Spousal IRA - IRS question

[Magnetar]

Hi All,
I just got a notice from the IRS that they are not allowing the $5000 Spousal IRA deduction I took in 2010 because my wife was eligible for a retirement plan at work. On her W2, the box for was checked for retirement plan. She only made $425 working part time and didn't contribute to the plan. Does that mean I lose the IRA deduction?
Thanks.

[JDCPAEsq]

Do you fall under the exceptions quoted in this article from "Smartmoney":
"A nonworking spouse can make a deductible IRA contribution of up to $5,000 for 2012 ($6,000 if age 50 or older as of 12/31/12) as long as the couple files a joint return, and the working spouse has enough earned income to cover the contribution. However, the deductibility of the nonworking spouse's contribution for 2012 is phased out for couples with adjusted gross income (AGI) between $173,000 and $183,000, provided that the working spouse is covered by a qualified retirement plan (via a job or self-employment). The working spouse's ability to make a deductible contribution for 2012 is phased out between AGI of $92,000 and $112,000".
John

[sscritic]

The W-2 may not have been correct.

You’re covered by an employer retirement plan for a tax year if your employer (or your spouse’s employer) has a:
Defined contribution plan (profit-sharing, 401(k), stock bonus and money purchase pension plan) and any contributions or forfeitures were allocated to your account for the plan year ending with or within the tax year;
...
Box 13 on the Form W-2 you receive from your employer should contain a check in the “Retirement plan” box if you are covered. If you are still not certain, check with your (or your spouse’s) employer.

Did the company contribute to the plan for her? You should have checked with the employer at the time and asked for a corrected W-2 if no contributions were made. Their computer must have just assumed that every employee was covered.

[BolderBoy]

Hi All,
I just got a notice from the IRS that they are not allowing the $5000 Spousal IRA deduction I took in 2010 because my wife was eligible for a retirement plan at work. On her W2, the box for was checked for retirement plan. She only made $425 working part time and didn't contribute to the plan. Does that mean I lose the IRA deduction?
Thanks.

From the facts as you stated them, my guess is "yes", you will lose the IRA deduction (at least $4575 of it anyway.) You are in the Catch-22 situation wherein the Spousal IRA Contribution is meant for non-working spouses, which yours is not. Depending upon the income limitations application, she may be entitled to a $425 contribution to her own IRA and deduction for that.

Disclaimer - do more research on this. I might be wrong.

[earlyout]

If you haven't done so, I'd encourage you to read IRS Publication 590.

[Magnetar]

Do you fall under the exceptions quoted in this article from "Smartmoney":
"A nonworking spouse can make a deductible IRA contribution of up to $5,000 for 2012 ($6,000 if age 50 or older as of 12/31/12) as long as the couple files a joint return, and the working spouse has enough earned income to cover the contribution.

Yes, joint return. I have enough income to cover contributions

However, the deductibility of the nonworking spouse's contribution for 2012 is phased out for couples with adjusted gross income (AGI) between $173,000 and $183,000, provided that the working spouse is covered by a qualified retirement plan (via a job or self-employment).

The working spouse, me, was not covered by a retirement account. I also made a deductible $5000 IRA contribution that was accepted.
Thanks

[Magnetar]

The W-2 may not have been correct.

You’re covered by an employer retirement plan for a tax year if your employer (or your spouse’s employer) has a:
Defined contribution plan (profit-sharing, 401(k), stock bonus and money purchase pension plan) and any contributions or forfeitures were allocated to your account for the plan year ending with or within the tax year;
...
Box 13 on the Form W-2 you receive from your employer should contain a check in the “Retirement plan” box if you are covered. If you are still not certain, check with your (or your spouse’s) employer.

Did the company contribute to the plan for her? You should have checked with the employer at the time and asked for a corrected W-2 if no contributions were made. Their computer must have just assumed that every employee was covered.

I got a letter from the company that states that she was eligible to contribute to the plan, but, she didn't participate. No contributions were made to the plan on her behalf.

[Magnetar]

If you haven't done so, I'd encourage you to read IRS Publication 590.

Thanks, I did read it.

