My income is social security disability and taxable "third party sick pay". I file as head of household. Can I contribute to a traditional IRA?

[Phillip1]

Yes, but your allowable contribution is limited to the amount of third party sick pay. 

Third party sick pay paid by agents [i.e., insurance company] of the employer are treated as supplemental wage income (see Treasury Regulation 31.3402(g)) - as such it can be treated as earned income.

[MrBobCoombs]

Thursday, October 15, 2020

Dear Philip,

I'm writing to you for having helped me so much.  You see, I'm on disability and receiving an income from Social Security Disability and a second income from The Hartford Long Term Disability.  I'm 58 and Social Security will continue paying me after retirement age 67, but The Hartford, being an important part of my income, ends at age 67 so I'll be living on half the income.  For months and months, I've wanted to open an IRA but no one was able to tell me that I quality except for you. I've asked over six people and hours and hours of research.  Thank you very much for answering the question asked of you!

My very best to you,

Bob Coombs

Pittsburgh, Pennsylvania  USA

[Rolex2001]

Identical situation except it pertains to my spouse. Can I assume that my spouse can put $7,500 ( max allowable) into her IRA to reduce taxable income as long as the amount in box #1 (w-2) is greater than $7,500?

Thanks

[Opus 17]

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@Rolex2001 wrote:

Identical situation except it pertains to my spouse. Can I assume that my spouse can put $7,500 ( max allowable) into her IRA to reduce taxable income as long as the amount in box #1 (w-2) is greater than $7,500?

Thanks

---

No.  You need to look at box 3 (social security wages).  That's what the IRS uses to determine if income is "compensation from working" or "earned income."  Also note, I believe that if a person is on long term disability, only the first 12 months is considered "earned income" and after 12 months it is considered "unearned income", not compensation from working, and not eligible to make IRA contributions.

However, if you have earned income/compensation, your wife can make IRA contributions from your income, even if she does not have her own earned income.  In that case, you and your wife's combined contributions can't be more than your earned income. 

[Rolex2001]

Perhaps I'm missing something but what you wrote appears to contradict what Phillip 1 wrote.

I found several other opinions including the link below.  Getting through to the IRS for an answer will take time but might be worth the effort.

https://www.taxaudit.com/tax-audit-blog/is-sick-pay-considered-compensation-for-ira-contributions#:~...

[Opus 17]

@Rolex2001 

You’re replying to a 4+ year old discussion and you haven’t the facts that apply to your situation. 

I double checked and I was wrong about the 1 year rule, but the important difference is who paid for the disability insurance.  

If the employer paid the premiums, this is considered “wage replacement” and the disability pay is taxable and is earned inomce, up until the employee reaches retirement age.  If payments continue after retirement age, the income is unearned.  

If the employee paid the premiums after tax, the income is not taxable at all and is not earned income or compensation for retirement contributions.  

[TomD8]

@Rolex2001 --

From IRS Publication 590-A:

"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."

"Wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services are compensation. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans)."

https://www.irs.gov/publications/p590a

[Rolex2001]

Fair enough....as per my first post my spouses situation is identical to the original individual with the Hartford policy who is receiving social security disability benefits. Her employer paid two thirds of the policy and she paid the other third after tax.  If this were not the situation there would be nothing in box 1 of the w2.  She is not at full retirement age and thus can deduct $7,500 from our income into her IRA.  Those are the facts.

Spoiler

[dmertz]

The amount in box 3 of a W-2 is not the amount that determines whether you have compensation that will support an IRA contribution.  The amount on your (or your spouse's) W-2 that will support an IRA contribution is the amount in box 1 minus any amount in box 11.