Study Unit 12: Individual Retirement Accounts

Which of the following is compensation for the purpose of contributions to individual retirement accounts?

• Deferred compensation received.

• 
  Foreign earned income excluded from income.

• 
  Pension or annuity income.

• 
  Taxable alimony and separate maintenance.

Answer explanation

Publication 590-A states that compensation is defined as earned income. It includes wages and salaries, commissions, self-employment income, and taxable alimony and separate maintenance payments. Compensation does not include earnings and profits from property, such as rental income, interest income, and dividend income or pension and annuity income.

When figuring compensation for purposes of determining the amount of an allowable contribution to a traditional IRA, which of the following is an incorrect statement?

• Pension or annuity income is not considered compensation for an IRA plan.

• Earnings and profits from property, such as rental income, are considered compensation.

• 
  Interest and dividends are not considered compensation for an IRA plan.

• Generally, amounts excluded from income are not considered compensation for an IRA plan.

Answer explanation

Compensation is defined as earned income. It includes

1. 1. Wages and salaries,

2. 2. Commissions,

3. 3. Self-employment income, and

4. 4. Taxable alimony and separate maintenance payments.

Compensation does not include earnings and profits from property such as rental income, interest income, dividend income, or pension and annuity income, the share of S corporation income, and deferred compensation distributions.

Generally, an IRA contribution is limited to the lesser of $6,000 in 2022 or the taxpayer’s compensation. However, which of the following items is NOT treated as compensation for this limitation?

• 
  Wages earned by an individual under the age of 18.

• 
  Taxable alimony.

• Self-employment loss.

• 
  Commissions.

Answer explanation

Compensation is defined as earned income. It includes

1. 1. Wages and salaries,

2. 2. Commissions,

3. 3. Self-employment income, and

4. 4. Taxable alimony and separate maintenance payments.

Self-employment loss is not considered income for the purposes of contributing to an IRA.

Which one of the following types of individual retirement accounts (IRAs) cannot be established?

• An individual retirement annuity that is purchased from a life insurance company.

• An individual retirement account with a trustee who invests one’s money in 1-ounce U.S. gold coins.

• A simplified employee pension account.

• An individual retirement account with a trustee who invests one’s money in life insurance contracts.

Answer explanation

An individual retirement account must be either a trust or a custodial account established in the United States for the exclusive benefit of the owner and the owner’s beneficiaries. It must be established by a written document and meet the requirements of Sec. 408(a). Section 408(a)(3) states that no part of the amount in the account may be used to buy life insurance.

All of the following types of income would be considered compensation in determining if an individual retirement account could be set up and contributions could be made EXCEPT

• Tip income.

• Net rental income.

• Partnership income of an active partner providing services to the partnership.

• Commissions.

Answer explanation

Section 219(f) defines compensation as earned income. Rental income is not generally considered earned income; rather, it is treated as a passive form of income.

All of the following types of accounts are permitted for individual retirement accounts EXCEPT

• 
  A trust or custodial account at an IRS-approved entity.

• An individual retirement annuity.

• An employer and employee association trust account.

• 
  Individual savings bonds clearly designated as an IRA.

Answer explanation

An 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. Beginning in 1997, an IRA can be part of a savings incentive match plan for employees (SIMPLE). Publication 590-A lists individual retirement bonds but does not list individual savings bonds as a permitted individual retirement account.

An individual retirement account (IRA) is a trust or custodial account created by a written document that must meet all of the following requirements, EXCEPT

• 
  The amount in your account must be fully vested.

• Money in your account can be used to buy a life insurance policy.

• Assets in your account cannot be combined with other property except in a common trust fund or common investment fund.

• You must start receiving distributions from your account by April 1 of the year following the year in which you reach age 72.

Answer explanation

Under Sec. 219(d) and Sec. 408, an IRA account must be fully vested at all times, the assets of the trust cannot be commingled with other property except in a common trust fund or common investment fund, and plan distributions must begin by April 1 of the calendar year following the later of the calendar year in which the employee (1) attains age 72 or (2) retires. No part of the trust funds can be used to purchase life insurance contracts.

With regard to IRAs, which of the following is considered earned compensation?

• Rental income.

• Taxable alimony.

• 
  Annuity income.

• Deferred compensation.

Answer explanation

Section 219(f) defines compensation as earned income. This includes wages, salaries, commissions, self-employment income, and taxable alimony.

All of the following types of income are considered earned compensation in determining whether an individual retirement account can be set up and contributions made EXCEPT

• Self-employment income.

• 
  Partnership income of an active partner providing services to the partnership.

• 
  Taxable alimony.

• Rental income from a property in which the taxpayer has active participation.

Answer explanation

Section 219(f) defines compensation as earned income. Rental income is not generally considered earned income; rather, it is treated as a passive form of income.

Ms. Seburn had the following during the current year:

Taxable alimony received $   4,000 

Wages 12,000 

Net loss from self-employment (10,000)

Interest income 3,000 

For the purpose of an IRA, Ms. Seburn had compensation for the current year of

• $2,000

• $6,000

• $16,000

• 
  $19,000

Answer explanation

Section 219(f) defines compensation as earned income. Wages are the most common example of earned income. Taxable alimony is included as compensation for this purpose. There is no provision for reducing earned income by net losses from self-employment. Interest income is not earned income. Therefore, for the purpose of an IRA, Ms. Seburn had compensation of

Taxable alimony $  4,000

Wages 12,000

Total compensation $16,000