From IRS 590: "You can have a traditional IRA whether or not you are covered by any other retirement plan. However, you may not be able to deduct all of your contributions if you or your spouse is covered by an employer retirement plan. See How Much Can You Deduct , later."

But, I am not sure if "covered" means elgible or participated.

[dbr]

Covered will mean eligible as indicated by the check box on the W-2.

[Magnetar]

Covered will mean eligible as indicated by the check box on the W-2.

So, that means I am losing a $5000 IRA deduction because she made $425 in wages?

[BolderBoy]

Covered will mean eligible as indicated by the check box on the W-2.

So, that means I am losing a $5000 IRA deduction because she made $425 in wages?

Yes. That is the Catch-22 I was referring to.

[Magnetar]

Covered will mean eligible as indicated by the check box on the W-2.

So, that means I am losing a $5000 IRA deduction because she made $425 in wages?

Yes. That is the Catch-22 I was referring to.

Since the rest of her IRA is deductible, do I need to take the $5000 out?

[sscritic]

Did the company contribute to the plan for her? You should have checked with the employer at the time and asked for a corrected W-2 if no contributions were made. Their computer must have just assumed that every employee was covered.

I got a letter from the company that states that she was eligible to contribute to the plan, but, she didn't participate. No contributions were made to the plan on her behalf.

If true and if I read correctly, she wasn't covered. You could ask for a corrected W-2, but at the very least you want to tell the IRS that the W-2 was incorrect and that she was not covered. Of course it is possible the IRS was not telling the truth when they defined covered the way they did in the quote I took from them, but I doubt it. What does pub 590 say about the definition of covered? Never mind, they don't give the definition, they just tell you to look at the box without telling you how to figure if the box was correct or not. Hmm, where to look next? Employer instructions for the W-2?

Retirement plan. Check this box if the employee was an “active participant” (for any part of the year) in any of the following.
...
Generally, an employee is an active participant if covered by (a) a defined benefit plan for any tax year that he or she is eligible to participate in or (b) a defined contribution plan (for example, a section 401(k) plan) for any tax year that employer or employee contributions (or forfeitures) are added to his or her account. For additional information on employees who are eligible to participate in a plan, contact your plan administrator. For details on the active participant rules, see Notice 87-16, 1987-1 C.B. 446; Notice 98-49, 1998-2 C.B. 365; section 219(g)(5); and Pub. 590, Individual Retirement Arrangements (IRAs). You can find Notice 98-49 on page 5 of Internal Revenue Bulletin 1998-38 at http://www.irs.gov/pub/irs-irbs/ irb98-38.pdf. Also see Notice 2000-30, which is on
page 1266 of Internal Revenue Bulletin 2000-25 at http://www.irs.gov/pub/irs-irbs/irb00-25.pdf.

I think the company goofed when they checked the box for someone who was not an active participant. Now I have to get ready for my saturday morning soaps (yes, some run on the weekends), so I will let you read the details on the active participant rules yourself (forget pub 590).

Edit added: P.S. Note that if it was a defined benefit plan, then she was covered even if no contributions were made. Details, details.

[BolderBoy]

Covered will mean eligible as indicated by the check box on the W-2.

So, that means I am losing a $5000 IRA deduction because she made $425 in wages?

Yes. That is the Catch-22 I was referring to.

Since the rest of her IRA is deductible, do I need to take the $5000 out?

Well, if you are filing a joint tax return, I'd say you need to remove $4575, right?

This whole "covered, eligible, uncovered" thing can be quite misleading. During Bush the Younger's term, the deductibility of health insurance premiums by self-employed people who also had an employer which "provided" a health plan the participation in which was voluntary, was changed several times over the 8 years. The argument was the same - if you are eligible to participate, does one's voluntary choice NOT to participate mean that one was not "covered". Some years the IRS said yes and others they said no.

I still think in your case, with the facts you cite and the plain reading of Pub 590, you are screwed in this instance.

Sorry.

(PS - I'm not an expert at this!)

[dbr]

I think the company goofed when they checked the box for someone who was not an active participant. Now I have to get ready for my saturday morning soaps (yes, some run on the weekends), so I will let you read the details on the active participant rules yourself (forget pub 590).

