Tax planning and compliance for investors
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Learn what counts as compensation income that allows you to make IRA contributions.
You can't make a regular (non-rollover) contribution to a traditional IRA or a Roth IRA unless you or your spouse have qualifying income. This page explains what types of income count as qualifying income for this purpose.
Reminder: Your IRA contribution or deduction may be limited by other rules:
This page is only about the rules defining qualifying income. The other rules mentioned above are explained on other pages.
This topic is covered in Chapter 12 of our book, Go Roth!
For each year you contribute to a regular IRA or a Roth IRA, you (or your spouse, if you file jointly) must have qualifying income. If you don't have qualifying income, you can't contribute. And if your qualifying income (together with qualifying income of your spouse that can be used to support your contribution) is less than the maximum contribution, then the amount you can contribute is reduced.
There are three categories of qualifying income:
If you work as an employee, compensation income generally includes your wages, salaries, tips, bonuses, commissions and similar amounts. But the following items are not qualifying income:
Qualifying income also includes the types of income that are subject to self-employment tax. (It includes these types of income even if you don't pay self-employment tax because of your religious beliefs.) You may earn self-employment income in various ways:
In any of these cases your income is self-employment income only if your services are "a material income-producing factor." To translate that into plain English, you don't have self-employment income if you are merely an investor. You need to be actively involved in the business that produces the income.
Even if you're actively involved in a business, you can't include investment income in your qualifying income. For example, if you're a member of a business partnership that maintains some investments on the side, the income produced by the investments isn't qualifying income. If your partnership doesn't have a business other than investing, none of the income is compensation income, even if you're actively involved.
When figuring how much qualifying income you have to support your IRA contribution, it's your net earnings from self-employment that count. Subtract your expenses and other deductions connected with the activity that produced the income. Also, reduce your self-employment income by the amount you contribute to a retirement plan connected with your self-employment (such as a Keogh plan), and by the deduction for one-half of the self-employment tax.
If you have a loss from self-employment, do not subtract the loss from any earnings you have as an employee when determining how much qualifying income you have. For example, if you work part of the year as an employee making $6,000, then spend the rest of the year being self-employed with a loss of $5,400, your qualifying income is still $6,000.
If you own stock in an S corporation, you'll receive a Schedule K-1 similar to the one you would receive as a member of a partnership. But income you receive as a shareholder of an S corporation is not qualifying income. If you are also an employee of the S corporation, your qualifying income includes amounts earned as an employee, as explained earlier.
For purposes of making an IRA contribution, taxable alimony income counts as qualifying income. This is a special rule that permits you to build retirement savings in an IRA even if you rely on alimony income for your support. The rule applies only to taxable alimony income, though. You can't include nontaxable items such as child support.
The following items may not be included in your compensation income:
There's an exception to the rule that the income has to be taxable. Nontaxable combat pay is qualifying income for this purpose. What's more, if you were unable to make contributions for 2004 or 2005 because your income was nontaxable combat income (before Congress fixed this rule in 2006), a special rule allows makeup contributions for those years. The deadline for those makeup contributions is May 29, 2009.
The IRS recognizes that it's unclear whether some items are "compensation income." To make things easy, the IRS says you can generally treat any item as compensation income if it's included in the box of Form W-2 labeled "Wages, tips, other compensation." There's one exception: any portion of "Wages, tips, other compensation" that's also reflected in the box labeled "Nonqualified plans" doesn't count as "compensation income" for this purpose.
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