| Pub. 535, Business Expenses |
2004 Tax Year |
Chapter 3 - Retirement Plans
This is archived information that pertains only to the 2004 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.
What's New for 2004
Compensation limit. For 2004, the maximum compensation used for figuring contributions and benefits increases to $205,000. This amount increases
to $210,000 in 2005.
Elective deferrals. The limit on elective deferrals increases to $13,000 for tax years beginning in 2004 and then increases $1,000 each tax year
thereafter until it
reaches $15,000 in 2006. These new limits will apply for participants in SARSEPs, 401(k) plans (excluding SIMPLE plans), and
deferred compensation
plans of state or local governments and tax-exempt organizations. The $15,000 figure is subject to cost-of-living increases
after 2006.
Catch-up contributions. A plan can permit participants who are age 50 or over at the end of the calendar year to also make catch-up
contributions. The catch-up contribution limit for 2004 is $3,000. This limit increases by $1,000 each year thereafter until
it reaches $5,000 in
2006. The limit is subject to cost-of-living increases after 2006. The catch-up contribution a participant can make for a
year cannot exceed the
lesser of the following amounts.
SIMPLE plan salary reduction contributions. The limit on salary reduction contributions to a SIMPLE plan increases to $9,000 beginning in 2004 and then increases to $10,000
in 2005. The
$10,000 figure is subject to adjustment after 2005 for cost-of-living increases.
Catch-up contributions. A SIMPLE plan can permit participants who are age 50 or over at the end of the calendar year to make catch-up
contributions. The catch-up contribution limit for 2004 is $1,500. This limit increases by $500 each year thereafter until
it reaches $2,500 in 2006.
The limit is subject to cost-of-living increases after 2006. The catch-up contributions a participant can make for a year
cannot exceed the lesser of
the following amounts.
Introduction
This chapter discusses retirement plans you can set up and maintain for yourself and your employees. Retirement plans are
savings plans that offer
you tax advantages to set aside money for your own and your employees' retirement.
In general, a sole proprietor or a partner is treated as an employee for retirement plan purposes.
SEP, SIMPLE, and qualified plans offer you and your employees a tax favored way to save for retirement. You can deduct contributions
you make to
the plan for your employees. If you are a sole proprietor, you can deduct contributions you make to the plan for yourself.
You can also deduct
trustees' fees if contributions to the plan do not cover them. Earnings on the contributions are generally tax free until
you or your employees
receive distributions from the plan.
Under certain plans, employees can have you contribute limited amounts of their before-tax pay to a plan. These amounts (and
the earnings on them)
are generally tax free until your employees receive distributions from the plan.
In general, individuals who are employed or self-employed can also set up and contribute to individual retirement arrangements
(IRAs).
Topics - This chapter discusses:
-
Simplified employee pension (SEP) plans
-
SIMPLE (Savings incentive match plan for employees) retirement plans
-
Qualified plans (also called H.R. 10 plans or Keogh plans when covering self-employed individuals)
-
Individual retirement arrangements (IRAs)
Useful Items - You may want to see:
Publication
-
560
Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans)
-
590
Individual Retirement Arrangements (IRAs)
Form (and Instructions)
-
W-2
Wage and Tax Statement
-
5304-SIMPLE
Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)—Not for Use With a Designated Financial Institution
-
5305-SIMPLE
Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)—for Use With a Designated Financial Institution
See chapter 14 for information about getting publications and forms.
Simplified Employee Pension (SEP)
A simplified employee pension (SEP) is a written plan that allows you to make deductible contributions toward your own and
your employees'
retirement without getting involved in more complex retirement plans. A corporation also can have a SEP and make deductible
contributions toward its
employees' retirement. However, certain advantages available to qualified plans, such as the special tax treatment that may
apply to lump-sum
distributions, do not apply to SEPs.
Under a SEP, you make the contributions to a traditional individual retirement arrangement (called a SEP-IRA) set up for each
eligible employee.
SEP-IRAs are set up for, at a minimum, each eligible employee. A SEP-IRA may have to be set up for a leased employee, but
need not be set up for an
excludable employee. For more information, see Publication 560.
Form 5305-SEP.
You may be able to use Form 5305-SEP, Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement,
in setting up your
SEP.
Contributions you make for 2004 to a common-law employee's SEP-IRA are limited to the lesser of $41,000 ($42,000 for 2005)
or 25% of the employee's
compensation. Compensation generally does not include your contributions to the SEP, but does include certain elective deferrals
unless you choose not
to include them.
Annual compensation limit.
You generally cannot consider the part of an employee's compensation over $205,000 ($210,000 for 2005) when you figure
your contribution limit for
that employee.
More than one plan.
If you also contribute to a defined contribution retirement plan (defined later), annual additions to all of a participant's
accounts are limited
to the lesser of $41,000 or 100% of the participant's compensation. When you figure this limit, you must add your contributions
to all defined
contribution plans. A SEP is considered a defined contribution plan for this limit.
Contributions for yourself.
