US Internal Revenue Service: p560--1999

8/14/2019 US Internal Revenue Service: p560--1999

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ContentsImportant Changes for 1999 ............. 1

Important Reminders ......................... 2

Introduction ........................................ 2

Definitions You Need To Know ........ 3

Simplified Employee Pension (SEP) 5

Setting Up a SEP ........................... 5

How Much Can I Contribute? ......... 5How Much Can I Deduct? .............. 6Salary Reduction Simplified

Employee Pension (SARSEP) . 6Distributions (Withdrawals) ............. 7Additional Taxes ............................. 7Reporting and Disclosure

Requirements ........................... 8

SIMPLE Plans ..................................... 8SIMPLE IRA Plan ........................... 8SIMPLE 401(k) Plan ....................... 10

Qualified Plans (Keogh Plans) .......... 10Kinds of Plans ................................. 10Setting Up a Qualified Plan ............ 10

Minimum Funding Requirements .... 11Contributions ................................... 11Employer Deduction ....................... 12Elective Deferrals (401(k) Plans) .... 13Distributions .................................... 14Prohibited Transactions .................. 15Reporting Requirements ................. 16Qualification Rules .......................... 16

AppendixRate Table, RateWorksheet, and DeductionWorksheet for Self-EmployedIndividuals With Qualified or SEPPlans ............................................. 18

How To Get More Information .......... 20

Index .................................................... 21

Important Changesfor 1999Hardship distributions are not eligiblerollover distributions. Certain hardshipdistributions from a 401(k) plan or tax-sheltered annuity plan (section 403(b) plan)that occur after 1998 cannot be rolled overinto an IRA or other eligible retirement plan.They are subject to the 10% additional tax onpremature distributions. However, they arenot subject to the 20% withholding tax thatgenerally applies to eligible rollover distribu-tions that are not transferred directly to an-other retirement plan or IRA.

The IRS has made application of this newrule optional for 1999. For more information,see Notice 995 in Internal Revenue BulletinNo. 19993.

Safe harbor 401(k) plans. Beginning in1999, a 401(k) plan under which participantsreceive a certain level of matching or none-lective contributions does not have to passthe special nondiscrimination tests that applyto elective deferrals and matching contribu-tions. For more information, see Notice9852 in Internal Revenue Bulletin No.199846.

Departmentof theTreasury

InternalRevenueService

Publica tion 560Cat. No. 46574N

RetirementPlansfor Sma llBusiness(SEP, SIMPLE, andKeogh Plans)

For use in preparing

1999Returns


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Important RemindersRepeal of a salary reduction arrangementunder a SEP (SARSEP). You may no longerset up a salary reduction simplified employeepension (SARSEP) plan. However, if youhave employees who are participants (in-cluding new participants), defined under De-finitions You Need To Know, in a SARSEPthat was set up before 1997, the employeescan continue to have you contribute part oftheir pay to the plan.

Plan amendments required by changes inthe law. If you must revise your qualified planto conform to recent legislation, you may

choose to get a determination letter from theIRS approving the revision. Generally, masterand prototype plans are amended by spon-soring organizations. However, there are in-stances when you may need to request adetermination letter regarding a master orprototype plan that is a nonstandardized planthat you maintain. Your request should bemade on the appropriate form (generallyForm 5300, or Form 5307 for a master orprototype plan). The request should be filedwith Form 8717, User Fee for Employee PlanDetermination Letter Request, and the ap-propriate user fee.

You may have to amend your plan tocomply with tax law changes made by thefollowing laws.

Uruguay Round Agreements Act, PublicLaw 103465.

Small Business Job Protection Act of1996, Public Law 104188.

Taxpayer Relief Act of 1997, Public Law10534.

Internal Revenue Service Restructuringand Reform Act of 1998, Public Law105206.

You need to make these amendments on orbefore the last day of the first plan year be-ginning after 1999.

IntroductionThis publication discusses retirement plansthat you can set up and maintain for yourselfand your employees. In this publication,you refers to the employer. See DefinitionsYou Need To Know, later. It covers the fol-lowing types of retirement plans.

SEP (Simplified Employee Pension)plans.

SIMPLE (Savings Incentive Match Planfor Employees) plans.

Qualified plans (also called H.R. 10 plansor Keogh plans when covering self-employed individuals).

SEP, SIMPLE, and qualified plans offeryou and your employees a tax favored wayto save for retirement. You can deduct con-tributions you make to the plan for your em-ployees. If you are a sole proprietor, you candeduct contributions you make to the plan foryourself. You can also deduct trustees' feesif contributions to the plan do not cover them.Earnings on the contributions are generallytax free until you or your employees receivedistributions from the plan in later years.

Under some plans, employees can haveyou contribute limited amounts of theirbefore-tax pay to a plan. These amounts (andearnings on them) are generally tax free untilyour employees receive distributions from theplan in later years.

What this publication covers. This publi-cation contains the information you need tounderstand the following topics.

What type of plan to set up.

How to set up a plan.

How much you can contribute to a plan.

How much of your contribution isdeductible.

How to treat certain distributions. How to report information about the plan

to the IRS and your employees.

Basic features of retirement plans. Somebasic features of SEP, SIMPLE, and qualifiedplans are discussed below. The key rules forSEP, SIMPLE, and qualified plans are out-lined in Table 1.

SEP plan. SEPs provide a simplifiedmethod for you to make contributions to aretirement plan for your employees. Insteadof setting up a profit-sharing or money pur-chase plan with a trust, you can adopt a SEPagreement and make contributions directly toa traditional individual retirement account ora traditional individual retirement annuity(SEP-IRA) set up for each eligible employee.

SIMPLE plan. A SIMPLE plan can be setup by an employer who had 100 or feweremployees who earned at least $5,000 incompensation for the preceding calendar yearand meets certain other requirements. Undera SIMPLE plan, employees can choose tomake salary reduction contributions ratherthan receiving these amounts as part of theirregular pay. In addition, you will contributematching or nonelective contributions. Thetwo types of SIMPLE plans are the SIMPLEIRA plan and the SIMPLE 401(k) plan.

Qualified plan. The qualified plan rulesare more complex than the SEP plan andSIMPLE plan rules. However, there are someadvantages available to qualified plans, such

as the special tax treatment that may applyto qualified plan lump-sum distributions.

What is not covered in this publication.Although the purpose of this publication is toprovide general information about retirementplans that an employer (including a sole pro-prietor) can set up for its employees, thispublication does not contain all of the rulesand exceptions that apply to these plans. Youmay also need professional help and guid-ance.

Also, this publication does not cover all therules that may be of interest to employees.For example, it does not cover the followingtopics.

The comprehensive IRA rules an em-ployee needs to know. These rules arecovered in Publication 590, IndividualRetirement Arrangements (IRAs) (Includ-ing Roth IRAs and Education IRAs).

The comprehensive rules that apply todistributions from retirement plans. Theserules are covered in Publication 575,Pension and Annuity Income.

Useful ItemsYou may want to see:

Publications

535 Business Expenses

575 Pension and Annuity Income

590 Individual Retirement Arrange-ments (IRAs) (Including RothIRAs and Education IRAs)

Forms (and Instructions)

W2 Wage and Tax Statement

1099R Distributions From Pensions,

Annuities, Retirement or Profit-Sharing Plans, IRAs, InsuranceContracts, etc.

