Spousal Roth IRA contribution

[jbbandkathy]

My husband is a pastor so his W2 shows he made over $16,970 and then has $19,000 for housing allowance which does not count toward earned income, I am assuming. I am retired and have a Federal govt pension so the Roth IRA is based on his income of $16,970. We did $7500 each and got this on turbo tax.. “contributions to a Roth IRA can't be more than your combined earned income of $14,370…excess contribution of $630”. I don’t understand. We contribute every year but never had this problem. 

[dmertz]

The sum of the deductible portion of self-employment taxes and the IRA contributions shown on Schedule 1  is not permitted to exceed the amount of wages shown on Form 1040 line 1.  The amount of wages shown on Form 1040 depends on the amount of the $19,000 allowance actually spent on housing.  The deductible amount of self-employment taxes depends on whether or not self-employment tax is being paid on the housing allowance.

With the contribution limit for someone over age 50 being increased to $7,500 for 2023, the $15,000 of combined contributions for 2023 put you over the compensation available to support the contributions. That would not be the case with the lower maximum contributions permitted for past years.

[Opus 17]

There is something wrong here.  A housing allowance is not considered taxable income, but it is subject to self-employment tax. Assuming the following:

• W-2 with box 1 wages of $16,970
• Housing allowance of $19,000
• Qualified housing expenses equal or more than $19,000

Then, your form 1040 line 1 income should be $16,970 and his schedule SE line 2 income subject to SE tax should be $35,980.  That should allow a full IRA contribution.

I can't actually think of any reason why line 1 would be reduced from the amount on the W-2.  Even if his housing expenses are more than the housing allowance, that is not allowed to reduce the W-2 box 1 income.

To get a limit of $14,370, I can only think that you did not enter the housing allowance on schedule SE, and you must have also reduced your schedule SE income by some work-related expenses.

To enter the housing allowance subject to SE tax, enter the W-2 and check the box for "religious wages."  You will then be prompted to enter the information and choose how it should be taxed.  "Pay SE tax on both wages and housing allowance" is the correct answer for almost everyone.  The other options are only used in rare situations where the church has taxed your income incorrectly or you have an approved exemption to SE tax on form 4361.  (And if you do have an exemption on form 4361, that might interact with the IRA limit in strange ways.  I would need to do more research.)

[dmertz]

"Then, your form 1040 line 1 income should be $16,970 and his schedule SE line 2 income subject to SE tax should be $35,980.  That should allow a full IRA contribution."

@Opus 17 , compensation calculated as you described is insufficient to support IRA contributions totaling $15,000.  The deductible portion of SE tax plus $15,000 is greater than $16,970.

I agree that $14,370 is slightly lower than I would expect, but not by much.

[Opus 17]

@dmertz 

I don't understand the calculation.  If W-2 box 1 wages are $16,970, and schedule SE net profit from self-employment is $35,980, why is "compensation" less than $15,000?  The housing allowance is "earned income" even though it is not subject to federal income tax.  

[Edited to add: I can understand that because the $16,970 was not subject to social security withholding by the employer, there might be a need to adjust it downward by 92% (more or less).  But the result should still be more than $15,000.]

For example, clergy are eligible for EITC based on their wages plus their housing allowance (minus the adjustment for deductible SE tax).

https://www.irs.gov/publications/p517

Earned income.

Earned income includes your:

1. Wages, salaries, tips, and other taxable employee compensation (even if these amounts are exempt from FICA or SECA under an approved Form 4029 or 4361); and

2. Net earnings from self-employment that are not exempt from SECA (you don't have an approved Form 4029 or 4361) that you report on Schedule SE (Form 1040), line 3, with the following adjustments.

   1. Subtract the amount you claimed (or should have claimed) on Schedule 1 (Form 1040), line 15, for the deductible part of your SE tax.

   2. Add any amount from Schedule SE (Form 1040), line 4b and line 5a.

[dmertz]

"The housing allowance is "earned income" even though it is not subject to federal income tax."

If we are to believe TurboTax, only the excess housing allowance, reported on Form 1040 line 1h, is treated as compensation.  The portion actually applied to housing is not compensation that will support an IRA contribution because that portion is not taxable.

[Opus 17]

Even if line 1h is zero because there is no excess HA, line 1a should still be $16,970.  Even subtracting the deductible portion of SE tax attributable to the $16,970 should be more than $15,000.

It sounds like Turbotax is subtracting the entire deductible portion of SE tax, and not just the deductible portion attributable to the wages.  I'm not sure that is correct, but I will need to do more research at home.  I don't see it directly covered in either publication 590-A or 517.

[dmertz]

"Even subtracting the deductible portion of SE tax attributable to the $16,970 should be more than $15,000."

TurboTax requires the user to select whether to calculate SE tax on wages only or on wages plus the housing allowance.

[Opus 17]

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@dmertz wrote:

"Even subtracting the deductible portion of SE tax attributable to the $16,970 should be more than $15,000."