The annual limits on your contributions to a common-law employee's SEP-IRA also apply to contributions you make to
your own SEP-IRA.
The most you can deduct for employer contributions (other than elective deferrals) for a common-law employee is 25% of the
compensation (limited to
$205,000 per participant) paid to him or her during the year from the business that has the plan, not to exceed $41,000 per
participant.
In 2005, the $205,000 and $41,000 amounts increase to $210,000 and $42,000.
Deduction of contributions for yourself.
When figuring the deduction for employer contributions made to your own SEP-IRA, compensation is your net earnings
from self-employment minus the
following amounts.
-
The deduction for one-half of your self-employment tax.
-
The deduction for contributions to your own SEP-IRA.
The deduction for contributions to your own SEP-IRA and your net earnings depend on each other. For this reason, you
determine the deduction for
contributions to your own SEP-IRA indirectly by reducing the contribution rate called for in your plan. Use Worksheet 3-A, shown under
Qualified Plan, later, to figure the rate.
SEP and defined contribution plan.
If you also contributed to a qualified defined contribution plan, you must reduce the 25% deduction limit for that
plan by the allowable deduction
for contributions to the SEP-IRAs of those participating in both the SEP plan and the defined contribution plan.
SEP and another qualified plan.
If you also contributed to any other type of qualified plan, treat the SEP as a separate profit-sharing (defined contribution)
plan when applying
the overall 25% deduction limit described in section 404(h)(3) of the Internal Revenue Code.
If your SEP contribution is more than the deduction limit (nondeductible contribution), you can carry over and deduct the
difference in later
years. However, the contribution carryover, when combined with the contribution for the later year, is subject to the deduction
limit for that year.
Employee contributions.
Employees can also make contributions of up to $3,000 (or $3,500 if they are 50 or older) for 2004 to their SEP-IRAs
independent of the employer's
SEP contributions. However, the employee's deduction for IRA contributions may be reduced or eliminated because the employee
is covered by an employer
retirement plan (the SEP plan). See Publication 590 for details.
Salary Reduction Simplified Employee Pension (SARSEP)
An employer is no longer allowed to set up a SARSEP. However, participants in a SARSEP set up before 1997 (including employees
hired after 1996)
can continue to have their employer contribute part of their pay to the plan.
A SARSEP is a SEP set up before 1997 that included a salary reduction arrangement. Under the arrangement, employees can choose
to have you
contribute part of their pay to their SEP-IRAs rather than receive it in cash. This contribution is called an elective deferral
because employees
choose (elect) to set aside the money and the tax on the money is deferred until it is distributed.
This choice is available only if all the following requirements are met.
-
The SARSEP was set up before 1997.
-
At least 50% of the eligible employees choose the salary reduction arrangement.
-
You had 25 or fewer eligible employees (or employees who would have been eligible if you had maintained a SEP) at any time
during the
preceding year.
-
Each eligible highly compensated employee's deferral percentage each year is no more than 125% of the average deferral percentage
(ADP) of
all nonhighly compensated employees eligible to participate (the ADP test). See Publication 560 for the definition of a highly
compensated employee
and information on how to figure the deferral percentage.
Limit on elective deferrals.
In general, the total income an employee can defer under a SARSEP and certain other elective deferral arrangements
for 2004 is limited to the
lesser of $13,000 or 25% of the employee's compensation (as defined in Publication 560). This limit applies only to amounts
that reduce the employee's
pay, not to any contributions from employer funds.
Catch-up contributions.
A SEP can permit participants who are age 50 or older at the end of the calendar year to make catch-up contributions.
The catch-up contribution
limit for 2004 is $3,000 ($4,000 for 2005). Elective deferrals are not treated as catch-up contributions for 2004 until they
exceed the limit
discussed earlier under Limit on elective deferrals, the SARSEP ADP test (see Publication 560), or the plan limit (if any). However, the
catch-up contribution a participant can make for a year cannot exceed the lesser of the following amounts.
Catch-up contributions are not subject to the limit discussed under Limit on elective deferrals, earlier.
Deduction limit and elective deferrals.
Compensation, as discussed earlier, under Deduction Limit, includes elective deferrals. Elective deferrals are no longer subject to this
deduction limit. However, the combined deduction for a participant's elective deferrals, and other SEP contributions, cannot
exceed $41,000.
Employment taxes.
Elective deferrals that meet the ADP test are not subject to income tax in the year of deferral, but they are included
in wages for social
security, Medicare, and federal unemployment (FUTA) tax.
Reporting SEP Contributions on Form W-2
Your contributions to an employee's SEP-IRA are excluded from the employee's income. Do not include these contributions in
your employee's wages on
Form W-2 for income, social security, or Medicare tax purposes. However, your SEP contributions under a salary reduction arrangement
are included in
your employee's wages for social security and Medicare tax purposes only.
Example.
