Qualifying Income for IRA Contributions
By Kaye A. Thomas
Current as of November 14, 2013
Learn what counts as compensation income that allows you to make IRA contributions.
You can’t make a regular (non-rollover) contribution to a traditional IRA or a Roth IRA unless you or your spouse have qualifying income. This page explains what types of income count as qualifying income for this purpose.
Reminder: Your IRA contribution or deduction may be limited by other rules:
- You can’t contribute to a regular IRA for the year you turn 70½ or any subsequent year. This rule doesn’t apply to Roth IRAs.
- In a regular IRA, your deduction is reduced if you participate in an employer retirement plan and your income exceeds certain limits, although your contribution is not reduced.
- In a Roth IRA, your contribution is reduced if your income exceeds certain limits.
This page is only about the rules defining qualifying income. The other rules mentioned above are explained on other pages.
This topic is covered in Chapter 14 of our book, Go Roth!
For each year you contribute to a regular IRA or a Roth IRA, you (or your spouse, if you file jointly) must have qualifying income. If you don’t have qualifying income, you can’t contribute. And if your qualifying income (together with qualifying income of your spouse that can be used to support your contribution) is less than the maximum contribution, then the amount you can contribute is reduced.
There are three categories of qualifying income:
- Amounts earned as an employee,
- Self-employment income, and
- Alimony income.
Amounts earned as an employee
If you work as an employee, compensation income generally includes your wages, salaries, tips, bonuses, commissions and similar amounts. See below for items not included and a safe harbor.
Qualifying income also includes the types of income that are subject to self-employment tax. (It includes these types of income even if you don’t pay self-employment tax because of your religious beliefs.) You may earn self-employment income in various ways:
- You can be an independent contractor who provides services (for example, as a consultant or a technician) without becoming an employee.
- You can be a professional (such as a dentist or an accountant) with your own practice.
- You can have your own business (not in a corporation) — in other words, you can be a sole proprietor. If you’re a sole proprietor, you report your business income and deductions on Schedule C of Form 1040.
- You can be a member of a partnership or limited liability company (“LLC”) that carries on a trade or business. In this case, the partnership or LLC should provide you with a Schedule K-1 each year telling you how much income to report, and how much of that income (if any) is self-employment income.
In any of these cases your income is self-employment income only if your services are “a material income-producing factor.” To translate that into plain English, you don’t have self-employment income if you’re merely an investor. You need to be actively involved in the business that produces the income.
No investment income
Even if you’re actively involved in a business, you can’t include investment income in your qualifying income. For example, if you’re a member of a business partnership that maintains some investments on the side, the income produced by the investments isn’t qualifying income. If your partnership doesn’t have a business other than investing, none of the income is compensation income, even if you’re actively involved.
Net earnings from self-employment
When figuring how much qualifying income you have to support your IRA contribution, it’s your net earnings from self-employment that count. Subtract your expenses and other deductions connected with the activity that produced the income. Also, reduce your self-employment income by the amount you contribute to a retirement plan connected with your self-employment (such as a Keogh plan), and by the deduction for one-half of the self-employment tax.
Loss from self-employment
If you have a loss from self-employment, do not subtract the loss from any earnings you have as an employee when determining how much qualifying income you have. For example, if you work part of the year as an employee making $6,000, then spend the rest of the year being self-employed with a loss of $5,400, your qualifying income is still $6,000.
If you own stock in an S corporation, you’ll receive a Schedule K-1 similar to the one you would receive as a member of a partnership. But income you receive as a shareholder of an S corporation is not qualifying income. If you are also an employee of the S corporation, your qualifying income includes amounts earned as an employee, as explained earlier.
For purposes of making an IRA contribution, taxable alimony income counts as qualifying income. This is a special rule that permits you to build retirement savings in an IRA even if you rely on alimony income for your support. The rule applies only to taxable alimony income, though. You can’t include nontaxable items such as child support.
Items not included
The following items may not be included in your compensation income:
- Investment income such as dividends and interest
- Pension or annuity income
- Compensation that was deferred from a previous year
- Any form of income that’s not taxable (such as foreign earned income and housing allowance that are excluded from income)
There’s an exception to the rule that the income has to be taxable: nontaxable combat pay is qualifying income for this purpose.
The IRS recognizes that it’s unclear whether some items are “compensation income.” To make things easy, the IRS says you can generally treat any item as compensation income if it’s included in the box of Form W-2 labeled “Wages, tips, other compensation.” There’s one exception: any portion of “Wages, tips, other compensation” that’s also reflected in the box labeled “Nonqualified plans” doesn’t count as “compensation income” for this purpose.