IRA contribution being limited

[ralphcook]

I am retired; I earend $1725 on a consulting job during 2023. I planned to put all of it into my traditional IRA.

TurboTax says I can only deduct $1603, and that if I contribute 1725, the difference will be a non-deductible excess contribution. 

Since the contribution seems to be limited, I will only contribute $1603; I'm only doing it for the tax advantage, and I don't need the money to be available soon. But I would like to know why they are limiting the amount of the contribution. I was limiting it to the amount of earned income I have, I don't know why I cannot contribute the entire amount to the IRA, as I did last year with a larger amount.

[VolvoGirl]

If you have self-employment income you can only contribute up to your net profit reduced by the deduction allowed for the ER portion of your self-employment taxes.  That amount will be on Schedule 1 line 14 which goes to 1040 line 10a. 

See IRS publication 590A page 6 about self employment income (it applies to both Traditional and ROTH IRAs)
https://www.irs.gov/pub/irs-pdf/p590a.pdf

[Opus 17 · Accepted solution]

Basically, if you are an employee, your compensation is your wages, but your wages are subject to an additional withholding of 7.65% for social security and medicare tax paid by the employer.  Effectively, for every $100 of gross wages, your income really was $107.65, with the employer paying $7.65 of social security and medicare tax before you pay your own social security and medicare tax plus federal and state tax via withholding.

For that reason and to make things equitable between employees and self-employed, a self-employed person's "compensation" for IRA purposes is the net profit minus the "employer half" of social security and medicare (which in case of a self-employed person is half their self-employment tax).   That's the basis of the calculation, although it works out to a little less than 7.65% because of how the formula is applied.  

[ralphcook]

thanks -- that's helpful.

[ralphcook]

Thanks, that explains it. And I now realize I didn't run into this before because I had always earned enough that it show up as readily; the difference wasn't as big a percentage of the total.