When an IRA deduction is denied
In a recent Tax Court case, a taxpayer's $5,000 IRA deduction was disallowed because she and her husband…
In a recent Tax Court case, a taxpayer's $5,000 IRA deduction was disallowed because she and her husband were active participants in company retirement plans, and their joint income exceeded the limit to be able to deduct her IRA contribution. The couple claimed that this was unfair since the amount of her plan participation was small. The court ruled that the money involved didn't matter.
Here are the facts. Delana Gallant contributed $5,000 to her IRA, and she and her husband, Douglas, deducted her IRA contribution on their 2007 joint tax return. Each was employed and each was an active participant in their respective company's plan.
A TINY CONTRIBUTION
Douglas contributed $6,983 to his company plan, and Delana contributed $192.87 to hers. That participation, and their income for 2007, made them ineligible for the $5,000 deduction they took for Delana's IRA contribution.
The Gallants went to Tax Court to fight the ruling, but this was a case they could not win: There was no wiggle room. The amount of their participation — in this case, Delana's relatively minor contribution — did not matter.
They thought this was unfair, and the judge sympathized, but they still lost.
The law in this area is clear. If, for any part of a taxable year, a taxpayer or the taxpayer's spouse is an “active participant” in a qualified plan under section 401(a), IRA deduct-ibility is subject to income limits. For 2012, the in-come phaseout range for deducting a contribution to a traditional IRA is $92,000 to $112,000 for those married and filing jointly, and $58,000 to $68,000 for those who are single.
These income limits are for those who are active in a company retirement plan; if there is no active plan participation for the year, then an IRA contribution can be deducted regardless of income.
If your client is not covered by a company plan but his or her spouse is, the phaseout range for 2012 is $173,000 to $183,000. For those who are married but filing separately, the phaseout range is $0-$10,000.
During the examination, the Gallants attempted to change their status, submitting an amended return to the Internal Revenue Service reporting the $192.87 employee contribution as income.
But that did not work. The court stated that when an employee makes a contribution to a company retirement plan, that employee is an active participant in that plan for the year for which the contribution is made.
EVERY BIT COUNTS
The Gallants then argued that the amount Delana contributed was so small that she should be allowed to deduct it. But the court said that the amount was irrelevant and in another case, the amount contributed to the company plan was even smaller — just $84.89.
“Even de minimis participation is sufficient to render a taxpayer an active participant,” the court wrote. “A taxpayer who forfeits rights to a balance in a qualified plan does not thereby negate his or her status as an active participant for the year in question.”
The Gallants lost their case (Douglas M. Gallant et ux. v. Commissioner; T.C. Summ. Op. 2012-7; No. 6935-10S, Jan. 10), and even the judge felt bad, stating: “The court must enforce the laws as written and interpreted. While the result to [the Gallants] seems harsh, we cannot ignore the plain language of the statute and, in effect, rewrite this statute to achieve what would appear to be an equitable result.”
The lesson here is that even minor participation in a company plan is participation and can result in an IRA deduction's being denied if income is over the statutory limits. But on the positive side, participants still can keep the nondeductible IRA contribution, if they wish.
Ed Slott (irahelp.com) is a certified public accountant whose eponymous firm educates financial professionals about individual retirement accounts.
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