5304SIMPLE Savings Incentive MatchPlan for Employees of Small Em-ployers (SIMPLE) (Not Subject tothe Designated Financial Institu-tion Rules)

5305SEP Simplified EmployeePension-Individual RetirementAccounts Contribution Agreement

5305ASEP Salary Reduction and OtherElective Simplified EmployeePension-Individual RetirementAccounts Contribution Agreement

5305SIMPLE Savings Incentive MatchPlan for Employees of Small Em-ployers (SIMPLE) (for Use With aDesignated Financial Institution)

5329 Additional Taxes Attributable toIRAs, Other Qualified RetirementPlans, Annuities, Modified En-dowment Contracts, and MSAs

5330 Return of Excise Taxes Relatedto Employee Benefit Plans

5500EZ Annual Return of One-Participant (Owners and TheirSpouses) Retirement Plan

Help from the Internal Revenue Service

(IRS). See How To Get More Informationnear the end of this publication for informationabout getting publications and forms. Addi-tionally, for further information, contact em-ployee plans taxpayer assistance telephoneservice between the hours of 1:30 p.m. and3:30 p.m. Eastern Time, Monday throughThursday at (202) 6226074/6075. (Theseare not toll-free numbers.) Or you can callcustomer service at 18778295500 (toll-free) from 8:00 a.m. to 4:30 p.m. EasternTime, Monday through Friday.

Note: All references to section in thefollowing discussions are to sections of theInternal Revenue Code (which can be foundat most libraries) unless otherwise indicated.

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Table 1. Key Retirement Plan Rules

Due date of employersreturn (includingextensions).

TypeofPlan

Maximum Contribution Maximum Deduction

Same as maximum

contribution.

Smaller of $30,000 or 15%1of

participants compensation.2

Last Date forContribution

Due date of employersreturn (includingextensions).

Defined Contribution PlansDefined Contribution Plans

Money Purchase: Smaller of $30,000 or25%

1of participants compensation.

2

SEP

Qualified

Profit-Sharing: Smaller of $30,000 or25%

1of participants compensation.

2

Defined Benefit Plans

Amount needed to provide an annualbenefit no larger than the smaller of

$130,000 or 100% of the participantsaverage taxable compensation for his orher highest 3 consecutive years.

1Net earnings from self-employment must take the contribution into account.

2Compensation is generally limited to $160,000.

3Does not apply to SIMPLE 401(k) plans. The deadline for qualified plans applies instead.

Elective employer

contributions: 30 daysfollowing the end of themonth with respect towhich the contributionsare to be made.

3

Employee: Salary reduction contribution,

up to $6,000.

SIMPLE

IRAandSIMPLE401(k)

Matching contributionsor nonelectivecontributions: Due dateof employers return(including extensions).

Employer contribution: Eitherdollar-for-dollar matching contributions,up to 3% of employees compensation,

4

orfixed nonelective contributions of 2%of compensation.

2

15% of all participantscompensation

2excluding

SEP contributions.

When To Set Up Plan

Any time between 1/1

and 10/1 of the calendaryear.

By the end of the taxyear.

For a new employercoming into existenceafter 10/1, as soon asadministratively feasible.

Any time up to due dateof employers return(including extensions).

Same as maximumcontribution.

Money Purchase: Sameas maximumcontribution.

Profit-Sharing: 15% ofall participantscompensation excludingplan contributions.

2

Defined Benefit Plans

Based on actuarialassumptions and

computations.

Note: For a definedbenefit plan subject tominimum fundingrequirements,contributions are due inquarterly installments.See Minimum FundingRequirementsunderQualified Plans (KeoghPlans).

4Under a SIMPLE 401(k) plan, compensation is generally limited to $160,000.

DefinitionsYou Need To KnowSome of the terms used in this publication aredefined below. The same term used in an-

other publication may have a slightly differentmeaning.

Annual additions. Annual additions are thetotal amounts of all your contributions in ayear, employee contributions (not includingrollovers), and forfeitures allocated to a par-ticipant's account.

Annual benefits. Annual benefits are thebenefits to be paid yearly in the form of astraight life annuity (with no extra benefits)under a plan to which employees do notcontribute and under which no rollover con-tributions are made.

Business. A business is an activity in whicha profit motive is present and some type ofeconomic activity is involved. Service as anewspaper carrier under age 18 is not abusiness, but service as a newspaper dealeris. Service as a sharecropper under anowner-tenant arrangement is a business.Service as a public official is not.

Common-law employee. A common-lawemployee is any individual who, under com-mon law, would have the status of an em-ployee. A leased employee can also be acommon-law employee.

A common-law employee is a person whoperforms services for an employer who hasthe right to control and direct both the resultsof the work and the way in which it is done.For example, the employer:

Provides the employee's tools, materials,and workplace, and

Can fire the employee.

Common-law employees are not self-employed and cannot set up retirement planswith respect to income from their work, evenif that income is self-employment income forsocial security tax purposes. For example,common-law employees who are ministers,members of religious orders, full-time insur-ance salespeople, and U.S. citizens em-

ployed in the United States by foreign gov-ernments cannot set up retirement plans withrespect to their earnings from those employ-ments, even though their earnings are treatedas self-employment income.

However, a common-law employee canbe self-employed as well. For example, anattorney can be a corporate common-lawemployee during regular working hours andalso practice law in the evening as a self-employed person. In another example, aminister employed by a congregation for asalary is a common-law employee eventhough the salary is treated as self-employ-ment income for social security tax purposes.

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However, fees reported on Schedule C (Form1040) for performing marriages, baptisms,and other personal services are self-employ-ment earnings for qualified plan purposes.

Compensation. Compensation for plan allo-cations is the pay a participant received fromyou for personal services for a year. You cangenerally define compensation as includingall the following payments.

1) Wages and salaries.

2) Fees for professional services.

3) Other amounts received (cash or non-cash) for personal services actually ren-dered by an employee, including, but notlimited to, the following items.

a) Commissions and tips.

b) Fringe benefits.

c) Bonuses.

For a self-employed individual, compen-sation means the earned income, discussedlater, of that individual.

Compensation also includes amounts de-ferred in the following employee benefit plans,

unless you choose not to include any amountcontributed under a salary reduction agree-ment (that is not included in the gross incomeof the employee).

Qualified cash or deferred arrangement(section 401(k) plan).

Salary reduction agreement to contributeto a tax-sheltered annuity (section 403(b)plan), a SIMPLE IRA plan, or a SARSEP.

Section 457 nonqualified deferred com-pensation plan.

Section 125 cafeteria plan.

The limit on elective deferrals is discussedlater under Salary Reduction Simplified Em-

ployee Pension (SARSEP) and QualifiedPlans (Keogh Plans).Other options. In figuring the compen-

sation of a participant, you can treat any ofthe following amounts as the employee'scompensation.

The employee's wages as defined for in-come tax withholding purposes.

The employee's wages that you report inbox 1 of Form W2.

The employee's social security wages(including elective deferrals).

Compensation generally cannot includeeither of the following items.

Reimbursements or other expense al-lowances (unless paid under a nonac-countable plan).

Deferred compensation (either amountsgoing in or amounts coming out), otherthan certain elective deferrals, unless youchoose not to include those electivedeferrals in compensation.

Contribution. A contribution is an amountyou pay into a plan for all those (includingself-employed individuals) participating in theplan. Limits apply to how much, under thecontribution formula of the plan, can be con-tributed each year for a participant.

Deduction. A deduction is the amount of plancontributions you can subtract from gross in-come on your federal income tax return.Limits apply to the amount deductible.

Earned income. Earned income is netearnings from self-employment, discussedlater, from a business in which your servicesmaterially helped to produce the income.

You can also have earned income fromproperty that your personal efforts helpedcreate, such as books or inventions on which

you earn royalties. Earned income includesnet earnings from selling or otherwise dis-posing of the property, but it does not includecapital gains. It includes income from licens-ing the use of property other than goodwill.

If you have more than one business, butonly one has a retirement plan, only theearned income from that business is consid-ered for that plan.

Employer. An employer is generally anyperson for whom an individual performs or didperform any service, of whatever nature, asan employee. A sole proprietor is treated ashis or her own employer for retirement planpurposes, and a partnership is the employerof each partner. A partner is not an employer

for retirement plan purposes.

Highly compensated employees. Highlycompensated employees are individuals who:

Owned more than 5% of the capital orprofits in your business at any time duringthe year or the preceding year, or

For the preceding year, received com-pensation from you of more than $80,000and, if you so choose, was in the top 20%of employees when ranked by compen-sation.