Jim's salary reduction arrangement calls for 10% of his salary to be contributed by his employer as an elective deferral to
Jim's SEP-IRA. Jim's
salary for the year is $30,000 (before reduction for the deferral). The employer did not choose to treat deferrals as compensation
under the
arrangement. To figure the deferral, the employer multiplies Jim's salary of $30,000 by 9.0909%, the reduced rate equivalent
of 10%, to get the
deferral of $2,727.27. (This method is the same one you, as a self-employed person, use to figure the contributions you make
on your own behalf. See
Worksheet 3-A, under Qualified Plan, later.)
On Jim's Form W-2, his employer shows total wages of $27,272.73 ($30,000 - $2,727.27), social security wages of $30,000, and
Medicare wages
of $30,000. Jim reports $27,272.73 as wages on his individual income tax return.
If his employer chooses to treat the deferrals as compensation, Jim's deferral would be $3,000 ($30,000 x 10%). In this case,
the employer uses the
rate called for under the arrangement (not the reduced rate) to figure the deferral and the ADP test. On Jim's Form W-2, the
employer shows total
wages of $27,000 ($30,000 - $3,000), social security wages of $30,000, and Medicare wages of $30,000. Jim reports $27,000
as wages on his
return.
In either case, the maximum deductible contribution would be $6,000 ($30,000 x 20%).
More information.
For more information on employer withholding requirements, see Publication 15, (Circular E), Employer's Tax Guide.
For more information on SEPs, see Publication 560.
A Savings Incentive Match Plan for Employees (SIMPLE plan) is a written arrangement that provides you and your employees with
a simplified way to
make contributions to provide retirement income. Under a SIMPLE plan, employees can choose to make salary reduction contributions
to the plan rather
than receiving these amounts as part of their regular pay. In addition, you will contribute matching or nonelective contributions.
SIMPLE plans can only be maintained on a calendar-year basis.
A SIMPLE plan can be set up in either of the following ways.
See Publication 560 for information on SIMPLE 401(k) plans.
Many financial institutions will help you set up a SIMPLE plan.
A SIMPLE IRA plan is a retirement plan that uses SIMPLE IRAs for each eligible employee. Under a SIMPLE IRA plan, a SIMPLE
IRA must be set up for
each eligible employee. For the definition of an eligible employee, see Who Can Participate in a SIMPLE IRA Plan?, next.
Who Can Set Up a SIMPLE IRA Plan?
You can set up a SIMPLE IRA plan if you meet both the following requirements.
Employee limit.
You can set up a SIMPLE IRA plan only if you had 100 or fewer employees who received $5,000 or more in compensation
from you for the preceding
year. Under this rule, you must take into account all employees employed at any time during the calendar year regardless of
whether they are eligible
to participate. Employees include self-employed individuals who received earned income and leased employees.
Once you set up a SIMPLE IRA plan, you must continue to meet the 100-employee limit each year you maintain the plan.
Grace period for employers who cease to meet the 100-employee limit.
If you maintain the SIMPLE IRA plan for at least 1 year and you cease to meet the 100-employee limit in a later year,
you will be treated as
meeting it for the 2 calendar years immediately following the calendar year for which you last met it.
A different rule applies if you do not meet the 100-employee limit because of an acquisition, disposition, or similar
transaction. Under this rule,
the SIMPLE IRA plan will be treated as meeting the 100-employee limit for the year of the transaction and the 2 following
years if both the following
conditions are satisfied.
The grace period for acquisitions, dispositions, and similar transactions also applies if, because of these types of transactions,
you do not meet
the rules explained under Other qualified plan, next, or Who Can Participate in a SIMPLE IRA Plan?, later.
Other qualified plan.
The SIMPLE IRA plan generally must be the only retirement plan to which you make contributions, or benefits accrue,
for service in any year
beginning with the year the SIMPLE IRA plan becomes effective.
Exception.
If you maintain a qualified plan for collective bargaining employees, you are permitted to maintain a SIMPLE IRA plan
for other employees.
Who Can Participate in a SIMPLE IRA Plan?
Eligible employee.
Any employee who received at least $5,000 in compensation during any 2 years preceding the current calendar year and
is reasonably expected to
receive at least $5,000 during the current calendar year is eligible to participate. The term employee includes a self-employed
individual who
received earned income.
You can use less restrictive eligibility requirements (but not more restrictive ones) by eliminating or reducing the
prior year compensation
requirements, the current year compensation requirements, or both. For example, you can allow participation for employees
who received at least $3,000
in compensation during any preceding calendar year. However, you cannot impose any other conditions on participating in a
SIMPLE IRA plan.
Excludable employees.
The following employees do not need to be covered under a SIMPLE IRA plan.
-
Employees who are covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees'
union and
you.
-
Nonresident alien employees who have received no U.S. source wages, salaries, or other personal services compensation from
you.
Compensation.
Compensation for employees is the total wages required to be reported on Form W-2. Compensation also includes the
salary reduction contributions
made under this plan, compensation deferred under a section 457 plan, and the employees' elective deferrals under a section
401(k) plan, a SARSEP, or
a section 403(b) annuity contract. If you are self-employed, compensation is your net earnings from self-employment (line
4, Section A, or line 6,
Section B, of Schedule SE (Form 1040)) before subtracting any contributions made to the SIMPLE IRA plan for yourself.
