Contribution to ira

[peggysioux]

Taxpayer is receiving a pension under the disability code "3" and is 57 years old. Would his pension be considered a "long-term disability benefit received prior to minimum retirement age" and therefore considered wages and he would then be able to contribute to an IRA?

[Koss]

Disability Pension

Looks like the answer is yes.

The definition of compensation, for purposes of an IRA, appears to be the definition found in IRC 415(c)(3), which does in fact contain a reference to disability benefits.

This interpretation is supported by the fact that such benefits are reported as wages on line 7 of Form 1040, and are also considered earned income for purposes of EIC.

And while certainly not an authoritative legal source, it is encouraging that the following article, dated June 2011, provides the same answer:

http://www.schwab.com/public/schwab/resource_center/expert_insight/ask_carrie/retirement/can_you_contribute_to_an_ira_if_you_dont_have_a_job.html

The article was published by Charles Schwab, and, interestingly, was written by a Schwab executive who appears to be part of the original Schwab family.

BMK

[Koss]

About that Schwab article...

I stand by my answer to the original question. Long-term disability, prior to retirement age, is treated as wages, for purposes of EIC and for purposes of IRA contributions.

But when I went back and read the Schwab article again, I found something rather disconcerting. The author asserts that alimony "is not considered earned income for tax and IRA contribution purposes."

That's incorrect. Publication 17 clearly states that alimony is included in compensation for purposes of determining IRA contributions.

Like I said in my previous post, the Schwab article is not an authoritative legal source...



BMK

[Gene V]

Need more research

According to IRC Section 219(f) compensation does not include any pension or annuity

219(f) Other definitions and special rules (1) Compensation

For purposes of this section, the term "compensation" includes earned income (as defined in section 401(c)(2)). The term "compensation" does not include any amount received as a pension or annuity and does not include any amount received as deferred compensation. The term "compensation" shall include any amount includible in the individual's gross income under section 71 with respect to a divorce or separation instrument described in subparagraph (A) of section 71(b)(2). For purposes of this paragraph, section 401(c)(2) shall be applied as if the

My thought would be, just because they want us to put the taxable pension on line 7, doesn't mean it would qualify for IRA compensation, we also put taxable scholarship on line 7, which doesn't qualify for IRA deduction.
JMO

[Koss]

Definition of Compensation

Gene makes an interesting point. But I stand by my answer.

I will reluctantly concede that this may be a gray area of the law, or an area where IRS guidance is ambiguous.

The definition of compensation that is used for IRA purposes appears to be the same definition that is used for other types of defined-benefit retirement plans. My reading of that definition is that it includes disability pensions.

Gene Vowles wrote:

just because they want us to put the taxable pension on line 7, doesn't mean it would qualify for IRA compensation, we also put taxable scholarship on line 7, which doesn't qualify for IRA deduction.

Yes, but taxable scholarships are a different animal. IRS Publication 970 instructs us to report taxable scholarships on line 7, but it does not characterize such a scholarship as wages. In contrast, Publication 17 states that you "must report your taxable disability payments as wages on line 7 of Form 1040 until you reach minimum retirement age" [emphasis supplied].

Furthermore, Publication 17 also says that taxable scholarship and fellowship payments are considered compensation for purposes of an IRA, if the amount is shown in box 1 of Form W-2. I admit that it is rare to see a scholarship or fellowship reported on Form W-2. But apparently there are some circumstances in which it would indeed be considered compensation for purposes of an IRA.

The key concept here is that a disability pension is a wage replacement, but it does not flow from a disability insurance policy.

I find it very relevant and persuasive that a disability pension is considered earned income for purposes of EIC, but payments from disability insurance, or third-party sick pay, are not so treated.

Of course, Gene is accurately citing references that clearly state that for purposes of contributing to an IRA, pension and annuity income is not considered compensation. Publication 17 says the same thing.

When is a pension not a pension?

When it's a disability pension, which, according to the IRS, must be "reported as wages."

This, in my view, changes the character of the income.

IRS publications, of course, are not authoritative. But if the taxpayer in question claims an IRA deduction and it is later disallowed, the ambiguity in the IRS publications would be sufficient to defend against any penalty.