Leased employee. A leased employee whois not your common-law employee must gen-

erally be treated as your employee for retire-ment plan purposes if he or she does all thefollowing.

Provides services to you under anagreement between you and a leasingorganization.

Has performed services for you (or foryou and related persons) substantially fulltime for at least 1 year.

Performs services under your primary di-rection or control.

Exception. A leased employee is nottreated as your employee if the employee iscovered by the leasing organization under its

qualified pension plan and leased employeesare not more than 20% of your nonhighlycompensated work force. The leasing organ-ization's plan must be a money purchasepension plan that has all the following pro-visions.

Immediate participation.

Full and immediate vesting.

A nonintegrated employer contributionrate of at least 10% of compensation foreach participant.

However, if the leased employee is yourcommon-law employee, that employee will be

your employee for all purposes, regardlessof any pension plan of the leasing organiza-tion.

Net earnings from self-employment. ForSEP and qualified plans, net earnings fromself-employment is your gross income fromyour trade or business (provided your per-sonal services are a material income-producing factor) minus allowable deductionsfor your business. Allowable deductions in-clude contributions to SEP and qualified plans

for common-law employees and the de-duction allowed for one-half of your self-employment tax.

Net earnings from self-employment do notinclude items that are excluded from grossincome (or their related deductions) otherthan foreign earned income and foreignhousing cost amounts.

For the deduction limits, earned income isnet earnings for personal services actuallyrendered to the business. You take into ac-count the income tax deduction for one-halfof self-employment tax and the deduction forcontributions to the plan made on your behalfwhen figuring net earnings.

Net earnings include a partner's distribu-tive share of partnership income or loss (other

than separately stated items, such as capitalgains and losses). It does not include incomepassed through to shareholders of S corpo-rations. Guaranteed payments to limitedpartnersare net earnings from self-employ-ment if they are paid for services to or for thepartnership. Distributions of other income orloss to limited partners are not net earningsfrom self-employment.

For SIMPLE plans, net earnings fromself-employment is the amount on line 4 ofShort Schedule SE (Form 1040) before sub-tracting any contributions made to theSIMPLE IRA plan for yourself.

Participant. A participant is an eligible em-ployee who is covered by your retirement

plan. See the discussions of the differenttypes or plans for the definition of an em-ployee eligible to participate in the plan.

Partner. A partner is an individual who sharesownership of an unincorporated trade orbusiness with one or more persons. For re-tirement plans, a partner is treated as anemployee of the partnership.

Self-employed individual. An individual inbusiness for himself or herself is self-employed. Sole proprietors and partners areself-employed. Self-employment can includepart-time work.

Not everyone who has net earnings from

self-employment for social security tax pur-poses is self-employed for qualified plan pur-poses. See Common-law employee, earlier.Also see Net earnings from self-employment.

In addition, certain fishermen may beconsidered self-employed for setting up aqualified plan. See Publication 595, TaxHighlights for Commercial Fishermen, for thespecial rules that are used to determinewhether fishermen are self-employed.

Sole proprietor. A sole proprietor is an in-dividual who owns an unincorporated busi-ness by himself or herself. For retirementplans, a sole proprietor is treated as both anemployer and an employee.

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Simplified EmployeePension (SEP)A simplified employee pension (SEP) is awritten plan that allows you to make contri-butions toward your own (if you are self-employed) and your employees' retirementwithout getting involved in the more complexqualified plan. But, some advantages avail-able to qualified plans, such as the special taxtreatment that may apply to qualified planlump-sum distributions, do not apply to SEPs.

Under a SEP, you make the contributionsto a traditional individual retirement arrange-ment (called a SEP-IRA) set up by or for eacheligible employee. SEP-IRAs are owned andcontrolled by the employee, and you makecontributions to the financial institution wherethe SEP-IRA is maintained.

SEP-IRAs are set up for, at a minimum,each eligible employee (defined later). ASEP-IRA may have to be set up for a leasedemployee (defined earlier under DefinitionsYou Need To Know), but does not need tobe set up for excludable employees(definedlater).

Eligible employee. An eligible employee is

an individual who has:

Reached age 21,

Worked for you in at least 3 of the last 5years, and

Received at least $400 in compensationfrom you for 1999.

TIPYou can use less restrictive partici-pation requirements than those listed,but not more restrictive ones.

Excludable employees. The following em-ployees can be excluded from coverage un-der a SEP.

Employees who are covered by a unionagreement and whose retirement benefitswere bargained for in good faith by theirunion and you.

Nonresident alien employees who haveno U.S.-source wages, salaries, or otherpersonal services compensation fromyou. For more information about non-resident aliens, see Publication 519, U.S.Tax Guide for Aliens.

Setting Up a SEPThere are three basic steps in setting up aSEP.

1) You must execute a formal writtenagreement to provide benefits to all eli-gible employees.

2) You must give each eligible employeecertain information about the SEP.

3) A SEP-IRA must be set up by or for eacheligible employee.

TIPMany financial institutions will helpyou set up a SEP.

Formal written agreement. You must exe-cute a formal written agreement to providebenefits to all eligible employees under aSEP. You can satisfy the written agreementrequirement by adopting an IRS model SEP

using Form 5305SEP. However, see Whennot to use Form 5305SEP, later.

If you adopt an IRS model SEP usingForm 5305SEP, no prior IRS approval ordetermination letter is required. Keep the ori-ginal form. Do not file it with the IRS. Also,using Form 5305SEP will usually relieve youfrom filing annual retirement plan informationreturns with the IRS and the Department ofLabor. See the Form 5305SEP instructionsfor details.

When not to use Form 5305SEP. Youcannot use Form 5305SEP if any of the fol-lowing apply.

You currently maintain any other qualifiedretirement plan. This does not preventyou from maintaining another SEP.

You have maintained a defined benefitplan (defined later under Qualified Plans(Keogh Plans)), even if it is now termi-nated.

You have any eligible employees forwhom IRAs have not been set up.

You use the services of leased employ-ees(as described earlier under Defi-nitions You Need to Know).

You are a member of an affiliated service

group (as described in section 414(m)),a controlled group of corporations (asdescribed in section 414(b)), or trades orbusinesses under common control (asdescribed in section 414(c)), unless alleligible employees of all the members ofthese groups, trades, or businesses par-ticipate under the SEP.

You do not pay the cost of the SEP con-tributions.

Information you must give to employees.You must give each eligible employee a copyof Form 5305SEP, its instructions, and theother information listed in the Form5305SEP instructions. An IRS model SEPis not considered adopted until you give each

employee this information.

Setting up the employee's SEP-IRA. ASEP-IRA must be set up by or for each eligi-ble employee. SEP-IRAs can be set up withbanks, insurance companies, or other qual-ified financial institutions. You send SEPcontributions to the financial institution wherethe SEP-IRA is maintained.

Deadline for setting up a SEP. You can setup a SEP for a year as late as the due date(including extensions) of your income tax re-turn for that year.

How Much

Can I Contribute?The SEP rules permit you to contribute alimited amount of money each year to eachemployee's SEP-IRA. If you are self-employed, you can contribute to your ownSEP-IRA. Contributions must be in the formof money (cash, check, or money order). Youcannot contribute property. However, partic-ipants may be able to transfer or roll overcertain property from one retirement plan toanother. See Publication 590 for more infor-mation about rollovers.

You do not have to make contributionsevery year. But if you make contributions,they must be based on a written allocationformula and must not discriminate in favor of

highly compensated employees (defined ear-lier under Definitions You Need To Know).When you contribute, you must contribute tothe SEP-IRAs of all participants who actuallyperformed personal services during the yearfor which the contributions are made, evenemployees who die or terminate employmentbefore the contributions are made.

The contributions you make under a SEPare treated as if made to a qualified pension,stock bonus, profit-sharing, or annuity plan.Consequently, contributions are deductiblewithin limits, as discussed later, and generallyare not taxable to the plan participants.

A SEP-IRA cannot be designated as aRoth IRA. Employer contributions to aSEP-IRA will not affect the amount that anindividual can contribute to a Roth IRA.