How To Set Up a SIMPLE IRA Plan
You can use
Form 5304-SIMPLE or
Form 5305-SIMPLE to set up a SIMPLE IRA plan. Each form is a model savings incentive match plan for employees
(SIMPLE) plan document. Which form you use depends on whether you select a financial institution or your employees select
the institution that will
receive the contributions.
Use Form 5304-SIMPLE if you allow each plan participant to select the financial institution for receiving his or her SIMPLE
IRA plan contributions.
Use Form 5305-SIMPLE if you require that all contributions under the SIMPLE IRA plan be deposited initially at a designated
financial institution.
The SIMPLE IRA plan is adopted when you (and the designated financial institution, if any) have completed all appropriate
boxes and blanks on the
form and you have signed it. Keep the original form. Do not file it with the IRS.
Other uses of the forms.
If you set up a SIMPLE IRA plan using Form 5304-SIMPLE or Form 5305-SIMPLE, you can use the form to satisfy other
requirements, including the
following.
-
Meeting employer notification requirements for the SIMPLE IRA plan. Page 3 of Form 5304-SIMPLE and Page 3 of Form 5305-SIMPLE
contain a
Model Notification to Eligible Employees that provides the necessary information to the employee.
-
Maintaining the SIMPLE IRA plan records and proving you set up a SIMPLE IRA plan for employees.
Deadline for setting up a SIMPLE IRA plan.
You can set up a SIMPLE IRA plan effective on any date from January 1 thru October 1 of a year, provided you did not
previously maintain a SIMPLE
IRA plan. This requirement does not apply if you are a new employer that comes into existence after October 1 of the year
the SIMPLE IRA plan is set
up and you set up a SIMPLE IRA plan as soon as administratively feasible after your business comes into existence. If you
previously maintained a
SIMPLE IRA plan, you can set up a SIMPLE IRA plan effective only on January 1 of a year. A SIMPLE IRA plan cannot have an
effective date that is
before the date you actually adopt the plan.
Setting up a SIMPLE IRA.
SIMPLE IRAs are the individual retirement accounts or annuities into which the contributions are deposited. A SIMPLE
IRA must be set up for each
eligible employee. Forms 5305-S,
SIMPLE Individual Retirement Trust Account, and 5305-SA,
SIMPLE Individual Retirement Custodial Account, are model trust and custodial account documents the participant and
the trustee (or custodian) can use for this purpose.
A SIMPLE IRA cannot be designated as a Roth IRA. Contributions to a SIMPLE IRA will not affect the amount an individual
can contribute to a Roth
IRA.
Deadline for setting up a SIMPLE IRA.
A SIMPLE IRA must be set up for an employee before the first date by which a contribution is required to be deposited
into the employee's IRA. See
Time limits for contributing funds, later, under Contribution Limits.
If you adopt a SIMPLE IRA plan, you must notify each employee of the following information before the beginning of the election
period.
-
The employee's opportunity to make or change a salary reduction choice under a SIMPLE IRA plan.
-
Your choice to make either reduced matching contributions or nonelective contributions (discussed later).
-
A summary description and the location of the plan. The financial institution should provide you with this information.
-
Written notice that his or her balance can be transferred without cost or penalty if you use a designated financial institution.
Election period.
The election period is generally the 60-day period immediately preceding January 1 of a calendar year (November 2
to December 31 of the preceding
calendar year). However, the dates of this period are modified if you set up a SIMPLE IRA plan in mid-year (for example, on
July 1) or if the 60-day
period falls before the first day an employee becomes eligible to participate in the SIMPLE IRA plan.
A SIMPLE IRA plan can provide longer periods for permitting employees to enter into salary reduction agreements or
to modify prior agreements. For
example, a SIMPLE IRA plan can provide a 90-day election period instead of the 60-day period. Similarly, in addition to the
60-day period, a SIMPLE
IRA plan can provide quarterly election periods during the 30 days before each calendar quarter, other than the first quarter
of each year.
Contributions are made up of salary reduction contributions and employer contributions. You, as the employer, must make either
matching
contributions or nonelective contributions, discussed later. No other contributions can be made to the SIMPLE IRA plan. These
contributions, which you
can deduct, must be made timely. See Time limits for contributing funds, later.
Salary reduction contributions.
The amount the employee chooses to have you contribute to a SIMPLE IRA on his or her behalf cannot be more than $9,000
for 2004 ($10,000 for 2005).
These contributions must be expressed as a percentage of the employee's compensation unless you permit the employee to express
them as a specific
dollar amount. You cannot place restrictions on the contribution amount (such as limiting the contribution percentage), except
to comply with the
$9,000 limit.
If an employee is a participant in any other employer plan during the year and has elective salary reductions or deferred
compensation under those
plans, the salary reduction contributions under a SIMPLE IRA plan also are elective deferrals that count toward the overall
$13,000 annual limit on
exclusion of salary reductions and other elective deferrals.
