Taxpayers who participate in their employer’s retirement plan are not able to deduct contributions the taxpayer makes to their IRA retirement account. This is also true for taxpayers who are entitled to participate in their employer’s retirement plan, but choose not to do so.
In Colombell v. Commissioner, T.C. 2006-184, the court considered whether an employee who was entitled to participate in her employer’s plan but was not qualified to do so as she worked to few hours, could deduct her IRA contributions.
Facts & Procedural History
The taxpayer-wife worked as a nurse for 15 years without entitlement to health benefits, sick leave, or vacation time.
The company she worked for had a retirement plan that was mandatory for all employees, but she did not qualify for any benefits under the plan as she did not work the minimum required hours.
The taxpayers claimed a deduction for contributions made to their IRAs on their 2002 tax return. The Form W-2 provided by her company indicated that the taxpayer was an active participant in a qualified retirement plan, despite never contributing to it.
The IRS computer matching system no doubt spotted the issue and triggered an IRS audit. This resulted in the $3,500 deduction for the IRA contribution being disallowed.
About IRA Contributions & Deductions
Section 219 sets out the rules for retirement savings deductions.
The maximum deduction an individual can claim for qualified retirement contributions is limited to the lesser of the deductible amount or the compensation included in the individual’s gross income.
The maximum deductible amount is $5,000, with an additional $1,000 applicable for individuals aged 50 or older.
However, the deductible amount may be limited if the taxpayer or their spouse is an “active participant” in a qualified plan under Section 401(a). The regulations define an active participant as an individual who is not excluded from the plan, regardless of actual participation or knowledge of the plan’s existence.
Who is an Active Participant?
In the present case, the company had a retirement plan that was mandatory for all employees. The taxpayer was not eligible for any benefits under the plan. However, the Form W-2 indicated that the taxpayer was an active participant in the plan.
The court concluded that the taxpayer was an active participant in the retirement plan for the year in question, even though she never contributed to it. As such, the court concluded that she was not entitled to deduct contributions to the IRA.
The court acknowledged that the result may seem harsh, but stated that it is bound by the language of the relevant provisions of the tax code and cannot rewrite the law to achieve a perceived better tax policy. The court also notes that it lacks general equitable powers and its jurisdiction to grant relief is limited.
This case applies to part-time workers who work for an employer who has a qualified plan. As the case explains, the part-time worker in this situation cannot contribute to their own IRA and deduct the contributions. This is true even if they are not eligible to contribute to their employer’s IRA due to working too few hours. Part-time employees should factor this into their tax planning.