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Publication 590
Individual Retirement Arrangements (IRAs)

For use in preparing 2002 Returns

How To Figure Your Reduced IRA Deduction

If you or your spouse is covered by an employer retirement plan and you did not receive any social security benefits, you can figure your reduced IRA deduction by using Worksheet 1-2, Figuring Your Reduced IRA Deduction for 2002. The instructions for both Form 1040 and Form 1040A include similar worksheets that you can use instead of the worksheet in this publication.

If you or your spouse is covered by an employer retirement plan, and you received any social security benefits, see Social Security Recipients, earlier.

Note.   If you were married and both you and your spouse contributed to IRAs, figure your deduction and your spouse's deduction separately.

Worksheet 1-1. Figuring Your Modified AGI Use this worksheet to figure your modified AGI for traditional IRA purposes.

1. Enter your adjusted gross income (AGI) shown on line 21, Form 1040A, or line 35, Form 1040 figured without taking into account line 17, Form 1040A, or line 24, Form 1040 1.       
2. Enter any student loan interest deduction from line 18, Form 1040A, or line 25, Form 1040 2.       
3. Enter any tuition and fees deduction from line 19, Form 1040A, or line 26, Form 1040 3.       
4. Enter any foreign earned income exclusion and/or housing exclusion from line 18, Form 2555-EZ, or line 43, Form 2555 4.       
5. Enter any foreign housing deduction from line 48, Form 2555 5.       
6. Enter any excluded qualified savings bond interest shown on line 3, Schedule 1, Form 1040A, or line 3, Schedule B, Form 1040 (from line 14, Form 8815) 6.       
7. Enter any exclusion of employer-paid adoption expenses shown on line 30, Form 8839 7.       
8. Add lines 1 through 7. This is your Modified AGI for traditional IRA purposes 8.       

Reporting Deductible Contributions

If you file Form 1040, enter your IRA deductions on line 24 of that form. If you file Form 1040A, enter your IRA deductions on line 17 of that form. You cannot deduct IRA contributions on Form 1040EZ.

Self-employed.   If you are self-employed (a sole proprietor or partner) and have a SEP-IRA or a SIMPLE IRA, enter your deduction for allowable plan contributions on line 31, Form 1040.

Nondeductible Contributions

Although your deduction for IRA contributions may be reduced or eliminated, contributions can be made to your IRA of up to the general limit of $3,000 ($3,500 if 50 or older) or 100% of compensation, whichever is less or the spousal IRA limit (if it applies). The difference between your total permitted contributions and your IRA deduction, if any, is your nondeductible contribution.

Example.   Tony Martin is 29 years old and single. In 2002, he was covered by a retirement plan at work. His salary is $52,312. His modified adjusted gross income (modified AGI) is $55,000. Tony makes a $3,000 IRA contribution for 2002. Because he was covered by a retirement plan and his modified AGI is above $44,000, he cannot deduct his $3,000 IRA contribution. He must designate this contribution as a nondeductible contribution by reporting it on Form 8606.

Form 8606.   To designate contributions as nondeductible, you must file Form 8606. (See the filled-in Forms 8606 in this chapter.)

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 contributions.

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

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

Penalty for overstatement.   If you overstate the amount of nondeductible contributions on your Form 8606 for any tax year, 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.

Tax on earnings on nondeductible contributions.   As long as contributions are within the contribution limits, none of the earnings or gains on those contributions (deductible or nondeductible) will be taxed until they are distributed.

Cost basis.   You will have a cost basis in your IRA if there are nondeductible contributions. Your cost basis is the sum of the nondeductible contributions to your IRA minus any withdrawals or distributions of nondeductible contributions.

CAUTION: Commonly, distributions from your traditional IRAs will include both taxable and nontaxable (cost basis) amounts. See Are Distributions Taxable, later, for more information.

FILES: Recordkeeping. There is a recordkeeping worksheet, Appendix A, Summary Record of Traditional IRA(s) for 2002, that you can use to keep records of deductible and nondeductible IRA contributions.

Examples - Worksheet for
Reduced IRA Deduction for 2002

The following examples illustrate the use of Worksheet 1-2, Figuring Your Reduced IRA Deduction for 2002.

Example 1.   For 2002, Tom and Betty Smith file a joint return on Form 1040. They are both 39 years old. They are both employed and Tom is covered by his employer's retirement plan. Tom's salary is $40,000 and Betty's is $16,555. They each have a traditional IRA and their combined modified AGI, which includes $2,000 interest and dividend income, is $58,555. Since their modified AGI is between $54,000 and $64,000 and Tom is covered by an employer plan, Tom is subject to the deduction phaseout discussed earlier under Limit If Covered By Employer Plan.