Time limit for making contributions. Todeduct contributions for a year, you mustmake the contributions by the due date (in-cluding extensions) of your tax return for theyear.

Contribution LimitsContributions you make for a year to a com-mon-law employee's SEP-IRA cannot bemore than the smaller of 15% of the employ-

ee's compensation or $30,000. Compen-sation generally does not include your contri-butions to the SEP. However, if you have asalary reduction arrangement, see Employeecompensation under Salary Reduction Sim-plified Employee Pension (SARSEP), later.

Example. Your employee, Mary Plant,earned $21,000 for the year. The maximumcontribution you can make to her SEP-IRA is$3,150 (15% x $21,000).

Contributions for yourself. The annuallimits on your contributions to a common-lawemployee's SEP-IRA also apply to contribu-tions you make to your own SEP-IRA. How-ever, special rules apply when figuring yourmaximum deductible contribution. See De-duction Limit for Self-Employed Individuals,later.

Annual compensation limit. You cannotconsider the part of an employee's compen-sation that is over $160,000 when figuringyour contribution limit for that employee.Therefore, $24,000 is the maximum contribu-tion amount for an eligible employee whosecompensation is $160,000 or more.

More than one plan. If you contribute to adefined contribution plan (defined later underQualified Plans (Keogh Plans)), annual addi-tions to an account are limited to the lesserof $30,000 or 25% of the participant's com-pensation. When you figure this limit, youmust add your contributions to all definedcontribution plans. Because a SEP is consid-ered a defined contribution plan for this limit,your contributions to a SEP must be addedto your contributions to other defined contri-bution plans.

Tax treatment of excess contributions.Excess contributions are your contributions toan employee's SEP-IRA (or to your ownSEP-IRA) for a year that are more than thelesser of the following amounts.

15% of the employee's compensation (or,for you, 13.0435% of your net earningsfrom self-employment).

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$30,000.

Excess contributions are included in the em-ployee's income for the year and are treatedas contributions by the employee to his or herSEP-IRA. For more information on employeetax treatment of excess contributions, seechapter 4 in Publication 590.

Reporting on Form W2. Do not includeSEP contributions on your employee's FormW2, Wage and Tax Statement, unless con-tributions were made under a salary reductionarrangement (discussed later).

How Much Can I Deduct?Generally, you can deduct the contributionsyou make each year to each employee'sSEP-IRA. If you are self-employed, you candeduct the contributions you make each yearto your own SEP-IRA.

Deduction Limitfor Your Contributionson Behalf of EmployeesThe most you can deduct for your contribu-tions for participants is the lesser of the fol-lowing amounts.

Your contributions (including any electivedeferrals and excess contributionscarryover).

15% of the compensation (limited to$160,000 per participant) paid to themduring the year from the business thathas the plan.

Deduction Limit forSelf-Employed IndividualsIf you contribute to your own SEP-IRA, youneed to make a special computation to figureyour maximum deduction for these contribu-tions. When figuring the deduction for contri-

butions made to your own SEP-IRA, com-pensation is your net earnings fromself-employment (defined under DefinitionsYou Need To Know), which takes into ac-count both the following deductions.

The deduction for one-half of your self-employment tax.

The deduction for contributions to yourown SEP-IRA.

The deduction for contributions to yourown SEP-IRA and your net earnings dependon each other. For this reason, you determinethe deduction for contributions to your ownSEP-IRA indirectly by reducing the contribu-tion rate called for in your plan. To do this,use the Rate Table for Self-Employedor theRate Worksheet for Self-Employed, which-ever is appropriate for your plan's contributionrate, in the Appendix. Then figure your maxi-mum deduction by using the DeductionWorksheet for Self-Employed in the Appen-dix.

Deduction Limitsfor Multiple PlansFor the deduction limits, treat all of yourqualified defined contribution plans as a sin-gle plan and all of your qualified definedbenefit plans as a single plan. See Kinds ofPlans, later under Qualified Plans (KeoghPlans) for the definitions of defined contribu-

tion plans and defined benefit plans. If youhave both kinds of plans, a SEP is treated asa separate profit-sharing (defined contribu-tion) plan. A qualified planis a plan that meetsthe requirements discussed later underQualification Rules. For information about thespecial deduction limits, see Deduction limitfor multiple plans under Qualified Plans(Keogh Plans), later.

SEP and profit-sharing plans. If you alsocontribute to a qualified profit-sharing plan,you must reduce the 15% deduction limit forthat profit-sharing plan by the allowable de-duction for contributions to the SEP-IRAs ofthose participating in both the SEP plan andthe profit-sharing plan.

Carryover ofExcess SEP ContributionsIf you made SEP contributions in excess ofthe deduction limit (nondeductible contribu-tions), you can carry over and deduct the ex-cess in later years. However, the excesscontributions carryover, when combined withthe contribution for the later year, cannot bemore than the deduction limit for that year. Ifyou also contributed to a defined benefit planor defined contribution plan, see Carryover

of Excess Contributions, under QualifiedPlans (Keogh Plans), later, for the carryoverlimit.

Excise tax. If you made nondeductible (ex-cess) contributions to a SEP, you may besubject to a 10% excise tax. For informationabout the excise tax, see Excise Tax forNondeductible (Excess) Contributions underQualified Plans (Keogh Plans), later.

When To Deduct ContributionsWhen you can deduct contributions made fora year depends on the tax year on which theSEP is maintained.

If the SEP is maintained on a calendaryear basis, you deduct contributionsmade for a year on your tax return for theyear with or within which the calendaryear ends.

If you file your tax return and maintain theSEP using a fiscal year or short tax year,you deduct contributions made for a yearon your tax return for that year.

Where To Deduct ContributionsDeduct contributions for yourself on line 29of Form 1040. You deduct contributions foryour employees on Schedule C (Form 1040),on Schedule F (Form 1040), on Form 1120S,or on Form 1065, whichever applies to you.

If you are a partner, the partnershippasses its deduction to you for the contribu-tions it made for you. The partnership will re-port these contributions on Schedule K1(Form 1065). You deduct the contributionson line 29 of Form 1040.

Salary ReductionSimplified EmployeePension (SARSEP)A SARSEP is a SEP set up before 1997thatincludes a salary reduction arrangement.(See the Caution, next). Under a SARSEP,your employees can choose to have youcontribute part of their pay to their SEP-IRAs.

The income tax on the part contributed isdeferred. This choice is called an electivedeferral, which remains tax free until distrib-uted (withdrawn).

CAUTION

!You are not allowed to set up aSARSEP after 1996. However, par-ticipants (including employees hired

after 1996) in a SARSEP that was set upbefore 1997 can continue to have you con-tribute part of their pay to the plan. If you areinterested in setting up a retirement plan thatincludes a salary reduction arrangement, see

SIMPLE Plans, later.

Who can have a SARSEP? A SARSEP thatwas set up before 1997 is available to youand your eligible employees only if all thefollowing requirements are met.

At least 50% of your employees eligibleto participate choose the salary reductionarrangement.

You have 25 or fewer employees whowere eligible to participate in the SEP (orwould have been eligible to participate ifyou had maintained a SEP) at any timeduring the preceding year.

The SEP meets the SARSEP ADP test.

SARSEP ADP test. Under the ADP test,the amount deferred each year by each eligi-ble highly compensated employee as a per-centage of pay (the deferral percentage)cannot be more than 125% of the averagedeferral percentage (ADP) of all other em-ployees eligible to participate. A highly com-pensated employee is defined earlier underDefinitions You Need To Know.

Deferral percentage. The deferral per-centage for an employee for a year is figuredas follows.

The amount of elective employercontributions paid to the SEP for the

employee for the year

The employees compensation(limited to $160,000)

Who cannot have a SARSEP? A state orlocal government or any of its political subdi-visions, agencies, or instrumentalities, or atax-exempt organization cannot have a SEPthat includes a salary reduction arrangement.

