.

Increased Roth IRA contribution limit.   If contributions on your behalf are made only to Roth IRAs, your contribution limit for 2002 generally is the lesser of:

• $3,000 (up from $2,000), or
• Your taxable compensation.

If you are 50 years of age or older in 2002 and contributions on your behalf are made only to Roth IRAs, your contribution limit for 2002 generally is the lesser of:

• $3,500 (up from $2,000), or
• Your taxable compensation.

However, if your modified AGI is above a certain amount, your contribution limit may be reduced. For more information, see How Much Can Be Contributed? under Roth IRAs.

Contributions to both traditional and Roth IRAs for same year.   If contributions are made on your behalf to both a Roth IRA and a traditional IRA, your contribution limit for 2002 is the lesser of:

• $3,000 ($3,500 if you are 50 years of age or older in 2002) (up from $2,000) minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs, or
• Your taxable compensation minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.

However, if your modified AGI is above a certain amount, your contribution limit may be reduced. For more information, see How Much Can Be Contributed? under Roth IRAs.

Change in exception to the age 59½ rule.   Generally, if you are under age 59½, you must pay a 10% additional tax on the distribution of any assets from your traditional IRA. However, if you receive distributions as part of a series of substantially equal payments over your life (or life expectancy), or over the lives (or the joint life expectancies) of you and your beneficiary, you do not have to pay this additional tax even if your receive distributions before you reach age 59½. If these payments are changed (for any reason other than death or disability) before the later of the date you reach age 59½ or 5 years after the first payment, you generally are subject to the 10% additional tax. You must pay the full amount of the additional tax that would have been due if your payments had not been substantially equal periodic payments. You must also pay interest. If your series of substantially equal periodic payments began before 2003, you can change your method of figuring your payment to the required minimum distribution method at any time without incurring the additional tax. For distributions beginning in 2002, and for any series of payments beginning after 2002, if you began receiving distributions using either the amortization method or the annuity factor method, you can make a one-time switch to the required minimum distribution method without incurring the additional tax. For more information, see Age 59½ Rule and its exceptions in chapter 1 of Publication 590. Rules for figuring your required minimum distribution are explained under Minimum Distributions in chapter 1 of Publication 590.

Important Changes for 2003

Modified AGI limit for traditional IRAs.   For 2003, if you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA will be reduced (phased out) if your modified adjusted gross income (AGI) is between:

• $60,000 and $70,000 for a married couple filing a joint return or a qualifying widow(er),
• $40,000 and $50,000 for a single individual or head of household, or
• $-0- and $10,000 for a married individual filing a separate return.

For all filing statuses other than married filing separately, the upper and lower limits of the phaseout range increase by $6,000. For more information, see How Much Can I Deduct? under Traditional IRAs.

Deemed IRAs.   For plan years beginning after 2002, a qualified employer plan (retirement plan) can maintain a separate account or annuity under the plan (a deemed IRA) to receive voluntary employee contributions. If the separate account or annuity otherwise meets the requirements of an IRA, it will only be subject to IRA rules. An employee's account can be treated as a traditional IRA or a Roth IRA.

For this purpose, a qualified employer plan includes:

• A qualified pension, profit-sharing, or stock bonus plan (section 401(a) plan),
• A qualified employee annuity plan (section 403(a) plan),
• A tax-sheltered annuity plan (section 403(b) plan), and
• A deferred compensation plan (section 457(b) plan) maintained by a state, a political subdivision of a state, or an agency or instrumentality of a state or political subdivision of a state.

Simplified rules for required minimum distributions.   There are new rules for determining the amount of a required minimum distribution for a year beginning after 2002. The new rules, including new life expectancy tables, have been incorporated into Publication 590. See When Must I Withdraw IRA Assets? in chapter 1 of Publication 590.

Important Reminders

IRA interest.   Although interest earned from your IRA is generally not taxed in the year earned, it is not tax-exempt interest. Do not report this interest on your tax return as tax-exempt interest.

Form 8606.   If you make nondeductible contributions to a traditional IRA and you do not file Form 8606, Nondeductible IRAs, with your tax return, you may have to pay a $50 penalty.

Spousal IRAs.   In the case of a married couple filing a joint return, up to $3,000 ($3,500 if 50 or older) can be contributed to IRAs (other than SIMPLE IRAs) on behalf of each spouse, even if one spouse has little or no compensation. See Spousal IRA limit under How Much Can Be Contributed? and under Can I contribute to a Roth IRA for my spouse? under Roth IRAs, later.

