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February 16, 2009

Nondeductible contribution

Your Guide

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Definition

A contribution for which no tax-deduction is allowed. The following are examples of contributions that can be deducted.

  • Traditional IRA: An individual who is not an Active Participant, nor married to an active participant is eligible to take a full deduction for contributions to a Traditional IRA providing the contribution is within the statutory limit for the year. If the individual is an active participant, or married to someone who is , his/her eligibility to deduct a traditional IRA contribution is determined by his/her tax filing status and modified adjusted gross income (MAGI)
  • SEP IRA: An employer may deduct up to 25% of compensation paid to eligible employees.
  • SIMPLE IRA: An employer may deduct contributions made to to the SIMPLE, proving the contributions do not exceed statutory limits
  • Profit Sharing plan: An employer may deduct up to 25%  of compensation paid to eligible employees
  • Money purchase pension plan: An employer may deduct the amount required to be contributed to the plan, as indicated in the Adoption Agreement. This amount cannot be more than 25%  of compensation paid to eligible employees

Referring Cite

IRC § 404(c), IRC § 219(a) , IRC § 219 (b), IRC § 404(h)(1)(C)

Additional Helpful Information

  • Distributions of nondeductible contributions  to IRAs are not subject to income tax or the early distribution penalty.
  • For any year that an individual makes nondeductible contributions or rolls-over after-tax amounts to his/her traditional IRA, he/she should file IRS Form 8606.
  • Form 8606 helps the individual to track the after tax/nondeductible amounts so that these amounts are not taxed when distributed from the traditional IRA.
  • Form 8606 must also be filed for any distributions that occur , beginning the year the after-tax/nondeductible amount is credited to the traditional IRA, until all the basis is distributed , and must be filed for any year that an individual takes a distribution from any of his traditional IRA, SEP IRA or SIMPLE IRA, if that individual has basis in any of his traditional or SEP IRAs . This helps to determine the non-taxable portion of the distribution. Note: A SIMPLE IRA should not include any basis, as IRA contributions cannot be made to a SIMPLE and rollover (from a qualified plan, 403(b) or 457 plan ) –including  after-tax or other amounts  cannot occur in a SIMPLE IRA.  Since these are the only two sources of after-tax ( nontaxable ) IRA balances,  SIMPLE IRAs should not hold these amounts.

Written By

Denise Appleby

Denise is CEO of Appleby Retirement Consulting Inc., a firm that provides IRA resources for financial/ tax/legal professionals. She has over 20 years of experience in the retirement plans field, which includes training and technical consultation.

Denise writes and publishes educational /marketing tools for advisors; available at http://irapublications.com. Denise co-authored several books on IRAs

Denise is a graduate of The John Marshall Law School, where she obtained a Masters of Jurisprudence in Employee Benefits, and has earned 5 professional retirement designations.
She has appeared on numerous media programs, sharing her insights on retirement tax laws.

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