A traditional individual retirement arrangement provides working people with a tax-deferred way to build up savings that will provide income after they retire. Contributions to an IRA are deducted from your taxable earned income. The rules governing tax-deductible IRA contributions draw a critical distinction between income earned from working and income from other sources.
Contributions to an IRA each year are limited to the lesser of $5,000 or your total taxable compensation for the year. In order to contribute anything to an IRA, Internal Revenue Service rules require that you earn taxable compensation from work. The IRS defines "compensation" as income generated from a wage, salary, commission or self-employment. It also counts alimony, separate maintenance and tax-exempt military combat pay as compensation.
No Contribution Allowed
You cannot make any contribution to an IRA if your income consists entirely of unearned taxable income from sources such as rental property, interest and dividends, pensions or annuities, or income from passive partnerships. The rules also exclude from the compensation definition any tax-exempt income from sources other than military combat pay.
If you and your spouse both have compensation and neither of you will turn 70.5 years in the current tax year, each of you can have an IRA and make contributions to it. If you are married filing jointly, only one of you needs to have compensation in order to contribute to the IRAs of yourself and your spouse. IRS rules impute compensation to the non-earning spouse for purposes of figuring his or her maximum IRA contribution by subtracting the earning spouse’s IRA contribution from his or her compensation. If the result is greater than $5,000, the non-earning spouse can contribute the maximum $5,000 to his or her IRA.
If you earned no compensation from work but made a contribution to your IRA anyway, the amount you contributed will be subject to the 6 percent penalty tax on excess contributions. The penalty tax will be applied each year that the excess contribution remains in your IRA. You can avoid the penalty tax by withdrawing the excess contribution before the due date of your tax return. You won’t owe taxes or penalties on the withdrawn excess contribution, but you will owe tax and penalties on any earnings that the excess contribution made while the money was in your IRA..
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