| Publication 535 |
2001 Tax Year |
Qualified Plan
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 can generally
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.
Kinds of Qualified Plans
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 be
10% of each participating employee's compensation regardless of
whether you have a profit, the plan is a money purchase pension plan.
Defined Benefit 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.
Setting Up a 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.
- Trade or professional organizations.
- Banks (including savings and loan associations and federally
insured credit unions).
- Insurance companies.
- Mutual funds.
Adoption of a master or prototype plan does not mean your plan
is automatically qualified. It must still 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. The following
revenue procedure and announcement will help you decide whether to
apply for approval.
- Revenue Procedure 2001-6 in Internal Revenue Bulletin
2001-1
- Announcement 2001-77 in Internal Revenue Bulletin
2001-30.
Deduction Limit
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.
Defined contribution plans.
The deduction limit for a defined contribution plan depends on
whether it is a profit-sharing plan or a money purchase pension plan.
Profit-sharing plan.
Your deduction for contributions to a profit-sharing plan cannot be
more than 15% 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.
Money purchase pension plan.
Your deduction for contributions to a money purchase pension plan
is generally limited to 25% of the compensation paid during the year
to a participating eligible employee. You must reduce this limit in
figuring the deduction for contributions you make for yourself, as
discussed later.
Defined benefit plans.
An actuary must figure the deduction for contributions to a defined
benefit plan since 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 profit-sharing plan, your deduction for
yourself is limited to the lesser of $35,000 or 13.0435% (15% reduced
as discussed later) of your net earnings from the trade or business
that has the plan. If the plan is a money purchase pension plan, the
deduction is limited to the lesser of $35,000 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 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
Partners under Who Must Pay 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
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 $170,000 of your
compensation in figuring your contribution to a defined contribution
plan.
Figuring Your Deduction
Use the following worksheet to find the reduced contribution rate
for yourself. Make no reduction to the contribution rate for any
common-law employees.
Rate Worksheet for Self-Employed
| 1) |
Plan contribution rate as a
decimal (for example, 10 1/2% = .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) |
|
Now that you have figured your self-employed rate, you can figure
your maximum deduction for contributions for yourself by completing
the following steps.
Deduction Worksheet for Self-Employed
| Step 1 |
|
| Enter the
rate shown on line 3 above |
|
| Step 2 |
|
| Enter your
net earnings (net profit) from line 31, Schedule C (Form 1040); line
3, Schedule C-EZ (Form 1040); line 36, Schedule F (Form 1040);
or line 15a, Schedule K-1 (Form 1065) |
|
| Step 3 |
|
| Enter your
deduction for self-employment tax from line 27, Form 1040 |
|
| Step 4 |
|
| Subtract
step 3 from step 2 and enter the result |
|
| Step 5 |
|
| Multiply
step 4 by step 1 and enter the result |
|
| Step 6 |
|
| Multiply
$170,000 by your plan contribution rate. Enter the result, but not
more than $35,000 |
|
| Step 7 |
|
| Enter the
lesser of step 5 or step 6. This is your maximum deductible
contribution. Enter your deduction on line 29, Form 1040 |
|
Example.
You are a self-employed farmer and you have employees. The terms of
your plan provide that you contribute 8 1/2% (.085) of
your compensation (defined earlier) and 8 1/2% of your
participants' compensation. Your net earnings from line 36, Schedule F
(Form 1040) are $200,000. In figuring this, you deducted your
participants' pay of $100,000 and contributions for them of $8,500 (8 1/2% x $100,000). You figure your self-employed rate and
maximum deduction for contributions on behalf of yourself as follows.
Rate Worksheet for Self-Employed
| 1) |
Plan contribution rate as a
decimal (for example, 10 1/2% = .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 |
Deduction Worksheet for Self-Employed
| Step 1 |
|
| Enter the
rate shown on line 3 above |
0.078 |
| Step 2 |
|
| Enter your
net earnings (net profit) from line 31, Schedule C (Form 1040); line
3, Schedule C-EZ (Form 1040); line 36, Schedule F (Form 1040);
or line 15a, Schedule K-1 (Form 1065) |
$200,000 |
| Step 3 |
|
| Enter your
deduction for self-employment tax from line 27, Form 1040 |
7,663 |
| Step 4 |
|
| Subtract
step 3 from step 2 and enter the result |
192,337 |
| Step 5 |
|
| Multiply
step 4 by step 1 and enter the result |
15,002 |
| Step 6 |
|
| Multiply
$170,000 by your plan contribution rate. Enter the result but not more
than $35,000 |
14,450 |
| Step 7 |
|
| Enter the
lesser of step 5 or step 6. This is your maximum deductible
contribution. Enter your deduction on line 29, Form 1040 |
$
14,450 |
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.
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