On May 29, 2006, the President signed the Heroes Earned Retirement Opportunities Act, which liberalizes IRA and Roth IRA contribution limits for military personnel receiving combat pay. Before the legislation, the annual limitation for traditional IRA and Roth IRA contributions – in general, the lesser of a specified dollar amount or 100% of taxable compensation – created an inequitable result for members of the armed forces receiving combat pay. Because combat pay is excluded from gross income by Internal Revenue Code section 112, individuals whose compensation consisted exclusively of combat pay had an IRA contribution limit of zero.
Effective with the 2004 tax year, the new law takes into account, for purposes of the annual IRA and Roth IRA contribution limitation, compensation earned for service in a combat zone by members of the armed forces. The legislation appears not to take such combat pay into account in applying the limitations based on adjusted gross income, e.g., the IRA deduction limit for active participants in retirement plans, and the Roth IRA contribution phase-out and conversion limitation.
The legislation allows military personnel to make or increase IRA and Roth IRA contributions in circumstances where otherwise such contributions would not be allowed. The retroactive effective date is intended both to ratify contributions previously made in anticipation of the legislation and to allow retroactive contributions for 2004 and 2005 anytime during the three-year period beginning with the date of enactment, which will relate back to those years. Procedural rules are also provided for dealing with overpayment or underpayment of 2004 and 2005 taxes by reason of contributions based on this legislation.
In an unrelated development, the Service published a private letter ruling approving the rollover of a "loan offset" amount under a qualified plan to an IRA. PLR 200617037. The taxpayer terminated employment while a loan under his employer’s 401(k) plan was outstanding. Under the plan, the loan was treated as a default and was offset against the taxpayer’s account balance, resulting in a taxable event. Within 60 days, the taxpayer rolled over the net 401(k) balance to an IRA, and also deposited in the IRA a personal check for the loan offset amount. The Service ruled that the distribution of the plan loan offset amount was an eligible rollover distribution and generally may be rolled over on a tax-free basis, subject to the usual rules for such rollovers. The ruling illustrates the principles of, and distinctions made in, Treas. Reg. §1.402(c)-2, Q&A 9. It was essential to the Service’s conclusion that the loan offset was an actual distribution for tax purposes; loans resulting in deemed distributions for failure to comply with Code section 72(p) are not eligible rollover distributions.
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This article is for informational purposes and is not intended to constitute legal advice.