For 2002, Tom contributed $3,000 to his IRA and Betty contributed $3,000 to hers. Even though they file a joint return, they must use separate worksheets to figure the IRA deduction for each of them.

Tom can take a deduction of only $1,640.

He can choose to treat the $1,640 as either deductible or nondeductible contributions. He can either leave the $1,360 ($3,000 - $1,640) of nondeductible contributions in his IRA or withdraw them by April 15, 2003. He decides to treat the $1,640 as deductible contributions and leave the $1,360 of nondeductible contributions in his IRA.

Using Worksheet 1-2, Figuring Your Reduced IRA Deduction for 2002, Tom figures his deductible and nondeductible amounts as shown on Filled-in Worksheet 1-2, Example 1 of Figuring Your Reduced IRA Deduction for 2002.

Betty figures her IRA deduction as follows. Betty can treat all or part of her contributions as either deductible or nondeductible. This is because her $3,000 contribution for 2002 is not subject to the deduction phaseout discussed earlier under Limit If Covered By Employer Plan. She does not need to use Worksheet 1-2, Figuring Your Reduced IRA Deduction for 2002, since their modified AGI is not within the phaseout range that applies. Betty decides to treat her $3,000 IRA contributions as deductible.

The IRA deductions of $1,640 and $3,000 on the joint return for Tom and Betty total $4,640.

Example 2.   For 2002, Tom and Betty Smith file a joint return on Form 1040. They are both 39 years old. Tom is covered by his employer's retirement plan. Tom's salary is $40,000. Betty had no compensation for the year and did not contribute to an IRA. Tom contributed $3,000 to his traditional IRA and $3,000 to a traditional IRA for Betty (a spousal IRA). Their combined modified AGI, which includes $2,000 interest and dividend income and a large capital gain from the sale of stock is $156,555.

Because the combined modified AGI is $64,000 or more, Tom cannot deduct any of the contribution to his traditional IRA. He can either leave the $3,000 of nondeductible contributions in his IRA or withdraw them by April 15, 2003.

Betty figures her IRA deduction as shown on Filled-in Worksheet 1-2, Example 2 of Figuring Your Reduced IRA Deduction for 2002.

Worksheet 1-2. Figuring Your Reduced IRA Deduction for 2002 (Use only if you or your spouse is covered by an employer plan and your modified AGI falls between the two amounts shown below for your coverage situation and filing status.) Note. If you were married and both you and your spouse contributed to IRAs, figure your deduction and your spouse's deduction separately.
IF you ... AND your filing status is ... AND your modified AGI is over ... THEN enter on line 1 below...
are covered by an employer plan single or head of household $34,000 $44,000
married filing jointly or qualifying widow(er) $54,000 $64,000
married filing separately $0 $10,000
are not covered by an employer plan, but your spouse is covered married filing jointly $150,000 $160,000
married filing separately $0 $10,000
1. Enter applicable amount from table above 1. $
2. Enter your modified AGI (that of both spouses, if married filing jointly) 2. $
Note. If line 2 is equal to or more than the amount on line 1. STOP HERE. Your IRA contributions are not deductible. See Nondeductible Contributions.
3. Subtract line 2 from 1. If line 3 is $10,000 or more, STOP HERE. You can take a full IRA deduction for contributions of up to $3,000 ($3,500 if 50 or older) or 100% of your (and if married filing jointly, your spouse's) compensation, whichever is less 3. $
4. Multiply line 3 by 30% (.30) (by 35% (.35) if age 50 or older at the end of 2002). If the result is not a multiple of $10, round it to the next highest multiple of $10. (For example, $611.40 is rounded to $620.) However, if the result is less than $200, enter $200 4. $
5. Enter your compensation minus any deductions on Form 1040, line 29 (one-half of self-employment tax) and line 31(self-employed SEP, SIMPLE, and qualified plans). If you are filing a joint return and your compensation is less than your spouse's, include your spouse's compensation reduced by his or her traditional IRA and Roth IRA contributions for this year. If you file Form 1040, do not reduce your compensation by any losses from self-employment 5. $
6. Enter contributions made, or to be made, to your IRA for 2002 but do not enter more than $3,000 ($3,500 if 50 or older). If contributions are more than $3,000 ($3,500 if 50 or older), see Excess Contributions, later. 6. $
7. IRA deduction. Compare lines 4, 5, and 6. Enter the smallest amount (or a smaller amount if you choose) here and on the Form 1040 or 1040A line for your IRA, whichever applies. If line 6 is more than line 7 and you want to make a nondeductible contribution, go to line 8 7. $
8. Nondeductible contribution. Subtract line 7 from line 5 or 6, whichever is smaller. Enter the result here and on line 1 of your Form 8606 8. $

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