Limits on Elective DeferralsThe most a participant can choose to deferfor calendar year 1999 is the lesser of thefollowing amounts.

15% of the participant's compensation(limited to $160,000 of the participant'scompensation).

$10,000.

The $10,000 limit applies to the totalelective deferrals the employee makes for theyear to a SEP and any of the following.

Cash or deferred arrangement (section401(k) plan).

Salary reduction arrangement under atax-sheltered annuity plan (section 403(b)plan).

SIMPLE IRA plan.

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Overall limit on SEP contributions. If youalso make nonelective contributions to aSEP-IRA, the total of the nonelective andelective contributions to that SEP-IRA cannotbe more than the lesser of $30,000 or 15%of the employee's compensation. The samerule applies to contributions you make to yourown SEP-IRA. See Contribution Limits, ear-lier.

Employee compensation. For figuring theelective deferral amount, compensation is

generally the amount you pay to the em-ployee for the year. Compensation includesthe elective deferral amount and otheramounts deferred in certain employee benefitplans. See Compensation, earlier under De-finitions You Need To Know. These amountsare included in figuring your employees' totalcontributions even though they are not in-cluded in the income of your employees forincome tax purposes.

TIPYou can choose not to treat thedeferral amount as compensation, asdiscussed later.

To figure the deferral amount, multiply theemployee's compensation by the deferralcontribution rate. However, you must alwaysuse the reduced rate method to determinethe maximum deductible contribution(13.0435% of unreduced compensation). Thisis the same method you use to figure yourdeduction for contributions you make to yourown SEP-IRA.

Example 1. Jim's SARSEP calls for adeferral contribution rate of 10% of his salary.Jim's salary for the year is $30,000 (beforereduction for the deferral). You multiply Jim'ssalary by 10% to get his deferral amount of$3,000. Your maximum deduction for electivedeferrals and any nonelective contributionswould be $3,913.05 ($30,000 .130435).

On Jim's Form W2, you show his total

wages as $27,000 ($30,000 $3,000). Socialsecurity wages and Medicare wages will eachbe $30,000. Jim will report $27,000 as wageson his individual income tax return.

Choice not to treat deferrals as com-pensation. You can choose not to treatelective deferrals (and other amounts de-ferred in certain employee benefit plans) fora year as compensation under your SARSEP.You may use this method for calculatingdeferral percentages for the SARSEP ADPtest defined earlier.

The deferral amount and the compen-sation (minus the deferral) depend on eachother. For this reason, you figure the deferralamount indirectly by reducing the contributionrate for deferrals called for under the salaryreduction arrangement. This method is thesame one that you use to figure your de-duction for contributions you make to yourown SEP-IRA. You must also use the re-duced rate method to determine the maxi-mum deductible contribution (13.0435% ofunreduced compensation).

To figure the deferral amount, use eitherthe rate table or rate worksheet in the Ap-pendix. Use the rate table if the deferral con-tribution rate called for under the SARSEP isa whole number. Otherwise, use the rateworksheet. When using the rate table, firstlocate the deferral contribution rate in ColumnA. Then read across to find the reduced ratein Column B. Multiply the reduced rate by

your employee's compensation to get thedeferral amount.

Example 2. The facts are the same as inExample 1 except that you chose not to treatdeferrals as compensation under the ar-rangement. To figure the deferral amount,you multiply Jim's salary of $30,000 by0.090909 (the reduced rate equivalent of10%) to get the deferral amount of $2,727.27.Your maximum deduction for elective defer-rals and any nonelective contributions wouldbe $3,913.05 ($30,000 .130435).

On Jim's Form W2, you show his totalwages as $27,272.73 ($30,000 minus$2,727.27). Social security wages and Medi-care wages will each be $30,000. Jim will re-port $27,272.73 as wages on his individualincome tax return.

Alternative definitions of compen-sation. In addition to the general definitionof compensation under Definitions You NeedTo Know and the choice described in thepreceding paragraphs, you can use any defi-nition of compensation that meets all the fol-lowing conditions.

It is reasonable.

It is not designed to favor highly com-

pensated employees. It provides that the average percentage

of total compensation used for highlycompensated employees as a group forthe year is not more than minimally higherthan the average percentage of totalcompensation used for all other employ-ees as a group.

Compensation of self-employed indi-viduals. If you are self-employed, compen-sation is your net earnings from self-employ-ment as defined earlier under Definitions YouNeed To Know.

To figure the deferral amount, you mustuse a reduced rate instead of the deferralcontribution rate called for under the

SARSEP. Use either the rate table or rateworksheet in the Appendixto get the reducedrate. Then use the deduction worksheet tofigure the deferral amount.

Compensation does not include tax-freeitems (or deductions related to them) otherthan foreign earned income and housing costamounts.

Compensation of disabled participants.You may be able to choose to use specialrules to determine compensation for a partic-ipant who is permanently and totally disabled.Under these rules, compensation means thecompensation the participant would have re-ceived if paid at the rate paid immediatelybefore becoming permanently and totally dis-abled. See Internal Revenue Code section415(c)(3)(C) for details.

Tax treatment of deferrals. You can deductyour deferrals that, when added to your otherSEP contributions, are not more than thelimits under How Much Can I Deduct?, earlier.

Elective deferrals that are not more thanthe limit discussed earlier are excluded fromyour employees' wages subject to federal in-come tax in the year of deferral. However,these deferrals are included in wages for so-cial security, Medicare, and federal unem-ployment (FUTA) tax.

Excess deferrals. For 1999, excessdeferrals are the elective deferrals for theyear that are more than the $10,000 limitdiscussed earlier. The treatment of excess

deferrals made under a SARSEP is similar tothe treatment of excess deferrals made undera qualified plan. See Treatment of ExcessDeferrals under Qualified Plans (KeoghPlans), later.

Excess SEP contributions. Excess SEPcontributions are elective deferrals of highlycompensated employees that are more thanthe amount permitted under the SARSEPADP test. You must notify your highly com-pensated employees within 21/2 months afterthe end of the plan year of their excess SEPcontributions. If you do not notify them withinthis time period, you must pay a 10% tax onthe excess. For an explanation of the notifi-cation requirements, see Revenue Procedure9144 in Cumulative Bulletin 19912. If youadopted a SARSEP using Form 5305ASEP,the notification requirements are explained inthe instructions for that form.

Reporting on Form W2. Do not includeelective deferrals in the Wages, tips, othercompensation box of Form W2. You must,however, include them in the Social securitywages and Medicare wages and tips boxes.You must also include them in box 13. Markthe Deferred compensation checkbox in box15. For more information, see the Form W2instructions.

Distributions (Withdrawals)As an employer, you cannot prohibit distribu-tions from a SEP-IRA. Also, you cannot makeyour contributions on the condition that anypart of them must be kept in the account.

Distributions are subject to IRA rules. Forinformation about IRA rules, including the taxtreatment of distributions, rollovers, requireddistributions, and income tax withholding, seePublication 590.

Additional TaxesThe tax advantages of using SEP-IRAs forretirement savings can be offset by additional

taxes. There are additional taxes for all thefollowing actions.

Making excess contributions.

Making early withdrawals.

Not making required withdrawals.

For information about these taxes, seechapter 1 in Publication 590. Also, a SEP-IRAmay be disqualified, or an excise tax mayapply, if the account is involved in a prohibitedtransaction, discussed next.

Prohibited transaction. If an employee im-properly uses his or her SEP-IRA, such asby borrowing money from it, the employeehas engaged in a prohibited transaction. Inthat case, the SEP-IRA will no longer qualifyas an IRA. For a list of prohibited trans-actions, see Prohibited Transactions underQualified Plans (Keogh Plans), later.

Effect on employee. If a SEP-IRA isdisqualified because of a prohibited trans-action, the assets in the account will betreated as having been distributed to the em-ployee of that SEP-IRA on the first day of theyear in which the transaction occurred. Theemployee must include in income the assets'fair market value (on the first day of the year)that is more than any cost basis in the ac-count. Also, the employee may have to paythe additional tax for making early with-drawals. For more information, see Tax on

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Prohibited Transactionsunder Qualified Plans(Keogh Plans), later.

