What Counts as Compensation for IRA Contributions and Exceptions

Taxpayers across the United States face an unchanged but often misunderstood gatekeeper to retirement savings in 2025: the definition of “compensation” for IRA purposes. As of August 27, 2025, the Internal Revenue Service continues to require that a taxpayer—or a spouse on a joint return—have taxable earned income to contribute to a traditional IRA or to Roth IRAs. The annual contribution ceiling stays at $7,000 if under age 50 and $8,000 if age 50 or older.

These rules matter for millions: immigrants and mixed‑status households that rely on a single earner, military families with nontaxable combat pay, and self‑employed workers whose income varies month to month. The IRS’s interpretation of compensation—focused on money earned from work and excluding most passive and deferred income—determines who can build retirement savings and how much they can put away before the April 15 deadline for prior‑year contributions.

What “compensation” includes for IRA purposes

At its core, compensation means money earned from working. For IRA eligibility, compensation includes:

• Wages, salaries, tips, professional fees, bonuses, and other amounts paid for personal services
• Taxable alimony
• Nontaxable combat pay

For self‑employed individuals (sole proprietors and partners), compensation is their net earnings from a trade or business, with two required reductions before treating that figure as IRA compensation:

1. The deduction for contributions they make on their own behalf to retirement plans
2. The deductible portion of self‑employment taxes

Important: a net loss from self‑employment does not count as negative compensation—the figure simply cannot go below zero for IRA eligibility calculations.

What does NOT count as compensation

Just as important as what counts is what doesn’t. The rules exclude income that does not come from current personal services:

• Rental income, interest, and dividends
• Pension or annuity payments
• Deferred compensation paid in a later year for earlier work
• Partnership distributions unless the person’s services were a material factor in producing the income
• Income excluded from tax under other provisions (notably, foreign earned income excluded under the usual rules does not qualify)

Exception: combat pay is expressly included even if nontaxable. People who rely on investment income or passive business income must remember that such funds cannot support a new IRA contribution for the year.

Spousal rules and joint returns

The spousal rules can be a lifeline:

• If a couple files a joint return, only one spouse needs to have compensation for both spouses to contribute to their own separate IRAs.
• Each spouse must have their own account; they cannot combine funds into one IRA.
• This helps households where one spouse stepped out of the workforce (e.g., caregiving), is not authorized to work, or is between jobs.

Contribution limits and timing (2025)

• Annual maximum contribution: $7,000 (under 50) or $8,000 (50 or older) — includes the catch‑up provision.
• Contribution deadline for a tax year: generally April 15 of the following year.
  This grace period lets taxpayers wait until early in the next year to confirm income and finalize contribution choices.

Roth IRA income (MAGI) limits for 2025

Roth IRA eligibility depends on modified adjusted gross income (MAGI):

• Single filers:
  • Full contribution if MAGI is below $150,000
  • Phase‑out between $150,000 and $165,000
  • No contribution at $165,000 or higher
• Married filing jointly:
  • Full contribution if MAGI is below $236,000
  • Phase‑out between $236,000 and $246,000
  • No contribution at $246,000 or higher
• Married filing separately:
  • Phase‑out below $10,000
  • No contribution at $10,000 or higher

These thresholds determine who can contribute directly to a Roth and how much of the $7,000/$8,000 limit can be allocated to a Roth.

Traditional IRA deduction limits for 2025

Traditional IRA contributions are not restricted by MAGI for eligibility, but deductibility depends on workplace plan coverage and income:

• If you are covered by a retirement plan at work:
  • Single filers: deduction phases out between $79,000 and $89,000 MAGI
  • Married filing jointly: deduction phases out between $126,000 and $146,000 MAGI
• If you are not covered by a workplace plan: deduction is generally available regardless of income
• If you are not covered but your spouse is covered: on a joint return, deduction phases out between $236,000 and $246,000 MAGI

These ranges help guide whether to contribute to a traditional IRA, a Roth, or split between them.

Common situations and examples

• Married couple, one earner: earner’s wages can support IRA contributions for both spouses (each must have a separate IRA), up to $7,000/$8,000 each, provided total contributions do not exceed the earner’s compensation.
• Single filer with wages and investment income: only wages count as compensation; dividends and interest do not expand IRA capacity.
• Self‑employed consultant: compensation equals net earnings reduced by retirement plan deduction and the deductible portion of self‑employment tax; a small loss does not create negative compensation.
• Service member with combat pay: nontaxable combat pay counts as compensation and can support a contribution.
• U.S. taxpayer with excluded foreign earned income: excluded wages do not count as compensation and may block IRA contributions unless other taxable earned income exists.

Practical guidance and checklist

Start with this step‑by‑step checklist:

1. Identify earned income for the year: wages, salaries, tips, professional fees, bonuses, taxable alimony, and any nontaxable combat pay. If self‑employed, begin with net earnings from the business.
2. Subtract required adjustments for the self‑employed: reduce net earnings by retirement plan contribution deduction for yourself and by the deductible portion of self‑employment tax. Do not let the figure go below zero.
3. Confirm excluded items: remove passive income (rent, interest, dividends), pensions/annuities, deferred compensation paid later, partnership income not tied to material services, and income excluded from U.S. tax (other than combat pay).
4. Determine filing status and MAGI ranges: check Roth phase‑out bands and traditional IRA deduction bands for 2025.
5. Choose contribution types and amounts: allocate up to $7,000 (or $8,000 if 50+) across traditional and Roth IRAs, subject to eligibility and phase‑outs. Each spouse needs a separate account.
6. Make contributions by the deadline: generally April 15 for prior‑year contributions, and keep records showing you had the compensation to support those contributions.

Key takeaway: without eligible compensation, there is no IRA contribution for the year — regardless of how much you have in investments or other income sources.

Special notes for immigrants, global workers, and military families

• Foreign earned income excluded under the foreign earned income rules does not qualify as compensation for IRA purposes. A U.S. taxpayer who excludes foreign wages may have zero eligible compensation for the year despite high earnings abroad.
• U.S. taxable wages earned domestically do count, even alongside foreign income. This is critical for globally mobile workers and mixed‑status immigrant households.
• Military families benefit from the rule that nontaxable combat pay counts as compensation, which can maintain retirement savings even during deployments.

Common pitfalls

• Assuming investment income (rent, dividends, interest) counts as compensation — it does not.
• Forgetting to reduce self‑employed net earnings for retirement plan deductions and the deductible portion of self‑employment tax.
• Overlooking the spousal rule that allows contributions on a joint return when only one spouse has compensation (but requiring separate IRAs).
• Relying on excluded foreign earned income as compensation for IRA contributions.

Policy footnote and resources

The SECURE 2.0 Act’s 529‑to‑Roth rollover opportunity (begun in 2024) does not change the definition of compensation for IRA purposes. It may help move leftover education funds into a Roth under specific conditions, but annual IRA contributions still require eligible compensation.

For official guidance, review the IRS materials at the IRS Traditional and Roth IRAs page: https://www.irs.gov/retirement-plans/traditional-and-roth-iras.

Final practical advice

• Start with compensation — confirm your income was earned from work and qualifies under the IRS definition.
• Check the 2025 thresholds for Roth contributions and traditional IRA deductions.
• Decide how to split contributions between traditional and Roth accounts based on tax strategy and eligibility.
• Use the filing deadline grace period (generally April 15) to finalize prior‑year contributions and retain documentation showing eligible compensation.

With the rules unchanged into 2025, verifying compensation and aligning contributions with MAGI and deduction rules is the essential first step for keeping retirement savings on track within the IRS framework.