Advanced Underwriting Consultants

Question of the Day – May 1

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers.  Here’s the question of the day.

Question: One of my clients divorced recently.  The only income she is receiving is alimony.  Can she make a traditional IRA or a SEP IRA contribution?

Answer: Yes, she can make a traditional IRA contribution, but not a SEP IRA contribution.

According to IRS Publication 590, alimony is considered compensation that allows a divorced spouse to make an IRA contribution.  Here’s an excerpt:

Who Can Open a Traditional IRA?

You can open and make contributions to a traditional IRA if:

  • You (or, if you file a joint return, your spouse) received taxable compensation during the year, and
  • You were not age 70½ by the end of the year.

You can have a traditional IRA whether or not you are covered by any other retirement plan. However, you may not be able to deduct all of your contributions if you or your spouse is covered by an employer retirement plan.

….

What Is Compensation?

….

Alimony and separate maintenance. For IRA purposes, compensation includes any taxable alimony and separate maintenance payments you receive under a decree of divorce or separate maintenance.

Is alimony self-employment income that would allow a divorce spouse to contribute to a SEP?  No.  Here’s the reasoning:

  • There is a special rule for traditional IRAs that makes it clear that alimony is a unique category of compensation that allows for eligibility to make traditional IRA contributions.  There is no special category that defines alimony as self-employment earnings within the SEP or pension rules.
  • The logic behind the divorced spouse IRA rule seems to be consistent with the basic rule allowing spousal IRA contribution eligibility where only one of the spouses has earned income.  That logic doesn’t seems to carry the same weight in the SEP arena.
  • SEP eligibility for a self-employed person generally requires the taxpayer to file Schedule C.  A spouse receiving alimony does not typically file Schedule C.

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