Catch-up contributions.
A SIMPLE plan can permit participants who are age 50 or older at the end of the calendar year to make catch-up contributions.
The catch-up
contribution limit for 2004 is $1,500. This limit increases by $500 each year thereafter until it reaches $2,500 in 2006.
The limit is subject to
cost-of-living increases after 2006. The catch-up contributions a participant can make for a year cannot exceed the lesser
of the following amounts.
Employer matching contributions.
You generally are required to match each employee's salary reduction contributions (other than catch-up contributions)
on a dollar-for-dollar basis
up to 3% of the employee's compensation. This requirement does not apply if you make nonelective contributions as discussed
later.
Example.
In 2004, your employee, John Rose, earned $25,000 and chose to defer 5% of his salary. You make a 3% matching contribution.
The total contribution
you can make for John is $2,000, figured as follows.
Lower percentage.
If you choose a matching contribution less than 3%, the percentage must be at least 1%. You must notify the employees
of the lower match within a
reasonable period of time before the 60-day election period (discussed earlier) for the calendar year. You cannot choose a
percentage less than 3% for
more than 2 years during the 5-year period that ends with (and includes) the year for which the choice is effective.
Nonelective contributions.
Instead of matching contributions, you can choose to make nonelective contributions of 2% of compensation on behalf
of each eligible employee who
has at least $5,000 of compensation (or some lower amount of compensation that you select) from you for the year. If you make
this choice, you must
make nonelective contributions whether or not the employee chooses to make salary reduction contributions. Only $205,000 of
the employee's
compensation can be taken into account to figure the contribution limit.
If you choose this 2% contribution formula, you must notify the employees within a reasonable period of time before
the 60-day election period
(discussed earlier) for the calendar year.
Example 1.
In 2004, your employee, Jane Wood, earned $36,000 and chose to have you contribute 10% of her salary. You make a 2% nonelective
contribution. Both
of you are under age 50. The total contributions you can make for her are $4,320, figured as follows.
Salary reduction contributions
($36,000 × .10)
|
$3,600
|
2% nonelective contributions
($36,000 × .02)
|
720
|
| Total contributions |
$4,320 |
Example 2.
Using the same facts as in Example 1, above, the maximum contribution you can make for Jane if she earned $75,000 is $10,500, figured as
follows.
Salary reduction contributions
(maximum amount)
|
$9,000
|
2% nonelective contributions
($75,000 × .02)
|
1,500
|
| Total contributions |
$10,500 |
Time limits for contributing funds.
You must make the salary reduction contributions to the SIMPLE IRA within 30 days after the end of the month in which
the amounts would otherwise
have been payable to the employee in cash. You must make matching contributions or nonelective contributions by the due date
(including extensions)
for filing your federal income tax return for the year.
When To Deduct Contributions
You can deduct SIMPLE IRA contributions in the tax year with or within which the calendar year for which contributions were
made ends. You can
deduct contributions for a particular tax year if they are made for that tax year and are made by the due date (including
extensions) of your federal
income tax return for that year.
Example 1.
Your tax year is the fiscal year ending June 30. Contributions under a SIMPLE IRA plan for the calendar year 2004 (including
contributions made in
2004 before July 1, 2004) are deductible in the tax year ending June 30, 2005.
Example 2.
You are a sole proprietor whose tax year is the calendar year. Contributions under a SIMPLE IRA plan for the calendar year
2004 (including
contributions made in 2005 by April 15, 2005) are deductible in the 2004 tax year.
Where To Deduct Contributions
Deduct contributions you make for your common-law employees on your tax return. For example, sole proprietors deduct them
on Schedule C (Form 1040)
or Schedule F (Form 1040), partnerships deduct them on Form 1065, and corporations deduct them on Form 1120, Form 1120-A,
or Form 1120S.
Sole proprietors and partners deduct contributions for themselves on line 32 of Form 1040. (If you are a partner, contributions
for yourself are
shown on the Schedule K-1 (Form 1065) you receive from the partnership).
Tax Treatment of Contributions
You can deduct your contributions and your employees can exclude these contributions from their gross income. SIMPLE IRA contributions
are not
subject to federal income tax withholding. However, salary reduction contributions are subject to social security, Medicare,
and federal unemployment
(FUTA) taxes. Matching and nonelective contributions are not subject to these taxes.
Reporting on Form W-2.
Do not include SIMPLE IRA contributions in the “ Wages, tips, other compensation” box of Form W-2. However, salary reduction contributions must
be included in the boxes for social security wages and Medicare wages. Also include the proper code in Box 12. For more information,
see the
instructions for Forms W-2 and W-3.
Distributions (Withdrawals)
Distributions from a SIMPLE IRA are subject to IRA rules and generally are includible in income for the year received. Tax-free
rollovers can be
made from one SIMPLE IRA into another SIMPLE IRA. A rollover from a SIMPLE IRA to a non-SIMPLE IRA can be made tax free only
after a 2-year
participation in the SIMPLE IRA plan.
