Federal Unemployment (FUTA) Tax

You must pay FUTA tax if you meet either of the following tests.

• You paid cash wages of $20,000 or more to farm workers in any calendar quarter during the current or preceding calendar year.
• You employed 10 or more farm workers for some part of at least 1 day during any 20 or more different calendar weeks during the current or preceding calendar year.

These rules do not apply to exempt services of your spouse, your parents, or your children under age 21. See Family Employees, earlier.

Alien farm workers.   Wages paid to aliens admitted on a temporary basis to the United States to perform farm work (also known as H-2(A) visa workers) are exempt from FUTA tax. However, include your employment of these workers and the wages you paid them to determine whether you meet either test above.

Commodity wages.   Payments in kind for farm labor are not cash wages. Do not count them to figure whether you are subject to FUTA tax or to figure how much tax you owe.

Tax rate and credit.   The gross FUTA tax is 6.2% of the first $7,000 cash wages you pay each employee. However, you are given a credit of up to 5.4% for the state unemployment tax you pay. The net tax rate, therefore, can be as low as 0.8% (6.2% - 5.4%). If your state tax rate (experience rate) is less than 5.4%, you may still be allowed the full 5.4% credit.

If you do not pay the state tax, you cannot take the credit. If you are exempt from state unemployment tax for any reason, the full 6.2% rate applies. See the instructions for Form 940 for additional information.

More information.   For more information on FUTA tax, see Circular A.

Reporting and Paying FUTA Tax

The FUTA tax is imposed on you as the employer. It must not be collected or deducted from the wages of your employees.

Form 940.   Report FUTA tax on Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return. The 2002 form is due January 31, 2003, (or February 10, 2003, if you deposit the tax on time and in full).

Form 940-EZ.   You can use Form 940-EZ, a simplified version of Form 940, if you meet all the following tests.

• You paid unemployment contributions to only one state.
• You paid all state unemployment contributions by the due date of Form 940 or 940-EZ.
• All wages subject to FUTA tax were also subject to your state's unemployment tax.

Deposits.   If at the end of any calendar quarter you owe, but have not yet deposited, more than $100 in FUTA tax for the year, you must make a deposit by the end of the following month. If the undeposited tax is $100 or less at the end of a quarter, you do not have to deposit it. You must add it to the tax for the next quarter. If the total undeposited tax is more than $100 at the end of the next quarter, a deposit will be required. If the total undeposited tax at the end of the 4th quarter is $100 or less, you can either make a deposit or pay it with your return by the January 31 due date.

Electronic deposit requirement.   If you are subject to the electronic deposit requirement, you must use EFTPS to deposit FUTA tax. See Reporting and Paying Social Security, Medicare, and Withheld Income Taxes, earlier, for a discussion of the requirement for making deposits electronically.

Retirement Plans

Important Changes for 2002

Many changes to the tax laws for retirement plans were made by the Economic Growth and Tax Relief Reconciliation Act of 2001 that was enacted on June 7, 2001. Most of those changes take effect in 2002. For information about those changes not covered in this chapter, see Publication 560, Retirement Plans for Small Business, or Publication 553, Highlights of 2002 Tax Changes.

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 in later years.

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 later years.

In general, individuals who are employed or self-employed can also set up and contribute to individual retirement arrangements (IRAs).

Topics

This chapter discusses:

• Individual retirement arrangements (IRAs)
• 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)

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 21 for information about getting publications and forms.

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.

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. But 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 by or 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.

Contribution Limits

Contributions you make for 2002 to a common-law employee's SEP-IRA are limited to the lesser of $40,000 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 an employee's compensation over $200,000 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 $40,000 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.

Deduction Limit

The most you can deduct for employer contributions (other than elective deferrals) for a common-law employee is 25% of the compensation (limited to $200,000 per participant) paid to him or her during the year from the business that has the plan.

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 which takes into account both the following amounts.

1. The deduction for one-half your self-employment tax.
2. 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. See Figuring your deduction under Deduction Limits under Qualified Plan, later.

SEP and defined contribution plans.   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 for 2002 (or $3,500 if they are 50 or older) 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 includes 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.
• There were 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 2002 is limited to the lesser of $11,000 or 25% of the participant'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.   Beginning in 2002, a SEP can permit participants who are age 50 or older at the end of the calendar year to also make catch-up contributions. (If the participant's 50th birthday is on January 1, 2003, the participant is considered age 50 at the end of 2002.) The catch-up contribution limit for 2002 is $1,000 ($2,000 for 2003). Elective deferrals are not treated as catch-up contributions for 2002 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.

• The catch-up contribution limit.
• The excess of the participant's compensation over the elective deferrals that are not catch-up contributions.

Catch-up contributions are not subject to the limit discussed under Limit on elective deferrals, earlier.

Deduction limit and elective deferrals.   For plan years beginning in 2002, elective deferrals are no longer included in the determination of the SEP deduction limit of 25% of an employee's eligible compensation. However, the deduction for employer contributions for participants and elective deferrals combined cannot exceed the maximum contribution limit discussed earlier under Contribution Limits.

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. Your SEP contributions under a salary reduction arrangement are included in your employee's wages for social security and Medicare tax purposes.

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 chose not 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 Figuring your deduction under Deduction Limits 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 does not make the choice explained above, 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.

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