Your eligibility to claim a deduction for your Traditional IRA contribution on your federal tax return depends on whether you are an active participant of an employer-sponsored plan in the year to which your deduction applies. If neither you nor your spouse is an active participant, you may deduct your full contribution for the year, up to the contribution limit. If, however, you are an active participant, your tax-filing status and modified adjusted gross income (MAGI) determine your eligibility to deduct your IRA contribution. Here we take a look at how to determine your active-participant status, which can be tricky as the rules vary for each type of employer-sponsored retirement plan.
If you are an active participant, your employer should indicate as such on your Form W-2 by checking the "retirement" box. However, administrative errors can happen, so this box is sometimes not checked even when it should be. It's helpful for you to understand the rules so that you don't have to rely on your employer's reports to determine whether you are considered an active participant for a tax year.
Determining Active Status
The rules regarding active-participant status are different for different types of employer retirement plans.
If you are eligible to participate in a defined-benefit plan for the tax year, you are considered an active participant for that year. This is so even if you decline to participate in the plan, fail to make mandatory contributions to the plan or fail to perform the minimum service required to accrue a benefit under the plan for the year.
Money-Purchase Pension and Target-Benefit Plan
For money-purchase pension and target-benefit plans, you are considered an active participant for the year to which your contributions to these plans apply. This is so, regardless of when your contribution is actually deposited to your account.
For example, say your employer sponsors a money-purchase pension plan and is required to contribute 10% of eligible compensation to the plan each year. Your employer has until its tax-filing deadline, including extensions, to deposit a particular year's contributions. So, if a 2018 contribution was made in 2019, you are considered an active participant for the 2018 tax year, the year to which the contribution applies.
Profit-Sharing Plans and SEP IRAs
With plans to which contributions are discretionary, such as profit-sharing plans and SEP IRAs, employees are considered active for the year in which the contributions are actually deposited to the employees' accounts – even if the contributions apply to the previous year. The reason for this rule is that it is usually impossible for employers to guarantee contributions to these plans for any particular year.
To demonstrate, let's say your employer sponsors a profit-sharing plan, to which it contributes 10% of eligible compensation for the 2018 tax year. But the contributions are deposited in 2019. Employees are considered active participants for 2019, the year in which the contributions are actually deposited to their accounts.
401(k) and 403(b) Plans
If you make salary-deferral contributions to a 401(k) or 403(b) plan, you are considered an active participant for the year to which your salary-deferral contributions apply. If you are eligible to make salary-deferral contributions but elect not to, you are not considered an active participant for that year.
Voluntary or Mandatory Contributions
You are considered an active participant for any year you make voluntary or mandatory contributions to an eligible employer-sponsored retirement plan.
Vesting Status Does Not Affect Active-Participant Status
Depending on the plan provisions, you may not be immediately vested in the year's contributions you receive from your employer. But your vesting status does not alter whether you are an active participant. This means that even if you leave that employer at a later date and you forfeit that non-vested contribution, you are still considered an active participant for the applicable year.
Example ABC Company contributes 10% of its employees' compensation to its money-purchase pension plan for the 2018 tax year. Under the provisions of the ABC money-purchase pension plan, employees' contributions are 100% vested after working three years – no vesting occurs before then. Jane leaves ABC Company for a new firm after two years of employment. Because Jane is leaving before she accrued any vested balance, she must forfeit the contributions that were made to her money-purchase-pension account at ABC Company. However, Jane is still considered an active participant for the 2018 tax year, because a required contribution was made to her money-purchase pension account.
The Bottom Line
If you and/or your spouse are active participants for a given year, you may need to perform a calculation to determine whether you are able to deduct your IRA contributions for that year. If you are not able to deduct the full amount, you may be able to deduct a portion, depending on your MAGI. This formula is explained in IRS Publication 590. Ultimately, you may want to consult with your tax professional for assistance with determining whether your IRA contribution is deductible.