8.4 IRA Deduction Restrictions for Active Participants in Employer Plan

If you are covered by an employer retirement plan, including a self-employed plan, you may be unable to make deductible IRA contributions to a traditional IRA. When you have coverage, your right to claim a full deduction, a limited deduction, or no deduction at all depends on your modified adjusted gross income (MAGI). If you are married, and your spouse has employer plan coverage for 2012 you are also considered to have coverage in most cases. However, if you file jointly and do not individually have employer plan coverage, a special MAGI phaseout rule may allow you to deduct IRA contributions even if a deduction for your spouse is limited or barred.

If you are unmarried and do not have employer plan coverage, or if you are married and neither of you has coverage, an IRA deduction of up to $5,000 ($6,000 if age 50 or older) for 2012 is allowed as long as you have compensation of $5,000 ($6,000 if age 50 or older) or more. The deduction phaseout rules do not apply, regardless of your income.

Are you an active plan participant?

Generally, you are considered to be “covered” by a retirement plan if you are an active participant in the plan for any part of the plan year ending within your taxable year. If you are an employee, your Form W-2 for 2012 should indicate whether you are covered for the year; if you are, the “Retirement plan” box within Box 13 of Form W-2 should be checked. Active participation (8.5) in a self-employed Keogh plan or SEP (Chapter 41) is treated as employer plan coverage for purposes of the IRA deduction phaseout rules.

EXAMPLE
Sara Wartes, a college teacher, quit her job in 1988 and withdrew all of the contributions she had made to her employee pension plan. The Tax Court held that Sara could not claim an IRA deduction in that year. Sara was an active participant in the college plan during 1988 and under the phaseout rules based upon adjusted gross income, no IRA deduction was allowed. The court noted that the active participation test is not made at the end of the year. Participation in a company plan at any time during the year triggers the deduction phaseout rules. This is true even where a person has forfeitable benefits.

You are not an active plan participant but your spouse is.

Even if you were not an active participant in an employer retirement plan at any time in 2012, your IRA deduction limit for 2012 may be phased out because of your spouse’s coverage. However, if you file jointly, your own deduction is not limited unless modified adjusted gross income (MAGI) on the 2012 joint return exceeds $173,000. For your spouse who has employer plan coverage, the rule is different: the phaseout threshold for his or her 2012 deduction is joint MAGI of $92,000, assuming you file jointly.

As a nonparticipant, you are not allowed any deduction if MAGI on your joint return is $183,000 or more. A deduction for your spouse as an active participant is completely phased out if joint return MAGI for 2012 is $112,000 or more.

Stricter phaseout rules apply to married persons filing separately if they live together at any time during the year. If you lived with your spouse at any time during 2012 and either of you was an active plan participant in 2012, you are both subject to the $0 − $10,000 MAGI phaseout range on separate returns. Neither of you may claim an IRA deduction if the MAGI on your separate return is $10,000 or more.

If you are married filing separately and you lived apart for all of 2012, your spouse’s plan participation does not affect your IRA deduction. Take into account only your own participation, if any, and if you are an active participant, your IRA deduction under the phaseout rules is figured as if you were single. If you are not an active participant, you may claim the full $5,000 deduction limit for 2012 ($6,000 if age 50 or older).

Modified adjusted gross income (MAGI) determines your deduction limit if you or your spouse is an active plan participant.

If either you or your spouse is an active plan participant, you still may be allowed a full or limited deduction, but this will depend on whether your 2012 modified adjusted gross income (MAGI) is within the phaseout range that applies to you as shown below.

For purposes of figuring your IRA deduction limit, MAGI may be higher than the actual AGI reported on your return because certain deductions and exclusions are not taken into account. To get MAGI, you ignore IRA contributions and must add back to AGI any deduction claimed for student loan interest (33.14), qualified college tuition and fees (33.13), or domestic production activities income (40.23). If you are claiming an exclusion for employer-provided adoption assistance (3.6) or an exclusion for interest on U.S. Savings Bonds used for tuition (33.4), you must add back that excluded amount to adjusted gross income to get MAGI. If you worked abroad and are claiming the foreign earned income exclusion (36.1), or a foreign housing exclusion or deduction (36.4), these amounts also must be added back to adjusted gross income to get MAGI.

Figuring Your 2012 IRA Deduction Under the Phaseout Rules

If you are an active plan participant for 2012, or you file a joint return for 2012 and your spouse was an active participant, the full $5,000 (or $6,000 if age 50 or older) deduction limit is available to you only if your modified adjusted gross income (MAGI) is below a phaseout threshold shown below. Your deduction limit is phased out over the first $10,000 of MAGI exceeding the threshold, or $20,000 if you are married filing jointly or a qualifying widow(er) and you are an active plan participant.

Phaseout threshold for 2012 returns.

On your 2012 return, the $5,000 (or $6,000 if age 50 or older) deduction limit is subject to phaseout if modified adjusted gross income exceeds:

  • $58,000 if you are single or head of household;
  • $58,000 if you are married filing separately, you lived apart from your spouse for all of 2012, and you were an active plan participant during 2012. If you lived apart the entire year and you were not an active participant, you qualify for the full deduction limit; the phaseout rule is inapplicable to you even if your spouse was an active plan participant;
  • $92,000 if you are married filing jointly and both you and your spouse were active plan participants during 2012, or you are a qualifying widow or widower and were an active plan participant during 2012;
  • $92,000 if you are married filing jointly and you are an active plan participant during 2012 but your spouse was not. You use the $92,000 threshold; your spouse uses the $173,000 threshold;
  • $173,000 if you are married filing jointly and you were not an active plan participant at any time during 2012 but your spouse was. You use the $173,000 threshold; your spouse uses the $92,000 threshold; and
  • $0 if you are married filing separately, you lived with your spouse at any time in 2012, and either you or your spouse was an active plan participant during 2012. You and your spouse are both subject to the “0” threshold on your separate 2012 returns so long as you lived together at any time in 2012 and either of you was an active plan participant during the year.