Edit added: P.S. Note that if it was a defined benefit plan, then she was covered even if no contributions were made. Details, details.

sscritic is probably right and I am wrong if the situation is that the company goofed.

[Magnetar]

I think the company goofed when they checked the box for someone who was not an active participant. Now I have to get ready for my saturday morning soaps (yes, some run on the weekends), so I will let you read the details on the active participant rules yourself (forget pub 590).

Edit added: P.S. Note that if it was a defined benefit plan, then she was covered even if no contributions were made. Details, details.

sscritic is probably right and I am wrong if the situation is that the company goofed.

I will send the letter in to the IRS stating that she wasn't covered and wait for their response.

[Magnetar]

Thanks to everyone for the help. This board is really a great asset.

[sscritic]

This whole "covered, eligible, uncovered" thing can be quite misleading. During Bush the Younger's term, the deductibility of health insurance premiums by self-employed people who also had an employer which "provided" a health plan the participation in which was voluntary, was changed several times over the 8 years. The argument was the same - if you are eligible to participate, does one's voluntary choice NOT to participate mean that one was not "covered". Some years the IRS said yes and others they said no.

At this point he has received a letter. Now it is time for him to state his case. To paraphrase someone, sometimes the IRS will say yes and sometimes they will say no. There is no reason for him to give up at this point, unless his wife was in a defined benefit plan, in which case it seems she was an "active participant" and covered, even if she didn't actively participate (and even then I would read the rules cited by the IRS to see if there is an out).

[sscritic]

I will send the letter in to the IRS stating that she wasn't covered and wait for their response.

Are you indirectly telling us that she was in a defined contribution plan?

[JW Nearly Retired]

Since the rest of her IRA is deductible, do I need to take the $5000 out?

Maybe you might want to take it out but it isn't required, you just can't deduct it if you make too much money. Anyone no matter how high their income can contribute to an IRA, the only limits are on the deductibility of it. If you leave it in you will need to file an IRS form 8606 to keep track of the non-deductible basis in the IRA forever. When you take money out in retirement you can deduct the after-tax contribution cost basis pro-rata from your yearly draw. It's just the contribution amount, all earnings on it are taxed.

It's not that hard to keep track of. DW has a mixed deductible/non-deductible contribution IRA like this.
JW

[Magnetar]

I will send the letter in to the IRS stating that she wasn't covered and wait for their response.

Are you indirectly telling us that she was in a defined contribution plan?

The letter from the company says "...Box 13 on your 2012 W-2 Form was appropriately checked because you were eligible for a retirement plan. Our records indicate that you did not participate."

I figure I will send this letter to the IRS and see what they say.

[Magnetar]

Since the rest of her IRA is deductible, do I need to take the $5000 out?

Maybe you might want to take it out but it isn't required, you just can't deduct it if you make too much money. Anyone no matter how high their income can contribute to an IRA, the only limits are on the deductibility of it. If you leave it in you will need to file an IRS form 8606 to keep track of the non-deductible basis in the IRA forever. When you take money out in retirement you can deduct the after-tax contribution cost basis pro-rata from your yearly draw. It's just the contribution amount, all earnings on it are taxed.

It's not that hard to keep track of. DW has a mixed deductible/non-deductible contribution IRA like this.
JW

Thanks. Is the non-deductible basis just the $5000? I don't have to keep track of anything else, do I?

[JW Nearly Retired]

Since the rest of her IRA is deductible, do I need to take the $5000 out?

Maybe you might want to take it out but it isn't required, you just can't deduct it if you make too much money. Anyone no matter how high their income can contribute to an IRA, the only limits are on the deductibility of it. If you leave it in you will need to file an IRS form 8606 to keep track of the non-deductible basis in the IRA forever. When you take money out in retirement you can deduct the after-tax contribution cost basis pro-rata from your yearly draw. It's just the contribution amount, all earnings on it are taxed.

It's not that hard to keep track of. DW has a mixed deductible/non-deductible contribution IRA like this.
JW

Thanks. Is the non-deductible basis just the $5000? I don't have to keep track of anything else, do I?