Early withdrawals generally are subject to a 10% additional tax. However, the additional tax is increased to 25% if funds
are withdrawn within 2
years of beginning participation.
More information.
See Publication 590 for information about IRA rules, including those on the tax treatment of distributions, rollovers,
required distributions, and
income tax withholding.
More Information on SIMPLE IRA Plans
If you need more help to set up and maintain a SIMPLE IRA plan, see the following IRS notice and revenue procedure.
Notice 98-4.
This notice contains questions and answers about the implementation and operation of SIMPLE IRA plans, including the
election and notice
requirements for these plans. Notice 98-4 is in Cumulative Bulletin 1998-1.
Revenue Procedure 97-29.
This revenue procedure provides guidance to drafters of prototype SIMPLE IRAs on obtaining opinion letters. Revenue
Procedure 97-29 is in
Cumulative Bulletin 1997-1.
A qualified retirement plan is a written plan you can set up for the exclusive benefit of your employees and their beneficiaries.
It is sometimes
called a Keogh or H.R. 10 plan.
You, or you and your employees, can make contributions to the plan. If your plan meets the qualification requirements, you
generally can deduct
your contributions to the plan. For more information, see Publication 560.
Your employees generally are not taxed on your contributions or increases in the plan's assets until they are distributed.
However, certain loans
made from qualified plans are treated as taxable distributions. For more information, see Publication 575.
Qualification requirements.
To be a qualified plan, the plan must meet many requirements. They include requirements that determine the following.
-
Who must be covered by the plan.
-
How contributions to the plan are to be invested.
-
How contributions to the plan and benefits under the plan are to be determined.
-
How much of an employee's interest in the plan must be guaranteed (vested).
For more information, see Publication 560.
More than one job.
If you are self-employed and also work for someone else, you can participate in retirement plans for both jobs. Generally,
your participation in a
retirement plan for one job does not affect your participation in a plan for the other job. However, if you have an IRA, you
may not be allowed to
deduct part or all of your IRA contributions. See Publication 590.
There are two basic kinds of qualified retirement plans: defined contribution plans and defined benefit plans.
Defined Contribution Plan
This plan provides for a separate account for each person covered by the plan. Benefits are based only on amounts contributed
to or allocated to
each account.
There are two types of defined contribution plans: profit-sharing and money purchase pension.
Profit-sharing plan.
This plan lets your employees or their beneficiaries share in the profits of your business. The plan must have a definite
formula for allocating
the contribution among the participating employees and for distributing the accumulated funds in the plan.
Money purchase pension plan.
Under this plan, contributions are fixed and are not based on your business profits. For example, if the plan requires
contributions of 10% of each
participating employee's compensation, regardless of whether you have a profit, the plan is a money purchase pension plan.
This is any plan that is not a defined contribution plan. In general, contributions to a qualified defined benefit plan are
based on what is needed
to provide definitely determinable benefits to plan participants. Your contributions to the plan are based on actuarial assumptions.
Generally, you
will need continuing professional help to administer a defined benefit plan.
You must adopt a written plan. The plan can be an IRS-approved master or prototype plan offered by a sponsoring organization.
Or it can be an
individually designed plan.
Master or prototype plans.
The following sponsoring organizations generally can provide IRS-approved master or prototype plans.
Adoption of a master or prototype plan does not mean your plan is automatically qualified. It still must meet all the qualification
requirements stated in the law.
Individually designed plan.
If you prefer, you can set up an individually designed plan to meet specific needs. Although advance IRS approval
is not required, you can apply
for approval by paying a fee and requesting a determination letter. You may need professional help with this. Revenue Procedure
2004-6 in Internal
Revenue Bulletin 2004-1 may help you decide whether to apply for approval.
The deduction limit for contributions to a qualified plan depends on the kind of plan you have.
In figuring the deduction for contributions to these plans, you cannot take into account any contributions or benefits that
are more than the
limits discussed under Limits on Contributions and Benefits in Publication 560. However, your deduction can be as much as
the plan's
unfunded current liability.
Defined contribution plans.
The deduction for contributions to a defined contribution plan (profit sharing plan or money purchase pension plan)
cannot be more than 25% of the
compensation paid (or accrued) during the year to the eligible employees participating in the plan. You must reduce this limit
in figuring the
deduction for contributions you make for your own account. See Deduction of contributions for yourself, later.
When figuring the deduction limit, the following rules apply.
-
Elective deferrals (discussed in Publication 560) are not subject to the limit.
-
Compensation includes elective deferrals.
-
The maximum compensation that can be taken into account for each employee is $205,000.
Defined benefit plans.
An actuary must figure the deduction for contributions to a defined benefit plan because it is based on actuarial
assumptions and computations.
Deduction of contributions for yourself.
To take a deduction for contributions you make to a plan for yourself, you must have net earnings from the trade or
business for which the plan was
set up.
Limit on deduction.
