Know the rules for your IRA contributions. Many taxpayers can take a deduction for money they contribute to a traditional IRA each year, but it depends on some rules. You must have earned income to qualify, know the type of IRA you are contributing to, and understand the IRS limit on the total amount of contributions that can be deducted.
What IRAs Are Eligible?
You can claim a deduction for traditional IRA contributions, but not for Roth accounts which are treated differently for tax purposes. Roth IRA distributions are tax-free after retirement, as long as you meet the holding time and age requirements. You don’t get a tax break on the money at the time you contribute it, the tax break comes when you take the money out tax-free.
Unlike Roth accounts, traditional IRA distributions are taxed when they’re withdrawn.
SEP, SIMPLE, and SARSEP IRA plan contributions are also deductible, but these can be subject to slightly different rules. The majority of taxpayers will utilize Roth or Traditional IRA’s, so check with your tax advisor for the rules around these plans.
You must have earned income to make IRA contributions. Interest and dividend income and earnings from property, such as rental income, do not count.
You and your spouse can take an IRA deduction regardless of how much you earn. There are no caps on income, but your IRA deduction is subject to income limitations if you would like to receive a tax break for your contribution.
The deadline for making deductible contributions is April 15 of the year following the tax year in which you’re claiming them. For 2020 contributions, you have until April 15, 2021, to fund your IRA.
Annual Contribution Caps
You can take an IRA deduction for up to $6,000 in contributions in 2021 if you’re age 49 or under. This increases to $7,000 if you’re age 50 or older. You can’t contribute more than your annual earnings. These limits apply to all IRA accounts that you hold. They’re not $6,000 or $7,000 for each IRA. They’re $6,000 or $7,000 for all your accounts collectively.
Spousal IRA Contributions
You can make a spousal IRA contribution for your non-working spouse—if you have enough earned income to cover the contributions in addition to your own. And yes, you can claim an IRA deduction for doing so.
You could make $7,000 in deductible contributions for each of you for a total of $14,000 if you and your unemployed spouse are age 50 and older.
If You Have an Employer-Sponsored Retirement Plan
Your IRA deduction can be limited if you also contribute to a company-sponsored retirement plan. It depends on the amount and the type of income you report.
A taxpayer is considered to be a participant in a company-sponsored retirement plan if their account balance receives any contributions at all in a given year, even if all the contributions were made by the employer. In this case, your ability to deduct your IRA contribution breaks down like this:
- The IRA deduction is phased out if you have between $66,000 and $76,000 in modified adjusted gross income (MAGI) as of 2021 if you’re single or filing as head of household. You’ll be entitled to less of a deduction if you earn $66,000 or more, and you’re not allowed a deduction at all if your MAGI is over $76,000.
- The IRA deduction is phased out between $105,000 and $125,000 if you’re married and filing jointly as of 2021, or if you’re a qualifying widow(er). Those with MAGIs over $125,000 aren’t allowed a deduction.
These limits plunge significantly for married taxpayers who file separate returns. They’re limited to a partial deduction in 2021 for MAGIs up to $10,000. There’s no deduction over this income threshold.
You can calculate your MAGI for purposes of claiming the IRA deduction by adding certain other deductions you might have taken back to your adjusted gross income (AGI), including the student loan interest deduction, and the tuition and fees deduction.
You must also add back certain income exclusions when calculating your MAGI, including foreign earned income and housing, employer adoption benefits, and savings bond interest.
As you can see there are many rules to comply with, so be sure to consult with us to ensure you get the best tax treatment for your IRA contributions.
Bradley Gay, CPA