Yep, just the $5000 and any future non-deductible $5000s. After you start taking it out you will start keeping track of the declining amount of non-deductible contributions left to be deducted but the form 8606 does that for you. Your tax software will do it.

It's very much like carryover losses on Schedule D.
JW

[Magnetar]

Since the rest of her IRA is deductible, do I need to take the $5000 out?

Maybe you might want to take it out but it isn't required, you just can't deduct it if you make too much money. Anyone no matter how high their income can contribute to an IRA, the only limits are on the deductibility of it. If you leave it in you will need to file an IRS form 8606 to keep track of the non-deductible basis in the IRA forever. When you take money out in retirement you can deduct the after-tax contribution cost basis pro-rata from your yearly draw. It's just the contribution amount, all earnings on it are taxed.

It's not that hard to keep track of. DW has a mixed deductible/non-deductible contribution IRA like this.
JW

Thanks. Is the non-deductible basis just the $5000? I don't have to keep track of anything else, do I?

Yep, just the $5000 and any future non-deductible $5000s.

OK, that doesn't seem very difficult. If I take it out, do I need to remove any gains that the $5000 generated since 2009?

[JW Nearly Retired]

OK, that doesn't seem very difficult. If I take it out, do I need to remove any gains that the $5000 generated since 2009?

I don't know about the gains.
JW

[BolderBoy]

OK, that doesn't seem very difficult. If I take it out, do I need to remove any gains that the $5000 generated since 2009?

This could get really complicated. Any withdrawal (*any*) that you make at this point from that account will be reported to you as a "distribution" in the year you make the withdrawal. It will be up to you to correctly report to the IRS the nature of the distribution, since the custodian will likely check the "taxability = undetermined" box on the 1099R they issue you at year-end, which gets them completely off the hook.

Ferreting out the "gains" portion alone can be tough if the custodian can't do it for you.

I guess I'd support SScritic's suggestion that you challenge the IRS and see if they'll back down on this issue for you this time. Write the letter carefully, using the lingo from Pub 590 so that you get the "eligible", "covered", etc words all used in such a way that they are consistent with YOUR position while being consistent with what Pub 590 says.

Don't forget that the IRS provides a "Problem Resolution Office" to help with ambiguities in the law. Get them involved if the IRS's next response isn't what you want.

What a nuisance for you to endure.

[Magnetar]

OK, that doesn't seem very difficult. If I take it out, do I need to remove any gains that the $5000 generated since 2009?

This could get really complicated. Any withdrawal (*any*) that you make at this point from that account will be reported to you as a "distribution" in the year you make the withdrawal. It will be up to you to correctly report to the IRS the nature of the distribution, since the custodian will likely check the "taxability = undetermined" box on the 1099R they issue you at year-end, which gets them completely off the hook.

Ferreting out the "gains" portion alone can be tough if the custodian can't do it for you.

I guess I'd support SScritic's suggestion that you challenge the IRS and see if they'll back down on this issue for you this time. Write the letter carefully, using the lingo from Pub 590 so that you get the "eligible", "covered", etc words all used in such a way that they are consistent with YOUR position while being consistent with what Pub 590 says.

Don't forget that the IRS provides a "Problem Resolution Office" to help with ambiguities in the law. Get them involved if the IRS's next response isn't what you want.

What a nuisance for you to endure.

OK, I will give it a try. Thanks for you help.

[BolderBoy]

Since the rest of her IRA is deductible, do I need to take the $5000 out?

Maybe you might want to take it out but it isn't required, you just can't deduct it if you make too much money. Anyone no matter how high their income can contribute to an IRA, the only limits are on the deductibility of it.
JW

Ummmm, I think it is more limited than this. You have to have earned income to contribute to *any* form of IRA, I think (that is the low end). So at least two issues are at play and with spousal contributions a third issue comes up, such as in this case.

At the upper limit, I agree with you - anyone can contribute to an IRA and only the deductibility is at issue.