Can someone cite the section of the Internal Revenue Code that defines compensation for purposes of IRA contributions?

As I noted earlier, I believe it is the same definition that is used for other "qualifying retirement plans," but I couldn't find a clear reference in the Code.

BMK

[Koss]

And also...

Drake software is allowing the IRA deduction in this context.

Of course, that doesn't prove I'm right. Over the years, I have identified many flaws in several different tax programs. And I have written more than once in this forum about the dangers of using the results of your software to draw conclusions. It should always work in the other direction. The software should produce a result that you can verify as correct with your own knowledge; you cannot assume that the output of your software is correct, and then use that output to make inferences about the tax law.

With that being said, I entered a Form 1099-R into Drake with Code 3 for disability. That does not automatically cause the amount to appear on line 7. This is because the program doesn't know whether the person has reached minimum retirement age. I had to check two boxes on the 1099-R screen:

1099-R for disability?

If so, reported as wages on the 1040?

With these two boxes checked, the amount is reported on line 7.

And the program allows an IRA deduction, even though the taxpayer has no wages and no Schedule C. After I entered an IRA contribution, the program automatically generated the IRA Deduction Worksheet that appears on pages 34 and 35 of the 1040 instructions. On line 8 of this worksheet, Drake entered the amount of the disability pension from line 7 of Form 1040.

This doesn't prove that I'm right. It merely proves that Drake agrees with my interpretation.

BMK

[Gene V]

Koss,
The more I read, the more I agree with you that it does qualify as earn income for IRA deduction.
Gene

[peggysioux]

Contribution to IRA

The Tax Almanac had a thread on the same issue and there were references to Letter Rul 8331069, 8325080, and 8014110 where the IRS ruled disability payments aren't counted as compensation as they are paid more in line with an annuity. Thread also refers to the preamble to Rev Proc 91-18:

"Section 219(f) of the Internal Revenue Code, and section 1.219-1 of the Income Tax Regulations define com*pensation for purposes of contribut*ing to an IRA. In general, contribu*tions to an IRA are based on "compensation" that is includible in gross income for services actually ren*dered, and that is not deferred com*pensation."

I read one piece of information and I think the disability pension should be deemed wages and then read something else and decide the opposite. It would be nice if the IRS did not have conflicting information.

Peggy Sioux

[New York Enrolled Agent]

Can someone cite the section of the Internal Revenue Code that defines compensation for purposes of IRA contributions?

As I noted earlier, I believe it is the same definition that is used for other "qualifying retirement plans," but I couldn't find a clear reference in the Code.

BMK

How about Reg. §1.219-1(c)

(1) Compensation.
For purposes of this section, the term "compensation" means wages, salaries, professional fees, or other amounts derived from or received for personal service actually rendered (including, but not limited to, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, and bonuses) and includes earned income, as defined in section 401 (c) (2), but does not include amounts derived from or received as earnings or profits from property (including, but not limited to, interest and dividends) or amounts not includible in gross income.

[Nashville]

(1) Compensation.
For purposes of this section, the term "compensation" means wages, salaries, professional fees, or other amounts derived from or received for personal service actually rendered (including, but not limited to, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, and bonuses) and includes earned income, as defined in section 401 (c) (2), but does not include amounts derived from or received as earnings or profits from property (including, but not limited to, interest and dividends) or amounts not includible in gross income.

Using this definition, would anyone care to offer an interpretation as to the exercise of a stock option? Appears in Box 1 of the W-2, but is somewhat related to earnings/profits, but not so strongly related as dividends.

[New York Enrolled Agent]

Using this definition, would anyone care to offer an interpretation as to the exercise of a stock option? Appears in Box 1 of the W-2, but is somewhat related to earnings/profits, but not so strongly related as dividends.

The IRS provides a "safe harbor" to determine compensation when a W-2 is involved. It is Rev Procedure 91-18 (noted previously by PS). Any amount in box 1 of a W-2 (reduced by any amount in box 11) is compensation for purposes of funding an IRA.