Generally, compensation is what you earn from working. For a summary of what compensation does and does not include, see Table 1-1. Compensation includes the items discussed next.

An individual retirement account is a trust or custodial account set up in the United States for the exclusive benefit of you or your beneficiaries. The account is created by a written document. The document must show that the account meets all of the following requirements.

You can set up an individual retirement annuity by purchasing an annuity contract or an endowment contract from a life insurance company.

An individual retirement annuity must be issued in your name as the owner, and either you or your beneficiaries who survive you are the only ones who can receive the benefits or payments.

An individual retirement annuity must meet all the following requirements.

The sale of individual retirement bonds issued by the federal government was suspended after April 30, 1982. The bonds have the following features.

If you cash (redeem) the bonds before the year in which you reach age 59½, you may be subject to a 10% additional tax. See Age 59½ Rule under Early Distributions, later. You can roll over redemption proceeds into IRAs.

A simplified employee pension (SEP) is a written arrangement that allows your employer to make deductible contributions to a traditional IRA (a SEP IRA) set up for you to receive such contributions. Generally, distributions from SEP IRAs are subject to the withdrawal and tax rules that apply to traditional IRAs. See Publication 560 for more information about SEPs.

Your employer or your labor union or other employee association can set up a trust to provide individual retirement accounts for employees or members. The requirements for individual retirement accounts apply to these traditional IRAs.

The trustee or issuer (sometimes called the sponsor) of your traditional IRA generally must give you a disclosure statement at least 7 days before you set up your IRA. However, the sponsor does not have to give you the statement until the date you set up (or purchase, if earlier) your IRA, provided you are given at least 7 days from that date to revoke the IRA.

The disclosure statement must explain certain items in plain language. For example, the statement should explain when and how you can revoke the IRA, and include the name, address, and telephone number of the person to receive the notice of cancellation. This explanation must appear at the beginning of the disclosure statement.

If you revoke your IRA within the revocation period, the sponsor must return to you the entire amount you paid. The sponsor must report on the appropriate IRS forms both your contribution to the IRA (unless it was made by a trustee-to-trustee transfer) and the amount returned to you. These requirements apply to all sponsors.

For 2007, the most that can be contributed to your traditional IRA generally is the smaller of the following amounts:

This general limit may be increased to $7,000 if you participated in a 401(k) plan maintained by an employer who went into bankruptcy in an earlier year. For more information, see Catch-up contributions in certain employer bankruptcies later.

This is the most that can be contributed regardless of whether the contributions are to one or more traditional IRAs or whether all or part of the contributions are nondeductible. (See Nondeductible Contributions, later.) Qualified reservist repayments do not affect this limit.

Catch-up contributions in certain employer bankruptcies.   If you participated in a 401(k) plan and the employer who maintained the plan went into bankruptcy, you may be able to contribute an additional $3,000 to your IRA. For this to apply, the following conditions must be met.

• You must have been a participant in a 401(k) plan under which the employer matched at least 50% of your contributions to the plan with stock of the company.

• You must have been a participant in the 401(k) plan 6 months before the employer went into bankruptcy.

• The employer (or a controlling corporation) must have been a debtor in a bankruptcy case in an earlier year.

• The employer (or any other person) must have been subject to indictment or conviction based on business transactions related to the bankruptcy.

  

If you choose to make these catch-up contributions, the higher contribution and deduction limits for individuals who are age 50 or older do not apply. The most you can contribute to your IRA is the smaller of $7,000 or your taxable compensation for the year.

For 2007, if you file a joint return and your taxable compensation is less than that of your spouse, the most that can be contributed for the year to your IRA is the smaller of the following two amounts:

This means that the total combined contributions that can be made for the year to your IRA and your spouse's IRA can be as much as $8,000 ($9,000 if only one of you is age 50 or older or $10,000 if both of you are age 50 or older).

This limit may be increased to $7,000 for each spouse who participated in a 401(k) plan maintained by an employer who went into bankruptcy in an earlier year. For more information, see Catch-up contributions in certain employer bankruptcies earlier.

Generally, except as discussed earlier under Spousal IRA Limit, your filing status has no effect on the amount of allowable contributions to your traditional IRA. However, if during the year either you or your spouse was covered by a retirement plan at work, your deduction may be reduced or eliminated, depending on your filing status and income. See How Much Can You Deduct, later.

If contributions to your traditional IRA for a year were less than the limit, you cannot contribute more after the due date of your return for that year to make up the difference.

If contributions to your IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year. However, a penalty or additional tax may apply. See Excess Contributions, later under What Acts Result in Penalties or Additional Taxes.

The Form W-2 you receive from your employer has a box used to indicate whether you were covered for the year. The “Retirement Plan” box should be checked if you were covered.

Reservists and volunteer firefighters should also see Situations in Which You Are Not Covered, later.

If you are not certain whether you were covered by your employer's retirement plan, you should ask your employer.

As discussed earlier, the deduction you can take for contributions made to your traditional IRA depends on whether you or your spouse was covered for any part of the year by an employer retirement plan. Your deduction is also affected by how much income you had and by your filing status. Your deduction may also be affected by social security benefits you received.