[JW Nearly Retired]

Ummmm, I think it is more limited than this. You have to have earned income to contribute to *any* form of IRA, I think (that is the low end). So at least two issues are at play and with spousal contributions a third issue comes up, such as in this case.

A spouse can use their spouse's earned income.
JW

[sscritic]

Are you indirectly telling us that she was in a defined contribution plan?

The letter from the company says "...Box 13 on your 2012 W-2 Form was appropriately checked because you were eligible for a retirement plan. Our records indicate that you did not participate."

I figure I will send this letter to the IRS and see what they say.

You have missed my point, made earlier. There is one set of rules for a defined benefit plan and another set of rules for a defined contribution plan. These are the rules the employer is supposed to follow in deciding whether to check the box. To know if the employer acted correctly, you have to know if her plan was a defined benefit plan or a defined contribution plan. Nowadays, most defined benefit plans are pensions from governments; defined contribution plans are things like 401(k)s offered by private employers. You should know where she worked and be able to look up the retirement plan to see what type it was.

It sounds as if it was a defined contribution plan, in which case my reading of the instructions for the W-2 is that the box should not have been checked. In that case, my letter wouldn't mention publication 590, but the instructions for the W-2. If the basis of your claim is that the box was incorrectly checked, then you have to show that the box was incorrectly checked by referring to the rules on when the box should be checked. Now that's the way my logic goes, and my personality, as you might surmise from what I write. Other people would write other letters, and you are free to write your own letter, but that's the letter I would write.

[Alan S.]

If the active participant status is based on a DB plan, here is a tax court case confirming that a miniscule amount of earnings will make one an active participant even when it would take over a century to qualify for any benefit under the plan:

http://www.ustaxcourt.gov/InOpHistoric/WADE.TCM.WPD.pdf

Of course, it may be a DC plan OR the W-2 might be incorrect. If it is incorrect, it needs to be corrected if such correction will result in a deduction for the contribution.

If the W-2 is correct, then the choice is whether to retain a non deductible TIRA contribution and file Form 8606 to report it, OR request a return of that IRA contribution (with net allocated earnings) prior to the extended due date for the return.

[Epsilon Delta]

The OP said this contribution occurred in 2010. I believe it is well past the extended due date for that return so it is no longer possible to withdraw this contribution.

[Magnetar]

This whole "covered, eligible, uncovered" thing can be quite misleading. During Bush the Younger's term, the deductibility of health insurance premiums by self-employed people who also had an employer which "provided" a health plan the participation in which was voluntary, was changed several times over the 8 years. The argument was the same - if you are eligible to participate, does one's voluntary choice NOT to participate mean that one was not "covered". Some years the IRS said yes and others they said no.

At this point he has received a letter. Now it is time for him to state his case. To paraphrase someone, sometimes the IRS will say yes and sometimes they will say no. There is no reason for him to give up at this point, unless his wife was in a defined benefit plan, in which case it seems she was an "active participant" and covered, even if she didn't actively participate (and even then I would read the rules cited by the IRS to see if there is an out).

Well. I stated my case to the IRS and they accepted my response. I was allowed to deduct that IRA contribution.

Now, I have another related question. In April 2012, I contributed to my wife's IRA. In September 2012, she accepted a new position that has a defined benefit plan and enrolled in it. I do not wish to keep track of this non-deductible IRA contribution. All the rest of the contributions were deductible. I contacted Vanguard and they said they can remove the contribution and the associated gains so I won't have to keep track of the non-deductible part. I am going to do it before I file my taxes. Does this seem correct?

Thanks

[jared]

This whole "covered, eligible, uncovered" thing can be quite misleading. During Bush the Younger's term, the deductibility of health insurance premiums by self-employed people who also had an employer which "provided" a health plan the participation in which was voluntary, was changed several times over the 8 years. The argument was the same - if you are eligible to participate, does one's voluntary choice NOT to participate mean that one was not "covered". Some years the IRS said yes and others they said no.

At this point he has received a letter. Now it is time for him to state his case. To paraphrase someone, sometimes the IRS will say yes and sometimes they will say no. There is no reason for him to give up at this point, unless his wife was in a defined benefit plan, in which case it seems she was an "active participant" and covered, even if she didn't actively participate (and even then I would read the rules cited by the IRS to see if there is an out).

