Nicholas Hartney EA Blog Nicholas Hartney, Licensed to Represent Taxpayers before the IRS | Snapshot of Current Tax Issues| Genesis Tax Consultants, LLC
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Nick's Tax Snapshots

Nicholas Hartney, Licensed to Represent Taxpayers before the IRS | Snapshots of Current Tax Issues

You Can't Contribute to a §401 (IRA and 401k) If You Have No Earned Income or the Income is Excluded under the Foreign Earned Income Exclusion

My wife (working as a contractor in Germany) had mentioned that there is some clown in her office making the rounds telling people to contribute to a Roth IRA (and/or other retirement plans).  Per my advice, she did tell this co-worker that income that is excluded under the foreign earned income exclusion (FEIE) is not eligible to be contributed to an IRA.  This is, in fact, the case and also holds true for 401K contributions. 

Nicholas Hartney, EA on IRA and 401(k) Plans with Foreign Earned Income Exclusion.jpg

IRS §1402(a)(11), §341(a)(8), §911 and Revenue Ruling 70-491 state that income excluded under the FEIE cannot be contributed to employment retirement plans that are formed under Internal Revenue Code §401. 

There is a popular misconception (spread by people like her armchair accountant co-worker) that if you are able to set up and contribute to one of these retirement plans than the strategy is allowed, but that is not the case.  Brokerage companies and employers are not responsible for checking to see if their customers or employees meet the IRS requirements for contributions. Generally, companies have disclaimers stating that they are not providing any tax advice. 

The question is then, what are the tax ramifications for people who have already contributed, what do they do with those deposited amounts and what will the tax ramifications be (i.e. will they be hit with an early withdrawal penalty or will they be granted a waiver for not this penalty but also other penalties and interest upon withdrawal), it is possible that the contributions may end up being taxable in full, which would leave you guys worse off than if they just used a regular brokerage account (i.e. investing in stocks).

So to summarize, if you have no earned income (Unearned income includes things like annuity payments, pension income, distributions from retirement accounts, capital gains, interest income, dividends, passive income generated from rental real estate, alimony, stock dividends, and bond interest), you must have earned income to make an IRA or Roth IRA contribution) or if you've excluded all earned income from U.S. tax using the FEIE and the foreign housing exclusion, you cannot contribute to a 401(k).

-Nicholas Hartney, EA

Nicholas Hartney, EA