If the qualified plan is a defined contribution plan, your deduction for yourself is limited to the lesser of $41,000
or 20% (25% reduced as
discussed later) of your net earnings.
Net earnings.
Your net earnings must be from self-employment in a trade or business in which your personal services are a material
income-producing factor. Your
net earnings do not include items excluded from income (or deductions related to that income), other than foreign earned income
and foreign housing
cost amounts.
Your net earnings are your business gross income minus the allowable business deductions from that business. Allowable
business deductions include
contributions to SEP and qualified plans for common-law employees and the deduction for one-half of your self-employment tax.
Net earnings include a partner's distributive share of partnership income or loss (other than separately stated items
such as capital gains and
losses) and any guaranteed payments. If you are a limited partner, net earnings include only guaranteed payments for services
rendered to or for the
partnership. For more information, see Partnership Income or Loss under Figuring Earnings Subject to Self-Employment Tax in
Publication 533.
Net earnings do not include income passed through to shareholders of S corporations.
Adjustments.
You must reduce your net earnings by the deduction for one-half of your self-employment tax. Also, net earnings must
be reduced by the deduction
for contributions you make for yourself. This reduction is made indirectly, as explained next.
Net earnings reduced by adjusting contribution rate.
You must reduce net earnings by your deduction for contributions for yourself. The deduction and the net earnings
depend on each other. You make
the adjustment indirectly by reducing the contribution rate called for in the plan and using the reduced rate to figure your
maximum deduction for
contributions for yourself.
Annual compensation limit.
You generally cannot take into account more than $205,000 of your compensation in figuring your contribution to a
defined contribution plan.
Use the following worksheet to find the reduced contribution rate for yourself. Make no reduction to the contribution rate
for any common-law
employees.
Worksheet 3-A. Rate Worksheet for Self-Employed
|
1)
|
Plan contribution rate as a decimal (for example, 10½% = .105)
|
|
|
2)
|
Rate in line 1 plus 1 (for example, .105 + 1 = 1.105)
|
|
|
3)
|
Self-employed rate as a decimal rounded to at least 3 decimal places (line 1 ÷ line 2)
|
|
After you have figured your self-employed rate, you can figure your maximum deduction for contributions for yourself by completing
Worksheet
3-B.
An Example of how to complete the worksheets follows.
Worksheet 3-B. Deduction Worksheet for Self-Employed
| |
Step 1
|
|
|
|
| |
|
Enter your net profit from line 31, Schedule C (Form 1040); line 3, Schedule C-EZ (Form 1040); line
36, Schedule F (Form 1040); or box 14, code A*, Schedule K-1 (Form 1065)
|
|
| |
|
*General partners should reduce this amount by the same additional expenses
subtracted from box 14, code A to determine the amount on line 1 or 2 of
Schedule SE
|
|
| |
Step 2
|
|
|
|
| |
|
Enter your deduction for self-employment tax from line 30, Form 1040
|
|
| |
Step 3
|
|
|
|
| |
|
Net earnings from self-employment. Subtract step 2 from step 1
|
|
| |
Step 4
|
|
|
|
| |
|
Enter your rate from the Worksheet 3-A |
|
| |
Step 5
|
|
|
|
| |
|
Multiply step 3 by step 4
|
|
| |
Step 6
|
|
|
|
| |
|
Multiply $205,000 by your plan contribution rate (not the reduced rate)
|
|
| |
Step 7
|
|
|
|
| |
|
Enter the smaller of step 5 or step 6
|
|
| |
Step 8
|
|
|
|
| |
|
Contribution dollar limit
|
$41,000
|
| |
|
•
|
If you made any elective deferrals, go to step 9. |
|
|
| |
|
•
|
Otherwise, skip steps 9 through 18 and enter the smaller of step 7 or step 8 on step 19. |
|
|
| |
Step 9
|
|
|
|
| |
|
Enter your allowable elective deferrals made during 2004. Do not enter more than $13,000
|
|
| |
Step 10
|
|
|
|
| |
|
Subtract step 9 from step 8
|
|
| |
Step 11
|
|
|
|
| |
|
Subtract step 9 from step 3
|
|
|
| |
Step 12
|
|
|
|
| |
|
Enter one-half of step 11
|
|
| |
Step 13
|
|
|
|
| |
|
Enter the smallest of step 7, 10, or 12
|
|
| |
Step 14
|
|
|
|
| |
|
Subtract step 13 from step 3
|
|
| |
Step 15
|
|
|
|
| |
|
Enter the smaller of step 9 or step 14
|
|
| |
|
•
|
If you made catch-up contributions, go to step 16. |
|
|
| |
|
•
|
Otherwise, skip steps 16 through 18 and go to step 19. |
|
|
| |
Step 16
|
|
|
|
| |
|
Subtract step 15 from step 14
|
|
| |
Step 17
|
|
|
|
| |
|
Enter your catch-up contributions, if any. Do not enter more than $3,000
|
|
| |
Step 18
|
|
|
|
| |
|
Enter the smaller of step 16 or step 17
|
|
| |
Step 19
|
|
|
|
| |
|
Add steps 13, 15, and 18. This is your maximum deductible contribution |
|
| |
|
Next: Enter this amount on line 32, Form 1040.
|
|
You are a sole proprietor with no employees. The terms of your plan provide that you contribute 8½% (.085) of your compensation
(defined earlier) to your plan. Your net profit from line 31, Schedule C (Form 1040) is $200,000. You have no elective deferrals
or catch-up
contributions. Your self-employment tax deduction on line 30 of Form 1040 is $8,128. You figure your self-employed rate and
maximum deduction for
employer contributions you made for yourself as shown in illustrated Worksheet 3-A and Worksheet 3-B.