Compute the deduction limit under the phaseout rule.

If your MAGI is within the phaseout range shown in the middle column of Table 8-1, you are allowed a portion of the deduction limit. You can figure the limit in your case by applying the following four steps. If you are married and both you and your spouse are contributing to traditional IRAs for 2012, you should separately figure your deduction limits, as each spouse may have a different phaseout threshold. The Examples below illustrate the computation.

Table 8-1 Phaseout Range for Deduction Limit on 2012 Returns

If your phaseout threshold (see above) is— Deduction limit is phased out if MAGI is— No deduction if MAGI is—
$58,000 Over $58,000 and under $68,000 or more $68,000
$92,000 Over $92,000 and under $112,000 or more $112,000
$173,000 Over $173,000 and under $183,000 or more $183,000
$0 $0–$9,999 $10,000 or more
1. Enter excess of your MAGI over your phaseout threshold. If married filing jointly, use the combined MAGI for both of you. ___________
2. If you are married filing jointly or a qualifying widow or widower, multiply Step 1 by 25% if you were under age 50 at the end of 2012, or by 30% if you were age 50 or older. All others, multiply Step 1 by 50% if you were under age 50 at the end of 2012, or by 60% if you were age 50 or older at the end of 2012. ___________
3. Subtract Step 2 from $5,000, or from $6,000 if you were age 50 or older at the end of 2012. ___________
4. If Step 3 is not a multiple of $10, round it up to the next highest multiple of $10. If the result is under $200, increase it to $200. This is your deductible limit for 2012. ___________
EXAMPLES
1. Rob Porter is single and under age 50 at the end of 2012. He is an active participant in an employer retirement plan. His salary for 2012 is $58,865 and his MAGI for 2012 is $59,343. His MAGI exceeds the $58,000 phaseout floor for single persons by $1,343. Rob figures a deduction limit for 2012 of $4,330.00 as follows:
1. Excess of MAGI over phaseout threshold for single persons ($59,343 − $58,000) $1,343.00
2. 50% of Step 1      671.50
3. $5,000 minus Step 2 $4,328.50
4. Round Step 3 to the next highest multiple of $10. This is Rob’s deductible limit.        4,330
2. Ted and Lynn Baker are both under age 50 at the end of 2012 and they file a 2012 joint return. They report wages of $45,000 for Ted and $49,000 for Lynn. Their modified adjusted gross income (MAGI) for 2012 is $95,020. Ted and Lynn are both active participants in employer retirement plans in 2012 and so they are both subject to the $92,000 phaseout threshold. They each figure a deduction of $4,250 as follows:
1. Excess of MAGI over phaseout threshold for married couples filing jointly ($95,020 − $92,000) $3,020.00
2. 25% of Step 1      755.00
3. $5,000 minus Step 2 $4,245.00
4. Round Step 3 to the next highest multiple of $10. This is the deductible limit for Ted and also for Lynn. On their joint return, they can each deduct IRA contributions of up to $4,250, for a total maximum deduction of $8,500.      $4,250
3. Assume the same facts as in Example 2 except that only Lynn was an active participant in an employer plan. Ted and Lynn must figure their deduction limitations separately using different phaseout thresholds.
For Lynn, the same $4,250 deduction limit applies as in Example 2. The $92,000 phaseout threshold applies, her excess MAGI is $3,020 ($95,020 MAGI on joint return − $92,000 threshold), and her deduction limit as shown in Example 2 is $4,250.
For Ted, the special $173,000 threshold for nonparticipant spouses applies. Since joint return MAGI is well below the $173,000 threshold, he is not affected by the phaseout rules and may deduct IRA contributions up to the $5,000 ceiling for 2012.
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image Planning Reminder
Roth IRA vs. Deductible IRA
Even if you qualify for a full IRA deduction, you may want to consider making a nondeductible contribution to a Roth IRA (8.20). For example, you may be willing to give up the current tax deduction in order to create a Roth IRA from which distributions will be completely tax free after age 59½ and a five-year waiting period has passed. If you choose to make a deductible contribution to a traditional IRA, distributions from the traditional IRA will be taxable. You may also prefer the Roth-IRA advantage of not having to take minimum distributions starting at age 70½, as is required with traditional IRAs.
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Nondeductible contributions.

Any contributions exceeding the amount allowed under the above rules may be treated as nondeductible IRA contributions (8.6). Alternatively, the excess may be contributed to a Roth IRA if allowed under the Roth IRA rules (8.20).

Figuring your IRA deduction if you receive Social Security benefits.

If you or your spouse (8.3) is an active participant in an employer plan and either of you receives Social Security benefits, you need to make an extra computation before you can figure whether an IRA deduction is allowed. Follow the rules discussed in 34.3 to determine if part of your Social Security benefits would be subject to tax, assuming no IRA deduction were claimed. If none of your benefits would be taxable, you follow the regular rules above for determining IRA deductions. If part of your Social Security benefits would be taxable, MAGI for IRA purposes is increased by the taxable benefits. The allowable IRA deduction is then taken into account to determine the actual amount of taxable Social Security. IRS Publication 590 has worksheets for making these computations.

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