Without a doubt, establishing and maintaining retirement benefits are important for all of your business owner clients. Fortunately, we practitioners now have greater options than ever before to help our clients. Current customized specialty programs are more efficient, provide greater benefits and are now possible since the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 followed by the Pension Protection Act. When done correctly, these plans can reduce taxes and provide future benefits. If done incorrectly, they may bring IRS scrutiny, among other problems. To avoid unwanted issues, you may want to consider some of the following plans available to business clients.
Qualified Retirement Plans; Qualified retirement plans are particularly suitable for small business owners who are in high-income tax brackets because they are fully deductible from ordinary income taxes to the business owner. This may also serve as a solution to the looming Alternative Minimum Tax (AMT) issue because they are not a tax-preference item.
Cash Balance Plans; Cash balance plans have been used to reduce the cost of employee benefits and can now be capitalized on to a greater extent since the passing of the Pension Protection Act. Cash balance plans offer employers advantages not available with other qualified plans. For example, small business owners can make large defined benefit-sized contributions with small 401(k)-sized costs for the employees. They can be used when employee cost is too large to make a traditional defined benefit plan appealing to the owner(s). When designed properly, the owner(s) contributions can exceed $100,000 per year and can even exceed their salary. A cash balance plan can be combined with a 401(k). A properly designed cash balance plan can make 90 percent of the contributions and benefits available to the owner(s) and/or preferred participants.
Self-employed Individual and Partnership Plans; Self-employed individuals and partnerships consisting of only owners and their spouses (i.e., no common law, non-owner employees) should consider the Micro (K) ®. For example, a one person S Corporation in which the sole owner has $116,000 of compensation paid on IRS Form W-2 can receive 25 percent of eligible payroll as an employer deductible contribution. Then the owner, as an employee, can defer salary up to $15,000 (2006 limit). Consequently, a W-2 $116,000 salary results in an allowable deductible contribution of $44,000. The calculation for a business entity that is not taxed as a corporation (no W-2 compensation) is not so simple, but the results are somewhat similar. This plan can also make life insurance tax deductible, if desired. Additionally, up to $50,000 can be borrowed from the plan.
Small Business Plans; Many small business clients have used a SEP-IRA or basic profit sharing plan for their retirement needs due to the simplicity and low cost of these designs. However, recent favorable tax law changes have made these designs less effective. Worse yet, if you have any eligible employees, these may be among the most expensive plans to fully fund. A Dash 401(k) is a much better alternative. One of the many benefits is a substantially lower employee cost. Unlike a SEP-IRA, a Dash 401(k) will allow you to borrow up to $50,000 from the plan. This allows a business owner to make the greatest possible contribution without tying up all of his money until retirement. The plan allows life insurance to be deducted, if it is needed. The Dash 401(k) is flexible.
For example, a business owner with a $100,000 W-2 wage has a staff member earning $40,000 in W-2 income while another staff member earns $25,000 in W-2 income. The Dash 401(k) would allow the owner a contribution of $45,000, while the workers’ contributions would be $2,000 and $1,250, respectively. This is a great way to maximize your business clients’ income and retirement security potential.
Additional Plan Options – If your client has a C Corporation and wants to get money out while obtaining a deduction, a §162 executive bonus plan could be considered. With this option money taken out of the corporation is a deduction. The plan can be discriminatory and the money can take the form of a bonus to the owner and/or key executive.
With these or any other type of plans, business owners must be careful when choosing a tax advisor. We are constantly called to help when a business owner runs into trouble. Many investment providers have entered the market with little emphasis on administration. A document may be provided, but no effort is made to monitor the calculation of allowable contributions. In addition, there is no built-in method for dealing with non-owner common law employees who are hired, or are improperly excluded because they are considered part-time or independent contractors. Many plans, especially 401(k) and profit sharing plans, quickly run unfavorably for reasons such as:
• Improperly excluded part-time employees.
• Improperly timed salary deferral elections and deposits
• Incorrectly calculated profit sharing contributions
• Incorrectly calculated loan amounts.
• Improperly managed loan repayment schedules.
• Incorrectly calculated incidental life insurance premiums.
• Improperly timed salary deferral elections and deposits.
• Improperly excluded newly eligible non-owner participants.
• Failure to make top-heavy minimum contributions.
The IRS, Department of Labor, and other regulators have increased enforcement and penalties. Some popular plans currently being sold are considered potentially abusive tax shelters, even putting the accountant at risk for penalties.
Remember, the time to handle potential problems is before they happen.