Tax

A SIMPLE Retirement Plan for the Self-Employed

Of all the retirement plans available to small business owners, the SIMPLE plan is the easiest to set up and the least expensive to manage.

These plans are intended to encourage small business employers to offer retirement coverage to their employees. SIMPLE plans work well for small business owners who don’t want to spend time and high administration fees associated with more complex retirement plans.

SIMPLE plans really shine for self-employed business owners. Here’s why…

Self-employed business owners are able to contribute both as employee and employer, with both contributions made from self-employment earnings.

SIMPLEs calculate contributions in two steps:

1. Employee out-of-salary contribution
The limit on this “elective deferral” is $11,500 in 2011, after which it can rise further with the cost of living.

Catch-up. Owner-employees age 50 or over can make a further $2,500 deductible “catch-up” contribution as employee in 2011.

2. Employer “matching” contribution
The employer match equals a maximum of 3% of employee’s earnings.

Example: A 52-year-old owner-employee with self-employment earnings of $40,000 could contribute and deduct $11,500 as employee plus a further $2,500 employee catch-up contribution, plus $1,200 (3% of $40,000) employer match, or a total of $15,200.

SIMPLE plans are an excellent choice for home-based businesses and ideal for full-time employees or homemakers who make a modest income from a sideline business.

If living expenses are covered by your day job (or your spouse’s job), you would be free to put all of your sideline earnings, up to the ceiling, into SIMPLE retirement investments.

A Truly Simple Plan

A SIMPLE plan is easier to set up and operate than most other plans. Contributions go into an IRA you set up. Those familiar with IRA rules – in investment options, spousal rights, creditors’ rights – don’t have a lot new to learn.

Requirements for reporting to the IRS and other agencies are negligible. Your plan’s custodian, typically an investment institution, has the reporting duties. And the process for figuring the deductible contribution is a bit simpler than with other plans.

What’s Not So Good About SIMPLEs

Once self-employment earnings become significant however, other retirement plans may be more advantageous than a SIMPLE retirement plan.

Example: If you are under 50 with $50,000 of self-employment earnings in 2011, you could contribute $11,500 as employee to your SIMPLE plus a further 3% of $50,000 as an employer contribution, for a total of $13,000. In contrast, a Keogh 401(k) plan would allow a $25,500 contribution.

With $100,000 of earnings, it would be a total of $14,500 with a SIMPLE and $35,500 with a 401(k).

Because investments are through an IRA, you’re not in direct control. You must work through a financial or other institution acting as trustee or custodian, and you will in practice have fewer investment options than if you were your own trustee, as you would be in a Keogh.

It won’t work to set up the SIMPLE plan after a year ends and still get a deduction that year, as is allowed with Simplified Employee Pension Plans, or SEPs. Generally, to make a SIMPLE plan effective for a year, it must be set up by October 1 of that year. A later date is allowed where the business is started after October 1; here the SIMPLE must be set up as soon thereafter as administratively feasible.

If the SIMPLE plan is set up for a sideline business and you’re already vested in a 401(k) in another business or as an employee the total amount you can put into the SIMPLE and the 401(k) combined (in 2011) can’t be more than $16,500 or $21,500 if catch-up contributions are made to the 401(k) by someone age 50 or over.

So someone under age 50 who puts $8,000 in her 401(k) can’t put more than $8,500 in her SIMPLE in 2011. The same limit applies if you have a SIMPLE while also contributing as an employee to a 403(b) annuity (typically for government employees and teachers in public and private schools).

How to Get Started with a SIMPLE Plan

You can set up a SIMPLE account on your own, but most people turn to financial institutions.

SIMPLES are offered by the same financial institutions that offer IRAs and Keogh master plans.

You can expect the institution to give you a plan document and an adoption agreement. In the adoption agreement you will choose an “effective date” – the beginning date for payments out of salary or business earnings. That date can’t be later than October 1 of the year you adopt the plan, except for a business formed after October 1.

Another key document is the Salary Reduction Agreement, which briefly describes how money goes into your SIMPLE. You need such an agreement even if you pay yourself business profits rather than salary.