Reporting andDisclosure RequirementsIf you set up a SEP using Form 5305SEPor Form 5305ASEP (see the Cautionlater),you must give your eligible employees certaininformation about the SEP at the time you setit up. See Setting Up a SEP, earlier. Also, youmust give your eligible employees a state-

ment each year showing any contributions totheir SEP-IRAs. If you set up a salary re-duction SEP, you must also give them noticeof any excess contributions. For details aboutother information you must give them, see theinstructions for either of these forms.

Even if you did notuse Form 5305SEPor Form 5305ASEP to set up your SEP, youmust give your employees information similarto that described above. For more informa-tion, see the instructions for either Form5305SEP or Form 5305ASEP.

CAUTION

!Form 5305ASEP is used to set upa SEP that includes a salary reductionarrangement. SEPs that include a

salary reduction arrangementcannotbe setup after 1996. However, eligible employees

hired after 1996 can have you contribute partof their pay to a SARSEP set up before 1997.See Salary Reduction Simplified EmployeePension (SARSEP), earlier.

SIMPLE PlansA Savings Incentive Match Plan for Employ-ees (SIMPLE plan) is a written arrangementthat provides you and your employees with asimplified way to make contributions to pro-vide retirement income. Under a SIMPLE

plan, employees can choose to make salaryreduction contributions to the plan rather thanreceiving these amounts as part of their reg-ular pay. In addition, you will contributematching or nonelective contributions.

SIMPLE plans can only be maintained ona calendar-year basis.

A SIMPLE plan can be set up in either ofthe following ways:

Using SIMPLE IRAs (SIMPLE IRA plan).

As part of a 401(k) plan (SIMPLE 401(k)plan).

TIPMany financial institutions will helpyou set up a SIMPLE plan.

SIMPLE IRA PlanA SIMPLE IRA plan is a retirement plan thatuses SIMPLE IRAs for each eligible em-ployee. Under a SIMPLE IRA plan, a SIMPLEIRA must be set up for each eligible em-ployee. For the definition of an eligible em-ployee, see Who Can Participate in a SIMPLEIRA Plan?, later.

Who Can Set Upa SIMPLE IRA Plan?You can set up a SIMPLE IRA plan if youmeet both of the following requirements.

You meet the employee limit.

You do not maintain another qualifiedplan unless the other plan is for collectivebargaining employees.

Employee limit. You can set up a SIMPLEIRA plan only if you had 100 or fewer em-ployees who earned $5,000 or more in com-pensation during the preceding year. Underthis rule, you must take into account allem-ployees employed at any time during the cal-endar year regardless of whether they areeligible to participate. Employees include

self-employed individuals who receivedearned income and leased employees (de-fined earlier under Definitions You Need ToKnow).

Once you set up a SIMPLE IRA plan, youmust continue to meet the 100-employee limiteach year that you maintain the plan.

Grace period for employers who ceaseto meet the 100-employee limit. If youmaintain the SIMPLE IRA plan for at least oneyear and you cease to meet the100-employee limit in a later year, you will betreated as meeting it for the 2 calendar yearsimmediately following the calendar year forwhich you last met it.

A different rule applies if you do not meetthe 100-employee limit because of an acqui-sition, disposition, or similar transaction. Un-

der this rule, the SIMPLE IRA plan will betreated as meeting the 100-employee limit forthe year of the transaction and the 2 followingyears if both the following conditions are sat-isfied.

Coverage under the plan has not signif-icantly changed during the grace period.

The SIMPLE IRA plan would have cont-inued to qualify after the transaction if youhad remained a separate employer.

CAUTION

!The grace period for acquisitions,dispositions, and similar transactionsalso applies if, because of these types

of transactions, you do not meet the rulesexplained underOther qualified plan orWho

Can Participate in a SIMPLE IRA Plan?, be-low.

Other qualified plan. The SIMPLE IRA plangenerally must be the only retirement plan towhich you make contributions, or benefitsaccrue, for service in any year beginning withthe year the SIMPLE IRA plan becomes ef-fective.

Exception. If you maintain a qualifiedplan for collective bargaining employees, youare permitted to maintain a SIMPLE IRA planfor other employees.

Who Can Participatein a SIMPLE IRA Plan?

Eligible employee. Any employee who re-ceived at least $5,000 in compensation duringany 2 years preceding the current calendaryear and is reasonably expected to earn atleast $5,000 during the current calendar yearis eligible to participate. The termemployee includes a self-employed individ-ual who received earned income.

You can use less restrictive eligibility re-quirements (but not more restrictive ones) byeliminating or reducing the prior year com-pensation requirements, the current yearcompensation requirements, or both. For ex-ample, you can allow participation for em-ployees who received at least $3,000 incompensation during any preceding calendar

year. However, you cannot impose any otherconditions on participating in a SIMPLE IRAplan.

Excludable employees. The following em-ployees do not need to be covered under aSIMPLE IRA plan.

Employees who are covered by a unionagreement and whose retirement benefitswere bargained for in good faith by theirunion and you.

Nonresident alien employees who haveno U.S.-source wages, salaries, or otherpersonal services compensation fromyou.

Compensation. Compensation for employ-ees is the total amount of wages required tobe reported on Form W2, including electivedeferrals (deferred amounts elected underany 401(k) plans, 403(b) plans, government(section 457(b)) plans, SEP plans, andSIMPLE IRA plans). If you are self-employed,compensation is your net earnings from self-employment (line 4 of Short Schedule SE(Form 1040)) before subtracting any contri-butions made to the SIMPLE IRA plan foryourself.

How To Set Up a SIMPLE IRA PlanYou can use Form 5304SIMPLE or Form5305SIMPLE to set up a SIMPLE IRA plan.Each form is a model savings incentive matchplan for employees (SIMPLE) plan document.Which form you use depends on whether youselect a financial institution or your employeesselect the institution that will receive the con-tributions.

Use Form 5304SIMPLE if you allow eachplan participant to select the financial institu-tion for receiving his or her SIMPLE IRA plancontributions. Use Form 5305SIMPLE if yourequire that all contributions under theSIMPLE IRA plan be deposited initially at adesignated financial institution.

The SIMPLE IRA plan is adopted whenyou have completed all appropriate boxesand blanks on the form and you have signedit. Keep the original form. Do not file it with theIRS.

Other uses of the forms. If you set up aSIMPLE IRA plan using Form 5304SIMPLEor Form 5305SIMPLE, you can use the formto satisfy other requirements, including thefollowing.

Meeting employer notification require-ments for the SIMPLE IRA plan. Page 3of Form 5304SIMPLE and Page 3 ofForm 5305SIMPLE contain a ModelNotification to Eligible Employeesthatprovides the necessary information to the

employee. Maintaining the SIMPLE IRA plan records

and proving you set up a SIMPLE IRAplan for employees.

Deadline for setting up a SIMPLE IRA plan.You can set up a SIMPLE IRA plan effectiveon any date between January 1 and October1 of a year, provided that you did not previ-ously maintain a SIMPLE IRA plan. If youpreviously maintained a SIMPLE IRA plan,you can set up a SIMPLE IRA plan effectiveonly on January 1 of a year. This requirementdoes not apply if you are a new employer thatcomes into existence after October 1 of theyear the SIMPLE IRA plan is set up and you

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set up a SIMPLE IRA plan as soon as ad-ministratively feasible after you come intoexistence. A SIMPLE IRA plan cannot havean effective date that is before the date youactually adopt the plan.

Setting up a SIMPLE IRA. SIMPLE IRAsare the individual retirement accounts or an-nuities into which the contributions are de-posited. A SIMPLE IRA must be set up foreach eligible employee. Forms 5305S and5305SA are model trust and custodial ac-

count documents that the participant and thetrustee (or custodian) can use for this pur-pose.

