Tax Talk: Four fundamental questions about a traditional IRA contribution are answered
Is it too late to make an IRA contribution for 2021? A friend of mine told me the IRA contribution rules permit this. The friend also indicated that people who are 50 or older are allowed to contribute more than the maximum amount. Is that true?
— WA, email
Before we cover the timing and amount of Individual Retirement Arrangements (IRAs) let's review the basics. Like many individual income tax items, several rules have been changed.
IRA contributions can be made to either a traditional or Roth IRA. These contributions are often made with different goals in mind. Both are popular retirement planning tools. Our response will focus on the "traditional" (also called "ordinary" or "regular") IRA, which can be opened and contributions made to if you or (if you file a joint return) your spouse received "taxable compensation" (e.g., wages, salaries, gig economy and/or net self-employment income) during the year. A tax law change (as of January 1, 2020) allows people earning compensation who are 70½ or older to make an IRA contribution. This alteration repealed the prohibition in place for septuagenarians (a.k.a., "seventy somethings").
Four fundamental questions about a traditional IRA contribution are (a) WHEN can it be made? (b) HOW MUCH? (c) Will the contribution be DEDUCTIBLE? and (d) HOW IS IT REPORTED on a tax return?
Addressing the WHEN question: Contributions can be made to a traditional IRA for a year at any time during the year or by the filing due date for that year not including extensions. For most people, 2021 contributions must be made on or before April 18, 2022 (Note: there are three extra days in this "tax season"). Extending the time to file a tax return will not extend the time to make an IRA contribution. It is the taxpayer's responsibility to make sure the IRA sponsor knows which year applies to the contribution. For example, it appears that you will make an IRA contribution in 2022 for the 2021 year. Communicating that explicitly to the IRA sponsor provides important information that will impact your 2021 filing.
HOW MUCH? For 2021, the most that can be contributed to a traditional IRA is generally the smaller of (a) $6,000 (Note: that increases to $7,000 if you are 50 or older by the end of 2021) or (b) "Taxable compensation" (defined above) for the year. Two caveats related to the HOW MUCH? query include: If you contribute less than the maximum amount, you cannot play "catch up" ball in a future year; in some situations where one spouse's compensation is lower than his/her spouse, the Kay Bailey Hutchinson Spousal IRA may allow a larger total IRA contribution. IRS Publication 590-A covers this as well as other IRA subjects in an excellent way and includes several practical examples.
Looking at WHAT'S DEDUCTIBLE? begins with an assumption that neither the taxpayer nor his/her spouse is an "active participant" in a retirement plan at work (usually designated by the "Retirement Plan" box – line 13 – of Form W-2 being checked). If that assumption applies, then the HOW MUCH? paragraph provides information. When a traditional IRA is held and there is an employer retirement plan in place for both spouses, the deductible amount is subject to specific amounts and a phase-out provision. For married taxpayers filing jointly, a modified adjusted gross income (MAGI) of $105,000 begins the trimming and continues until $125,000 where a full phase out occurs. Single or Head of Household taxpayers contend with amounts of $66,000 to $76,000 for a full phase out. If one spouse is an active participant in an employer-plan and the other spouse is not in a work plan, the MAGI figures are $198,000 and $208,000.
HOW IS IT REPORTED? Schedule 1, line 20 of Form 1040 shows the deductible amount. If nondeductible contributions are made, complete Form 8606. Note that Form 8606 must be filed even if a Form 1040 is not required. Failure to complete a Form 8606 can lead to the IRS levying taxes and penalties.
Ken & Klee's income tax bulletin board. The IRS … is still processing between five and six million individual tax returns from 2020 … Free File Program which allows taxpayers with 2021 income of $73,000 or less to self-prepare and e-file using tax preparation software went active on Jan. 14 … has or will send Letter 6419, 2021 Advanced Child Tax Credit, which provides information about these payments.
Rick Klee served as the tax director at the University of Notre Dame from 1998 through August 2019. A retired CPA, Klee is a graduate of Notre Dame. You can contact him at rklee@nd.edu.
Ken Milani is a professor of accountancy at Notre Dame where he served as the faculty coordinator of the Notre Dame Tax Assistance Program. Contact him at milani.1@nd.edu.E-mail questions to either.
This article originally appeared on South Bend Tribune: Tax Talk: Four fundamental questions about IRA contributions answered