TurboTax requires the user to select whether to calculate SE tax on wages only or on wages plus the housing allowance.

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"Both" is almost always correct (and likely is in this case); what is puzzling is why the IRS or Turbotax would penalize someone on the IRA calculation.   In this case, the IRA eligible amount for $16,970 of wages with no housing allowance would be about $15,600.  By adding a housing allowance, the IRS eligible amount drops below $15,000, even though the wage portion hasn't changed.  This doesn't seem equitable.  I want to see if the behavior is similar in previous years and I want to check my clergy reference guides if I can find one that does not require a subscription. 

[Opus 17]

@jbbandkathy 

II have confirmed the behavior of Turbotax for both 2023 and 2022 (it was the same last year as this year.)

For purposes of IRA contributions, your W-2 box 1 wages are reduced by the "deductible portion of SE taxes."  Since your SE taxes include both the wages and the housing allowance, your SE tax should be $5082, the deductible portion of SE tax is $2541, and your wages minus the deductible portion of SE tax are 16970 minus 2541 = $14429.  That is the allowable IRA maximum contribution.

I don't know why your contribution is reduced further, one reason that would happen is if your husband had some clergy business expense adjustments on schedule SE that further reduced his net earnings.

The reason you are seeing this for the first time this year is probably because the IRA maximum contribution was increased and you we just under the limit before and are now just over the limit.

The calculation, to "reduce SE income by the deductible portion of SE tax", is correct in the majority of circumstances.  It seems unequitable in the case of a clergy housing allowance, but I have not been able to track down any sources that show a different kind of calculation for clergy.  If you want to use a different calculation that would allow a full $15,000 contribution, you will need to find an accountant to support your argument. 

I think that in this case, you need to remove $630 as an excess contribution.  You do this by contacting the Roth custodian and asking for a removal of excess.  You can remove the $630 from either account or a combination of both.  The custodian must also return any earnings that are attributable to that $630 of ineligible contribution (interest, dividends, etc.).  This must be completed before April 15.  The earnings are taxable on this year's (2023) tax return even though you won't get a 1099-R for those earnings until 2024.   Use the procedure to create a substitute 1099-R.  You will get a 1099-R next year and you will report it in your tax return, but the program will know to not make it taxable next year.

The earnings are subject to regular income tax but not a 10% penalty.

To create a Form 1099-R in your 2023 return please follow the steps below:

1. Login to your TurboTax Account 
2. Click on the "Search" on the top right and type “1099-R” 
3. Click on “Jump to 1099-R”
4. Answer "Yes" to "Did you get a 1099-R in 2023?"
5. Select "I'll type it in myself"
6. Box 1 enter total distribution (contribution plus earning)
7. Box 2a enter the earnings
8. Box 7 enter P and J
9. Click "Continue"
10. On the "Which year on Form 1099-R" screen say that this is a 2023 1099-R.
11. Click "Continue" after all 1099-R are entered and answer all the questions.

[jbbandkathy]

Thank you for your response. I will reduce the IRA amount. He pays the full amount of the self employment tax, both the employee and employer portion which is the $5202 since he is considered self employed as a clergy. So I don’t understand why he would have to subtract the deductible portion of SE which is $2601 from his wages. 

[Opus 17]

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@jbbandkathy wrote:

Thank you for your response. I will reduce the IRA amount. He pays the full amount of the self employment tax, both the employee and employer portion which is the $5202 since he is considered self employed as a clergy. So I don’t understand why he would have to subtract the deductible portion of SE which is $2601 from his wages. 

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There is a general rule for all self-employed people that "compensation" for purposes of IRA contributions is their net profit minus half the SE tax.  The reason for this is to make things equitable with W-2 employees.  Imagine an employee who makes $100.  The employer musts pay $7.65 to the social security administration for the employer half of social security, so the employer's "real wage" before SS and medicare was really $107.65.    When you are self-employed, you are both employer and employee and pay both halves.  So if your net profit is $107.65 and you pay $15.21 in self-employment tax, you subtract half the SECA which results in "compensation" of $100.04 for IRA purposes, which is pretty close.

In other words, the calculation equalizes the "real compensation" between employees and self-employed people by adjusting for the employer half of social security and medicare.

While that formula is correct almost all the time, I am not 100% certain it should be calculated that way for clergy.  But it would require some sophisticated research to come up with a different answer, and then you would have to override the program and file by mail, and you would need an accountant to defend you if you were audited.  So in this case, I think you probably just live with the adjustment.  

[jbbandkathy]

Yes…all the $19000 was spent on housing and yes SE taxes was paid on housing allowance plus wages. 

[JohnB5677]

The $14,370 was his total income ($16,970) les social security & Medicare.  Therefore, his available income to fund the IRA's was $14,370.

The self-employment tax rate is 15.3%. That rate is the sum of 12.4% for Social Security and 2.9% for Medicare.