A SIMPLE IRA cannotbe designated asa Roth IRA. Contributions to a SIMPLE IRAwill not affect the amount that an individualcan contribute to a Roth IRA.

Deadline for setting up a SIMPLE IRA.A SIMPLE IRA must be set up for an em-ployee before the first date by which a con-tribution is required to be deposited into theemployee's IRA.

Notification RequirementsIf you adopt a SIMPLE IRA plan, you mustgive each employee the following information

before the beginning of the election period.

1) The employee's opportunity to make orchange a salary reduction choice undera SIMPLE IRA plan.

2) Your choice to make either reducedmatching contributions or nonelectivecontributions (discussed later).

3) A summary description and the locationof the plan. The financial institutionshould provide you with this information.

4) Written notice that his or her balance canbe transferred without cost or penalty ifyou use a designated financial institu-tion.

Election period. The election period is gen-erally the 60-day period immediately preced-ing January 1 of a calendar year (November2 to December 31 of the preceding calendaryear). However, the dates of this period aremodified if you set up a SIMPLE IRA plan inmid-year (for example, on July 1) or if the60-day period falls before the first day anemployee becomes eligible to participate inthe SIMPLE IRA plan.

A SIMPLE IRA plan can provide longerperiods for permitting employees to enter intosalary reduction agreements or to modify prioragreements. For example, a SIMPLE IRAplan can provide a 90-day election period in-stead of the 60-day period. Similarly, in addi-

tion to the 60-day period, a SIMPLE IRA plancan provide quarterly election periods duringthe 30 days before each calendar quarter,other than the first quarter of each year.

Contribution LimitsContributions are made up of salary reductioncontributions and employer contributions.You, as the employer, must make eithermatching contributions or nonelective contri-butions, defined later. No other contributionscan be made to the SIMPLE IRA plan. Thesecontributions, which you can deduct, must bemade timely. See Time limits for contributingfunds, later.

Salary reduction contributions. Theamount the employee chooses to have youcontribute to a SIMPLE IRA on his or herbehalf cannot be more than $6,000 for 1999.These contributions must be expressed as apercentage of the employee's compensationunless you permit the employee to expressthem as a specific dollar amount. You cannotplace restrictions on the contribution amount(such as limiting the contribution percentage),except to comply with the $6,000 limit.

If an employee is a participant in any otheremployer plan during the year and has elec-tive salary reductions or deferred compen-sation under those plans, the salary reductioncontributions under a SIMPLE IRA plan alsoare an elective deferral that counts toward theoverall $10,000 annual limit on exclusion ofsalary reductions and other elective deferrals.

If the other plan is a deferred compen-sation plan of a state or local government ora tax-exempt organization, the limit on elec-tive deferrals is $8,000.

Employer matching contributions. You aregenerally required to match each employee'ssalary reduction contributions on a dollar-for-dollar basis up to 3% of the employee'scompensation. This requirement does notapply if you make nonelective contributions

as discussed later.

Example. In 1999, your employee, JohnRose, earned $25,000 and chose to defer 5%of his salary. You make a 3% matching con-tribution. The total contribution you can makefor John is $2,000, figured as follows.

Lower percentage. If you choose amatching contribution less than 3%, the per-centage must be at least 1%. You must notifythe employees of the lower match within a

reasonable period of time before the 60-dayelection period (discussed earlier) for thecalendar year. You cannot choose a per-centage less than 3% for more than 2 yearsduring the 5-year period that ends with (andincludes) the year for which the election iseffective.

Nonelective contributions. Instead ofmatching contributions, you can choose tomake nonelective contributions of 2% ofcompensation on behalf of each eligible em-ployee who has at least $5,000 of compen-sation from you for the year. Only $160,000of the employee's compensation can be takeninto account to figure the contribution limit.

If you choose this 2% contribution formula,

you must notify the employees within a rea-sonable period of time before the 60-dayelection period (discussed earlier) for thecalendar year.

Example 1. In 1999, your employee,Jane Wood, earned $36,000 and chose tohave you contribute 10% of her salary. Youmake a 2% nonelective contribution. The totalcontributions you can make for her are$4,320, figured as follows.

Example 2. Using the same facts as inExample 1, above, the maximum contributionyou can make for Jane if she earned $75,000is $7,500, figured as follows.

Time limits for contributing funds. You

must make the salary reduction contributionsto the SIMPLE IRA within 30 days after theend of the month in which the amounts wouldotherwise have been payable to the employeein cash. You must make matching contribu-tions or nonelective contributions by the duedate (including extensions) for filing your fed-eral income tax return for the year.

When To Deduct ContributionsYou can deduct contributions under aSIMPLE IRA plan in the tax year with or withinwhich the calendar year for which contribu-tions were made ends. You can deduct con-tributions for a particular tax year if they aremade for that tax year and are made by the

due date (including extensions) of your fed-eral income tax return for that year.

Example 1. Your tax year is the fiscalyear ending June 30. Contributions under aSIMPLE IRA plan for the calendar year 1999(including contributions made in 1999 beforeJuly 1, 1999) are deductible in the tax yearending June 30, 2000.

Example 2. Your are a sole proprietorwhose tax year is the calendar year. Contri-butions under a SIMPLE IRA plan for thecalendar year 1999 (including contributionsmade in 2000 by April 17, 2000) are deduct-ible in the 1999 tax year.

Tax Treatment of ContributionsYou can deduct your contributions and youremployees can exclude these contributionsfrom their gross income. SIMPLE IRA contri-butions are not subject to federal income taxwithholding. However, salary reduction con-tributions are subject to social security, Med-icare, and federal unemployment (FUTA)taxes. Matching and nonelective contributionsare not subject to these taxes.

Reporting on Form W2. Do not includeSIMPLE IRA contributions in the Wages, tips,other compensation box of Form W2.However, salary reduction contributions mustbe included in the boxes for social securityand Medicare wages. Also include the propercode in Box 13. For more information, see

the instructions for Forms W2 and W3.

Distributions (Withdrawals)Distributions from a SIMPLE IRA are subjectto IRA rules and generally are includible inincome for the year received. Tax-freerollovers can be made from one SIMPLE IRAinto another SIMPLE IRA. A rollover from aSIMPLE IRA to another IRA can be made taxfree only after a 2-year participation in theSIMPLE IRA plan.

Early withdrawals generally are subject toa 10% additional tax. However, the additionaltax is increased to 25% if funds are withdrawnwithin 2 years of beginning participation.

Salary reduction contributions(maximum amount) ...................................... $6,0002% nonelective contributions($75,000 .02) ............................................ 1,500Total contributions .................................... $7,500

Salary reduction contributions($25,000 .05) ............................................ $1,250Employer matching contribution($25,000 .03) ............................................ 750Total contributions .................................... $2,000

Salary reduction contributions($36,000 .10) ............................................ $3,6002% nonelective contributions($36,000 .02) ............................................ 720Total contributions .................................... $4,320

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More information. See Publication 590 forinformation about IRA rules, including thoseon the tax treatment of distributions, rollovers,required distributions, and income tax with-holding.

More Informationon SIMPLE IRA PlansIf you need more help to set up and maintainSIMPLE IRA plans, see the following IRSnotice and revenue procedure.

Notice 984. This notice contains questionsand answers about the implementation andoperation of SIMPLE IRA plans, including theelection and notice requirements for theseplans. Notice 984 is in Internal RevenueBulletin No. 19982.

Revenue Procedure 9729. This revenueprocedure provides guidance to drafters ofprototype SIMPLE IRAs on obtaining opinionletters. Revenue Procedure 9729 is in Cu-mulative Bulletin 19971.

SIMPLE 401(k) PlanYou can adopt a SIMPLE plan as part of a

401(k) plan if you meet the 100-employeelimit as discussed earlier under SIMPLE IRAplans. A SIMPLE 401(k) plan generally mustsatisfy the rules that apply to a 401(k) plan,as discussed in Qualification Rules underQualified Plans (Keogh Plans), later. How-ever, contributions and benefits under aSIMPLE 401(k) plan will be considered not todiscriminate in favor of highly compensatedemployees provided the plan meets the con-ditions listed below.