Worksheet 3-A. Rate Worksheet for Self-Employed — Illustrated
|
1)
|
Plan contribution rate as a decimal (for example, 10½% = .105)
|
0.085
|
|
2)
|
Rate in line 1 plus 1 (for example, .105 + 1 = 1.105)
|
1.085
|
|
3)
|
Self-employed rate as a decimal rounded to at least 3 decimal places (line 1 ÷ line 2)
|
0.078
|
Worksheet 3-B. Deduction Worksheet for Self-Employed — Illustrated
| |
Step 1
|
|
|
|
| |
|
Enter your net profit from line 31, Schedule C (Form 1040); line 3, Schedule C-EZ (Form 1040); line
36, Schedule F (Form 1040); or box 14, code A*, Schedule K-1 (Form 1065)
|
$200,000
|
| |
|
*General partners should reduce this amount by the same additional expenses
subtracted from box 14, code A to determine the amount on line 1 or 2 of
Schedule SE
|
|
| |
Step 2
|
|
|
|
| |
|
Enter your deduction for self-employment tax from line 30, Form 1040
|
8,128
|
| |
Step 3
|
|
|
|
| |
|
Net earnings from self-employment. Subtract step 2 from step 1
|
191,872
|
| |
Step 4
|
|
|
|
| |
|
Enter your rate from Worksheet 3-A |
0.078
|
| |
Step 5
|
|
|
|
| |
|
Multiply step 3 by step 4
|
14,966
|
| |
Step 6
|
|
|
|
| |
|
Multiply $205,000 by your plan contribution rate (not the reduced rate)
|
17,425
|
| |
Step 7
|
|
|
|
| |
|
Enter the smaller of step 5 or step 6
|
14,966
|
| |
Step 8
|
|
|
|
| |
|
Contribution dollar limit
|
$41,000
|
| |
|
•
|
If you made any elective deferrals, go to step 9. |
|
|
| |
|
•
|
Otherwise, skip steps 9 through 18 and enter the smaller of step 7 or step 8 on step 19. |
|
|
| |
Step 9
|
|
|
|
| |
|
Enter your allowable elective deferrals made during 2004. Do not enter more than $12,000
|
N/A
|
| |
Step 10
|
|
|
|
| |
|
Subtract step 9 from step 8
|
|
| |
Step 11
|
|
|
|
| |
|
Subtract step 9 from step 3
|
|
|
| |
Step 12
|
|
|
|
| |
|
Enter one-half of step 11
|
|
| |
Step 13
|
|
|
|
| |
|
Enter the smallest of step 7, 10, or 12
|
|
| |
Step 14
|
|
|
|
| |
|
Subtract step 13 from step 3
|
|
| |
Step 15
|
|
|
|
| |
|
Enter the smaller of step 9 or step 14
|
|
| |
|
•
|
If you made catch-up contributions, go to step 16. |
|
|
| |
|
•
|
Otherwise, skip steps 16 through 18 and go to step 19. |
|
|
| |
Step 16
|
|
|
|
| |
|
Subtract step 15 from step 14
|
|
| |
Step 17
|
|
|
|
| |
|
Enter your catch-up contributions, if any. Do not enter more than $3,000
|
|
| |
Step 18
|
|
|
|
| |
|
Enter the smaller of step 16 or step 17
|
|
| |
Step 19
|
|
|
|
| |
|
Add steps 13, 15, and 18. This is your maximum deductible contribution |
$14,966
|
| |
|
Next: Enter this amount on line 32, Form 1040.
|
|
When to make contributions.
To take a deduction for contributions for a particular year, you must make the contributions not later than the due
date (generally April 15 for
calendar year taxpayers), plus extensions, of your tax return for that year.
More information.
See Publication 560 for more information on retirement plans for small business owners, including the self-employed.
Publication 560 also discusses
the reporting forms that must be filed for these plans.
Individual Retirement Arrangement (IRA)
An individual retirement arrangement (IRA) is a personal savings plan that allows you to set aside money for your retirement.
You may be able to
deduct your contributions, depending on the type of IRA and your circumstances. Generally, amounts in an IRA, including earnings
and gains, are not
taxed until they are distributed. In certain cases, your earnings and gains may not be taxed at all if they are distributed
according to the rules.
For more information on IRAs, see Publication 590.
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