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CCH® PENSION AND BENEFITS — 10/5/06

Distribution from DC plan was not "compensation" for purposes of the IRA deduction rules

A taxpayer was not entitled to deduct the amount of a contribution made to an IRA where the taxpayer had not received any compensation or earned income during the year at issue, the U.S. Tax Court has ruled. Amounts received as distributions from a defined contribution plan could not be counted as compensation, the court held.

The taxpayer retired under the Civil Service Retirement System in 1998, and began receiving distributions from a defined contribution plan for federal employees. The taxpayer and his wife filed a joint Federal income tax return for 2002 on which they reported a distribution from the defined contribution plan. The taxpayers received no income from wages or salaries in 2002 and engaged in no business. They claimed a deduction for a $3,500 contribution to an IRA. The taxpayer was over age 50 in 2002. The IRS disallowed the taxpayers' IRA deduction in its notice of deficiency.

The taxpayer contended that the distribution he received from his defined contribution plan in 2002 constituted "earned income" which he reported. He contended that some of his salary income earned, but not taxed, in prior years, and deposited in the defined contribution account, continued to be earned income taxable in the years that distributions were made to him.

The court explained that the deduction a taxpayer is entitled to take for amounts contributed to an IRA is limited to the lesser of the deductible amount, or an amount equal to the compensation includible in the taxpayer's gross income. Compensation as defined in Code Sec. 219(f) includes earned income but, the court noted, does not include any amount received as a pension or annuity and does not include any amount received as deferred compensation. Therefore, the court concluded that the amounts the taxpayer received as distributions from his defined contribution plan were not compensation or earned income and the maximum amount of the taxpayer's IRA deduction for 2002 was accordingly zero.

For more information on this and related topics, consult the CCH Pension Plan Guide.

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