Well. I stated my case to the IRS and they accepted my response. I was allowed to deduct that IRA contribution.

Was the W-2 actually wrong? What was your case? Or did this one just slide by the IRS?

[JW Nearly Retired]

Now, I have another related question. In April 2012, I contributed to my wife's IRA. In September 2012, she accepted a new position that has a defined benefit plan and enrolled in it. I do not wish to keep track of this non-deductible IRA contribution. All the rest of the contributions were deductible. I contacted Vanguard and they said they can remove the contribution and the associated gains so I won't have to keep track of the non-deductible part. I am going to do it before I file my taxes. Does this seem correct?

Thanks

Yes, correct. It just undoes the contribution. Happens all the time when people end up making too much to contribute. I had to do it once and found VG has on the phone "specialists" for it.
JW

[Alan S.]

You should request a return of her contribution soon, because any earnings on the contribution will have to be added to your 2012 tax return on line 15b because the contribution was made IN 2012. There will also be a 10% penalty on the earnings portion only unless she is over 59.5. You will know the earnings amount from looking at her statements, since the 1099R will not be issued until Jan, 2014 and will be coded to show that the earnings were taxable in 2012. An explanatory statement about the contribution and return of contribution should be included on your 2012 return as well.

Note that she does not have an excess contribution, but a return of contribution and excess contribution distributions are handled the same way.

[Magnetar]

You should request a return of her contribution soon, because any earnings on the contribution will have to be added to your 2012 tax return on line 15b because the contribution was made IN 2012. There will also be a 10% penalty on the earnings portion only unless she is over 59.5. You will know the earnings amount from looking at her statements, since the 1099R will not be issued until Jan, 2014 and will be coded to show that the earnings were taxable in 2012. An explanatory statement about the contribution and return of contribution should be included on your 2012 return as well.

Note that she does not have an excess contribution, but a return of contribution and excess contribution distributions are handled the same way.

Thanks for the info Alan.

I talked to Vanguard and they said exactly the same thing. The only thing that has me a little confused is the amount of the gains from the excess contribution.

Vanguard said I need to take the total IRA balance from the contribution date to the reversal date, subtract the earnings and apply that to the ratio of contribution to balance. I think this means the following:
If I have two funds in my IRA, Fund A and Fund B,
On 4/24, I have $20K in Fund A, $10K in Fund B Total IRA = $30K
On 4/25, I add $5K to Fund B $20K in Fund A, $15K in Fund B Total IRA = $35K
On 12/25 (Day of return of contribution): $30K in Fund A $15K in Fund B Total IRA = $45K Fund A increased in value, Fund B did not
So earnings are: $45K(Balance now) - $30K(Balance before Contribution) - $5K (Contribution) = $10K
Initial Ratio: 10K/30K = 33.3%
So, I will remove from my IRA: $5k contribution + 1/3($10K Earnings) = $8333.33
I will pay taxes on $3333.33 earnings + $333.33 penalty

Does this sound correct?

[Alan S.]

No, the result is incorrect.
Your adjusted opening balance is 30k plus 5k contribution = 35k
Your adjusted closing balance is 45k (no adjustments)
45/35 = gain of 28.6%
1.286 X 5k = 6,430 returned amount that includes 1,430 of earnings that are taxable and subject to penalty.

You were on the right track except that in your initial ratio your divisor should be 35, not 30. Your gain occurred on a base amount of 35k which of course includes the contribution amount. So your tax and penalty is lower than you thought.

But there are more questions. You show 12/25 for the corrective distribution, and you probably meant 1/25/2013....

Are you sure that your joint modified AGI exceeds 173k? Under 173k you qualify for a full Roth contribution and since the earnings on this contribution are excellent, you should consider recharacterizing it to a Roth contribution if your incomes permit, instead of removing it and paying tax and penalty. Not sure if you actually ordered the distribution yet, because if you did you cannot recharacterize it.

[FinancialDave]

What not just put the money in a Roth IRA account -- I don't see where that gets reduced at all by any retirement contributions.

fd