Printed guidance on operating the SIMPLE may also be provided. You will also be establishing a SIMPLE IRA account for yourself as participant.

Keoghs, SEPs, and SIMPLES Compared

Keogh	SEP	SIMPLE
Plan type: Can be defined benefit or defined contribution (profit sharing or money purchase)	Defined contribution only	Defined contribution only
Number you can own: Owner may have two or more plans of different types, including an SEP, currently or in the past	Owner may have SEP and Keoghs	Generally, SIMPLE is the only current plan
Due dates: Plan must be in existence by the end of the year for which contributions are made	Plan can be set up later – if by the due date (with extensions) of the return for the year contributions are made	Plan generally must be in existence by October 1 of the year for which contributions are made
Dollar contribution ceiling (for 2011): $49,000 for defined contribution plan; no specific ceiling for defined benefit plan	$49,000	$23,000
Percentage limit on contributions: 50% of earnings for defined contribution plans (100% of earnings after contribution). Elective deferrals in 401(k) not subject to this limit. No percentage limit for defined benefit plan.	50% of earnings (100% of earnings after contribution). Elective deferrals in SEPs formed before 1997 not subject to this limit.	100% of earnings, up to $11,500 (for 2011) for contributions as employee; 3% of earnings, up to $11,500, for contributions as employer
Deduction ceiling: For defined contribution, lesser of $49,000 or 20% of earnings (25% of earnings after contribution). 401(k) elective deferrals not subject to this limit. For defined benefit, net earnings.	Lesser of $49,000 or 25% of eligible employee’s compensation. Elective deferrals in SEPs formed before 1997 not subject to this limit.	Same as percentage ceiling on SIMPLE contribution
Catch-up contribution age 50 or over: Up to $5,500 in 2011 for 401(k)s	Same for SEPs formed before 1997	Half the limit for Keoghs and SEPs (up to $2,750 in 2011)
Prior years’ service can count in computing contribution	No	No
Investments: Wide investment opportunities. Owner may directly control investments.	Somewhat narrower range of investments. Less direct control of investments.	Same as SEP
Withdrawals: Some limits on withdrawal before retirement age	No withdrawal limits	No withdrawal limits
Permitted withdrawals before age 59 1/2 may still face 10% penalty	Same as Keogh rule	Same as Keogh rule except penalty is 25% in SIMPLE’s first two years
Spouse’s rights: Federal law grants spouse certain rights in owner’s plan	No federal spousal rights	No federal spousal rights
Rollover allowed to another plan (Keogh or corporate), SEP or IRA, but not a SIMPLE.	Same as Keogh rule	Rollover after 2 years to another SIMPLE and to plans allowed under Keogh rule
Some reporting duties are imposed, depending on plan type and amount of plan assets	Few reporting duties	Negligible reporting duties

Please contact us if you are a business owner interested in exploring retirement plan options, including SIMPLE plans.

Employee Relocation in a Down Market

Many companies have questions about what to do with an employee’s home when he or she is moved to a new job location, especially with the real estate market in a downturn throughout much of the country.

Typically, the employer wants to protect the employee against financial loss on a “forced” sale of the home. Here are the most common ways to do that, and their consequences to the employee:

The employer reimburses the employee’s financial loss. Here the employer has the home appraised and agrees to pay the employee the difference between the appraised fair market value and any lesser amount the employee gets on the sale. Such reimbursement would cover the employee’s costs of the sale.

Note: The financial loss here is not the same as a tax loss. The financial loss is the home’s value less what the employee collects under “forced sale” conditions. In the current real estate market, the value is not always clearly determined. The relocating employee might think the home is worth more, based on earlier appraisals or comparative sales. A tax loss is the property’s tax basis (cost plus capital investments) less what’s collected on the sale.

If the employee has a gain on the sale (the amount collected on the sale exceeds the basis), gain can be tax-exempt up to $250,000 ($500,000 on certain husband-wife sales). However, tax loss on the sale of one’s residence is not deductible.