Employer contributions under a SEP plan are not counted when figuring the limits just discussed. SEP plans are discussed in chapter 3 of Publication 590.

Spouse covered by employer plan.   If you are not covered by an employer retirement plan and you file a joint return, you may be able to deduct all of your contributions to a traditional IRA, even if your spouse is covered by a plan. See How Much Can I Deduct? under Traditional IRAs.

Distributions for higher education expenses.   You can take distributions from your traditional IRA or Roth IRA for qualified higher education expenses without having to pay the 10% additional tax on early distributions. For more information, see Publication 590.

Distributions for first home.   You can take distributions of up to $10,000 from your traditional or Roth IRA to buy, build, or rebuild a first home without having to pay the 10% additional tax on early distributions. For more information, see Publication 590.

Roth IRA.   You cannot claim a deduction for any contributions to a Roth IRA. But, if you satisfy the requirements, all earnings are tax free and neither your nondeductible contributions nor any earnings on them are taxable when you withdraw them. See Roth IRAs, later.

Introduction

An individual retirement arrangement (IRA) is a personal savings plan that offers you tax advantages to set aside money for your retirement.

This chapter discusses:

1. The rules for a traditional IRA (any IRA that is not a Roth or SIMPLE IRA), and
2. The Roth IRA, which features nondeductible contributions and tax-free distributions.

Simplified Employee Pensions (SEPs) and Savings Incentive Match Plans for Employees (SIMPLEs) are not discussed in this chapter. For more information on these plans and employees' SEP-IRAs and SIMPLE IRAs that are part of these plans, see Publication 590.

Useful Items

You may want to see:

Publication

• 590   Individual Retirement Arrangements (IRAs)

Form (and Instructions)

• 5329   Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts
• 8606   Nondeductible IRAs

Traditional IRAs

In this chapter the original IRA (sometimes called an ordinary or regular IRA) is referred to as a traditional IRA. Two advantages of a traditional IRA are:

1. You may be able to deduct some or all of your contributions to it, depending on your circumstances, and,
2. 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 or a SIMPLE IRA.

Who Can Set Up
a Traditional IRA?

You can set up and make contributions to a traditional IRA if:

1. You (or, if you file a joint return, your spouse) received taxable compensation during the year, and
2. You were not age 70½ 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, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans). Scholarship and fellowship payments are compensation for this purpose only if shown in box 1 of Form W-2. 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 the net earnings from your trade or business (provided your personal services are a material income-producing factor) reduced by the total of:

1. The deduction for contributions made on your behalf to retirement plans, and
2. The deduction allowed for one-half of your self-employment taxes.

Compensation includes earnings from self-employment even if they 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).
• Income from a partnership for which you do not provide services that are a material income-producing factor.
• Any amounts you exclude from income, such as foreign earned income and housing costs.

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 Contributions Be Made, 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.

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

How Much Can Be
Contributed?

There are limits and other rules that affect the amount that can be contributed and the amount you can deduct. These limits and other rules are explained below.

Community property laws.   Except as discussed later under Spousal IRA limit, each spouse figures his or her limit separately, using his or her own compensation. This is the rule even in states with community property laws.

Brokers' commissions.   Brokers' commissions paid in connection with your traditional IRA are subject to the contribution limit.

Trustees' fees.   Trustees' administrative fees are not subject to the contribution limit.

Contributions to your traditional IRAs reduce the limit for contributions to Roth IRAs. (See Roth IRAs, later.)

General limit.   The most that can be contributed 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. $3,000 ($3,500 if you are 50 or older).

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.)

Example 1.   Betty, who is 34 years old and single, earned $24,000 in 2002. Her IRA contributions for 2002 are limited to $3,000.

Example 2.   John, a college student working part time, earned $1,500 in 2002. His IRA contributions for 2002 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. $3,000 ($3,500 if you are 50 or older), or
2. The total compensation includible in the gross income of both you and your spouse for the year, reduced by the following two amounts.
   1. Your spouse's contribution for the year to a traditional IRA.
   2. Any contribution for the year to a Roth IRA on behalf of your spouse.

This means that the total combined contributions that can be made for the year to your IRA and your spouse's IRA can be as much as $6,000 ($6,500 if only one of you is 50 or older, or $7,000 if both of you are 50 or older).

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