During the 90's I got burned by the AMT (Alternative Minimum Tax) when I exercised some stock options on the anticipation of the company going public. It never happened and I ended up paying income tax on $90,000 in 'paper' profit. In 2004 the company got sold and my common shares were worthless. Lesson learned.
In 2004 I thought that I would contribute to my personal IRA the amount of $4500. The company that bought my never-went-public-company didn't have any pension, 401K plans. This is what happened.
A few months ago I received correspondence from the IRS saying that my $4500 IRA contribution was not deducible and I owned them about $1500 with the interest. I couldn't believe that I owned them any money. I would never try to 'cheat' the IRS but at the same time I try to maximize my deductions.
So a number of back and forth letters ended up with me paying another $60.00 to have this reviewed by the 'Tax Court'. It turns out that my deduction isn't allowed because there is a ceiling on how much money you can earn before taxes. This amount is $60,000. If you earn over that amount then you can't claim the IRA contribution.
So I'm going to pay the taxes plus the interest and file an amended 2005 tax return because I deducted a $5000 contribution into my IRA and again I'm over the ceiling.
This is what really gets me about this. So let's assume that I made just below $60,000 before taxes. Let's say the taxes (income, social security, medicare, state taxes, etc) is $15,000 dollars leaving me with $45,000 dollars to live on. That is $3750/month that I'm taking home. Assuming I live in a modest house/apartment I'm paying $1500/month for it. Let's say I have a car (not a fancy one) that I'm paying $250/month on. That brings my monthly amount down to $2000. So with $2000/month to pay for food, gas, insurance, co-payments on medical, clothes, maintenance on the car and other normal expenses I'm suppose to put aside around $400/month to contribute to my IRA.
This seems like a very difficult thing to do without living a very frugal lifestyle. I'm not saying someone couldn't do it but it seems to me that the tax law is set up so most people can't contribute to an IRA.
However, if my company had a pension/401K that I could contribute and that would be deducible. Of course, a 401K is run by some major corporation that offers some 'mutual funds' to choose from and not some 'personal' IRA account. On top to that this major corporation makes money off of my 401K unless it is a no load fund. In addition I'm limited in my choices of mutual funds. But if I did this I could then take the money in my pension/401K and roll it over into my personal IRA and not pay taxes on it. There isn't any earnings ceiling if I do it that way.
To me, this is just another example of the middle class getting the short end of it. Do you have any similar experiences from the IRS?