The employer’s reimbursement of the employee’s financial loss is taxable pay to the employee. Employers who want to shelter the employee from any tax burden on what is usually an employer-instigated relocation may “gross-up” the reimbursement to cover the tax. But gross-up can be costly. For example, a grossed-up income tax reimbursement for a $10,000 loss would be $14,575 for an employee in the 35% bracket – more where Social Security taxes or state taxes are also grossed-up.

Employer buys the home. Few employers directly buy and sell employees’ homes. But many do this indirectly, effectively becoming the homes’ owners, through use of relocation firms acting as the employers’ agents. An IRS ruling shows how to do this with no tax on the employee:

Option 1. The relocation firm as employer’s agent buys the home for its appraised fair market value, and later resells it. The firm collects a fee from the employer, which will cover sales costs and any financial loss to the firm on resale. The IRS now says that this fee is not taxable to the employee. Also, the employee’s gain on the sale to the relocation firm qualifies for the tax exemption under the limits described above ($250,000 or $500,000).

Option 2. The relocation firm offers to buy the home for its appraised value, but the employee can choose to pursue a higher price through a broker he or she chooses from a list provided by the relocation firm. If a higher offer is made, the relocation firm pays that price to the employee (whether or not the home is then sold to that bidder). Here again, the employee is not taxed on the firm’s fee and the gain is tax exempt under the above limits.

Tip: Either option works for the employee, letting him or her realize full value on the sale of the home (with possibly greater value through Option 2), without an element of taxable pay.

Caution: If the deal is structured so that the relocation firm facilitates a sale from the employee to a third-party buyer (rather than to the relocation firm), the employer’s payment of the relocation firm’s fee is taxable to the employee.

The Employer’s Side

Reimbursing the employee’s loss. This is fully deductible as a business expense, as would be any additional amount paid as a gross-up.

Note: It’s fully deductible, but it may be more costly, before and after taxes, than buying the home for resale through the relocation firm.

Note: Paying the relocation fee only, without buying the home, as in the “Caution” above, is also fully deductible, as would be any gross-up amount on that fee.

Buying the home. The change in the IRS rule was good news for employees, but it gave nothing to employers, whose tax treatment wasn’t covered. The official IRS position is that employer costs (other than carrying costs such as mortgage interest, maintenance, and fees to a relocation management company) are deductible only as capital losses, which, for corporate employers, are deductible only against capital gains. Taxpayer advocates tend to argue that employer costs here are fully deductible ordinary costs of doing business.

Questions?

Are you an employee who is being relocated this fall? Are you wondering about the sale of your home and the tax implications for you? We can answer your questions. Just give us a call.

5 Tips If You Changed Your Name This Year

If you changed your name this year as a result of a recent marriage or divorce, you’ll want to take the necessary steps to ensure the name on your tax return matches the name registered with the Social Security Administration. A mismatch between the name shown on your tax return and the SSA records can cause problems in the processing of your tax return and may even delay your refund.

Here are 5 tips for recently married or divorced taxpayers who have made a name change.

If you took your spouse’s last name or if both spouses hyphenate their last names, you may run into complications if you don’t notify the SSA. When newlyweds file a tax return using their new last names, IRS computers can’t match the new name with their Social Security Number.
If you were recently divorced and changed back to your previous last name, you’ll also need to notify the SSA of this name change.
It’s easy to inform the SSA of a name change. You just need to file Form SS-5, Application for a Social Security Card, at your local SSA office and provide a recently issued document as proof of your legal name change.
Form SS-5 is available on SSA’s website at www.socialsecurity.gov, by calling 800-772-1213, or at local offices. Your new card will have the same number as your previous card, but it will show your new name.
If you adopted your spouse’s children after getting married, you’ll want to make sure the children have an SSN. Taxpayers must provide an SSN for each dependent claimed on a tax return. For adopted children without SSNs, the parents can apply for an Adoption Taxpayer Identification Number, or ATIN, by filing Form W-7A, Application for Taxpayer Identification Number for Pending U.S. Adoptions with the IRS. The ATIN is a temporary number used in place of an SSN on the tax return. Form W-7A is available on the IRS website at www.irs.gov, or by calling 800-TAX-FORM (800-829-3676).