Traditional IRA - What Is A Traditional IRA

This chapter discusses the original IRA. In this publication the original IRA (sometimes called an ordinary or regular IRA) is referred to as a “traditional IRA.” The following are two advantages of a traditional IRA:

You may be able to deduct some or all of your contributions to it, depending on your circumstances.
Generally, amounts in your IRA, including earnings and gains, are not taxed until they are distributed.

What Is a Traditional IRA?

A traditional IRA is any IRA that is not a Roth IRA or a SIMPLE IRA.

Who Can Set Up a Traditional IRA?

You can set up and make contributions to a traditional IRA if:

You (or, if you file a joint return, your spouse) received taxable compensation during the year, and
You were not age 70½ by the end of the year.

You can have a traditional IRA whether or not you are covered by any other retirement plan. However, you may not be able to deduct all of your contributions if you or your spouse is covered by an employer retirement plan.

Both spouses have compensation. If both you and your spouse have compensation and are under age 70½, each of you can set up an IRA. You cannot both participate in the same IRA.

What Is Compensation?

Generally, compensation is what you earn from working. For a summary of what compensation does and does not include, see Table 1-1. Compensation includes the items discussed next.

Wages, salaries, etc. Wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services are compensation. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans). Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2.

Commissions. An amount you receive that is a percentage of profits or sales price is compensation.

Self-employment income. If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your personal services are a material income-producing factor) reduced by the total of:

The deduction for contributions made on your behalf to retirement plans, and
The deduction allowed for one-half of your self-employment taxes.

Compensation includes earnings from self-employment even if they are not subject to self-employment tax because of your religious beliefs.

When you have both self-employment income and salaries and wages, your compensation includes both amounts.

Self-employment loss. If you have a net loss from self-employment, do not subtract the loss from your salaries or wages when figuring your total compensation.

Alimony and separate maintenance. For IRA purposes, compensation includes any taxable alimony and separate maintenance payments you receive under a decree of divorce or separate maintenance.

Nontaxable combat pay. If you were a member of the U.S. Armed Forces, compensation includes any nontaxable combat pay you received. This amount should be reported in box 12 of your 2006 Form W-2 with code Q.

If you received nontaxable combat pay in 2004 or 2005, and the treatment of the combat pay as compensation means that you can contribute more for those years than you already have, you can make additional contributions to an IRA for 2004 or 2005 by May 28, 2009. The contributions will be treated as having been made on the last day of the year you designate. If you have already filed your return for a year for which you make a contribution, you must file Form 1040X, Amended U.S. Individual Income Tax Return, by the latest of:

3 years from the date you filed your original return for the year for which you made the contribution,
2 years from the date you paid the tax due for the year for which you made the contribution, or
1 year from the date on which you made the contribution.

Table 1-1. Compensation for Purposes of an IRA

Includes ...	Does not include ...
	earnings and profits from property.
wages, salaries, etc.
	interest and dividend income.
commissions.
	pension or annuity income.
self-employment income.
	deferred compensation.
alimony and separate maintenance.
	income from certain partnerships.
nontaxable combat pay.
	any amounts you exclude from income.

What Is Not Compensation?

Compensation does not include any of the following items.

Earnings and profits from property, such as rental income, interest income, and dividend income.
Pension or annuity income.
Deferred compensation received (compensation payments postponed from a past year).
Income from a partnership for which you do not provide services that are a material income-producing factor.
Any amounts (other than combat pay) you exclude from income, such as foreign earned income and housing costs.

When Can a Traditional IRA Be Set Up?

You can set up a traditional IRA at any time. However, the time for making contributions for any year is limited.

How Can a Traditional IRA Be Set Up?

You can set up different kinds of IRAs with a variety of organizations. You can set up an IRA at a bank or other financial institution or with a mutual fund or life insurance company. You can also set up an IRA through your stockbroker. Any IRA must meet Internal Revenue Code requirements. The requirements for the various arrangements are discussed below.

Kinds of traditional IRAs. Your traditional IRA can be an individual retirement account or annuity. It can be part of either a simplified employee pension (SEP) or an employer or employee association trust account.