Now that tax filing season is upon us, you may be looking for additional deductions to lower your income tax liability from your small business operations. One of the best ways to shelter income is to contribute to a qualified retirement plan. These plans are easy to set up and don't have the operational complexities associated with 401(k) plans.
The SEP-IRA is a pension plan available to sole proprietors, partnerships, and LLC's that allows owner's to contribute more of their income than any other plan. New accounts can be established for 2011 at any time prior to the return due date, including extensions. Contributions must be made by the employer for themselves and all eligible employees. An eligible employee must be 21, have worked for the employer 3 of the last 5 years, and have received at least $550 in compensation during 2011. The employer must contribute the same percentage of compensation for all employees. The employer can contribute up to 20% of net self-employment income up to $49,000. SEP-IRA's are not subject to adjusted gross income phase-out rules and have no annual reporting requirements. This advantage is offset by the requirement that employers fund all of a qualifying participant's contribution.
The SIMPLE IRA is another popular plan because it allows business owners to contribute more to their IRA's than traditional or Roth IRA's. SIMPLE IRA's are available to all business entities. Employees under age 50 can do elective deferrals up to $11,500 for 2011 and those over 50 can contribute $14,000. Employees are eligible to do elective deferrals if they received at least $5,000 in compensation from the employer during any two years prior to the current year, and they expect to receive $5,000 in the current year. There are two options for employer matching contributions. Employers can match 3% of the employee deferrals dollar for dollar up to 3% of the employee's compensation. No matching is required for employees who don't contribute to the plan. The second option requires employers to match 2% of wages for all employees including nonparticipants. A SIMPLE IRA must be set up by October 1st to be eligible for that tax year unless the business is new and began operations after October 1st. Employer matching contributions must be made by the due date of the return, including extensions.
The costs of starting a pension plan can be offset by a tax credit of up to 50% of the qualified plan start-up costs. The credit is limited to $500 per year for the first 3 years the plan is in existence. Eligible small businesses are those with no more than 100 employees who received at least $5,000 in compensation during the tax year preceding the first credit year.
Traditional and Roth IRA's are another retirement funding option for business owners to consider that do not require contributions on behalf of employees. Contributions of up to $5,000 can be made to Traditional IRA' s and are deductible against income if the individual is under age 70 1/2 and not an active participant in an employer-sponsored pension plan. The contribution limit is increased to $6,000 for those over age 50. Contributions must be made by April 17, 2012 to qualify as deductions for the 2011 tax year.
Individuals can also contribute $5,000 to Roth IRA's ($6,000 if over age 50). These limits can't be exceeded for the combined contributions to Traditional and Roth IRA's. The individual doesn't get a deduction against current year income for Roth contributions, but all future earnings are tax-free if the account holder has held the account for five years and is age 59 1/2. Distributions due to death, disability, or for a first time home purchase are also qualifying as tax-free withdrawals. Roth IRA contributions are subject to income phase-out limits starting at $107,000 of modified AGI for single filers and $169,000 for joint filers. The Roth IRA account owner has until April 17, 2012 to contribute to their Roth IRA for 2011.
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For additional questions, please contact John Fossum at 320-650-0234 or jfossum@kdv.com.
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