1) Under the plan, an employee canchoose to have you make salary re-duction contributions for the year to atrust in an amount expressed as a per-centage of the employee's compen-sation, but not more than $6,000 for

1999.

2) You must make either:

a) Matching contributions up to 3% ofcompensation for the year, or

b) Nonelective contributions of 2% ofcompensation on behalf of each el-igible employee who has at least$5,000 of compensation from youfor the year.

3) No other contributions can be made tothe trust.

4) No contributions are made, and no ben-efits accrue, for services during the yearunder any other qualified retirement plan

of the employer on behalf of any em-ployee eligible to participate in theSIMPLE 401(k) plan.

5) The employee's rights to any contribu-tions are nonforfeitable.

No more than $160,000 of the employee'scompensation can be taken into account infiguring salary reduction contributions,matching contributions, and nonelective con-tributions.

Top-heavy plan exception. A SIMPLE401(k) plan that allows only contributionsmeeting the conditions listed above will notbe treated as a top-heavy plan. Top-heavy

qualified plans are discussed in Top-heavyplan requirements under Qualified Plans(Keogh Plans), later.

Employee notification. The notificationrules that apply to SIMPLE IRA plans alsoapply to SIMPLE 401(k) plans. See Notifica-tion Requirements, earlier.

More Information onSIMPLE 401(k) Plans

If you need more help to set up and maintainSIMPLE 401(k) plans, see Revenue Proce-dure 979. Revenue Procedure 979 is inCumulative Bulletin 19971. This revenueprocedure provides a model amendment thatyou can use to adopt a plan with SIMPLE401(k) provisions. This model amendmentprovides guidance to plan sponsors for in-corporating 401(k) SIMPLE provisions inplans containing cash or deferred arrange-ments.

Qualified Plans(Keogh Plans)A qualified employer plan set up by a self-employed individual is sometimes called aKeogh or HR10 plan. A sole proprietor or apartnership can set up a qualified plan. Acommon-law employee or a partner cannotset up a qualified plan. The plans describedhere can also be set up and maintained byemployers that are corporations. All the rulesdiscussed here apply to corporations exceptwhere specifically limited to the self-employed.

The plan must be for the exclusive benefitof employees or their beneficiaries. A qual-ified plan can include coverage for a self-employed individual. A self-employed indi-vidual is treated as both an employer and anemployee.

As an employer, you can usually deduct,subject to limits, contributions you make to aqualified plan, including those made for yourown retirement. The contributions (andearnings and gains on them) are generally taxfree until distributed by the plan.

Kinds of PlansThere are two basic kinds of qualified plans

defined contribution plans and definedbenefit plans and different rules apply toeach. You can have more than one qualifiedplan, but your contributions to all the plansmust not total more than the overall limitsdiscussed under Contributionsand EmployerDeduction, later.

Defined Contribution PlanA defined contribution plan provides an indi-vidual account for each participant in the plan.It provides benefits to a participant largelybased on the amount contributed to that par-ticipant's account. Benefits are also affectedby any income, expenses, gains, losses, andforfeitures of other accounts that may be al-located to an account. A defined contributionplan can be either a profit-sharing plan or amoney purchase pension plan.

Profit-sharing plan. A profit-sharing plan isa plan for sharing your business profits withyour employees. However, you do not have

to make contributions out of net profits tohave a profit-sharing plan.

The plan does not need to provide a defi-nite formula for figuring the profits to beshared. But, if there is no formula, there mustbe systematic and substantial contributions.

The plan must provide a definite formulafor allocating the contribution among the par-ticipants and for distributing the accumulatedfunds to the employees after they reach acertain age, after a fixed number of years, orupon certain other occurrences.

In general, you can be more flexible inmaking contributions to a profit-sharing planthan to a money purchase pension plan (dis-cussed next) or a defined benefit plan (dis-cussed later). But the maximum deductiblecontribution may be less under a profit-sharing plan (see Limits on Contributions andBenefits, later).

Forfeitures under a profit-sharing plan canbe allocated to the accounts of remainingparticipants in a nondiscriminatory way orthey can be used to reduce your contribu-tions.

Money purchase pension plan. Contribu-tions to a money purchase pension plan arefixed and are not based on your businessprofits. For example, if the plan requires that

contributions be 10% of the participants'compensation without regard to whether youhave profits (or the self-employed person hasearned income), the plan is a money pur-chase pension plan. This applies even thoughthe compensation of a self-employed individ-ual as a participant is based on earned in-come derived from business profits.

Defined Benefit PlanA defined benefit plan is any plan that is nota defined contribution plan. Contributions toa defined benefit plan are based on what isneeded to provide definitely determinablebenefits to plan participants. Actuarial as-sumptions and computations are required tofigure these contributions. Generally, you willneed continuing professional help to have adefined benefit plan.

Forfeitures under a defined benefit plancannot be used to increase the benefits anyemployee would otherwise receive under theplan. Forfeitures must be used instead to re-duce employer contributions.

Setting Up a Qualified PlanThere are two basic steps in setting up aqualified plan. First you adopt a written plan.Then you invest the plan assets.

You, the employer, are responsible forsetting up and maintaining the plan.

TIP

If you are self-employed, it is not

necessary to have employees be-sides yourself to sponsor and set upa qualified plan. If you have employees, seeEligible Employees, later.

Set-up deadline. To take a deduction forcontributions for a tax year, your plan mustbe set up (adopted) by the last day of thatyear (December 31 for calendar-year em-ployers).

Adopting a Written PlanYou must adopt a written plan. The plan canbe an IRS-approved master or prototype planoffered by a sponsoring organization. Or itcan be an individually designed plan.

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Written plan requirement. To qualify, theplan you set up must be in writing and mustbe communicated to your employees. Theplan's provisions must be stated in the plan.It is not sufficient for the plan to merely referto a requirement of the Internal RevenueCode.

Master or prototype plans. Most qualifiedplans follow a standard form of plan (a masteror prototype plan) approved by the IRS.Master and prototype plans are plans that are

made available by plan providers for adoptionby employers (including self-employed indi-viduals). Under a master plan, a single trustor custodial account is established, as partof the plan, for the joint use of all adoptingemployers. Under a prototype plan, a sepa-rate trust or custodial account is establishedfor each employer.

Plan providers. The following organiza-tions generally can provide IRS-approvedmaster or prototype plans.

Banks (including some savings and loanassociations and federally insured creditunions).

Trade or professional organizations.

Insurance companies. Mutual funds.

Individually designed plans. If you prefer,you can set up an individually designed planto meet specific needs. Although advanceIRS approval is not required, you can applyfor approval by paying a fee and requestinga determination letter. You may need profes-sional help for this. Revenue Procedure 996may help you decide whether to apply forapproval of your plan. Revenue Procedure996 is in Internal Revenue Bulletin No.19991. It is also available at most IRS officesand at some libraries.

Investing Plan AssetsIn setting up a qualified plan, you arrange howthe plan's funds will be used to build its as-sets.

You can establish a trust or custodialaccount to invest the funds.

You, the trust, or the custodial accountcan buy an annuity contract from an in-surance company. Life insurance can beincluded only if it is incidental to the re-tirement benefits.

You, the trust, or the custodial accountcan buy face-amount certificates from aninsurance company. These certificatesare treated like annuity contracts.

You set up a trust by a legal instrument(written document). You may need profes-sional help to do this.

You can set up a custodial account witha bank, savings and loan association, creditunion, or other person who can act as theplan trustee.

You do not need a trust or custodial ac-count, although you can have one, to investthe plan's funds in annuity contracts or face-amount certificates. If anyone other than atrustee holds them, however, the contractsor certificates must state that they are nottransferable.

Eligible EmployeesAn employee must be allowed to participatein your plan if he or she meets both the fol-lowing requirements.

Has reached age 21.

Has at least 1 year of service (2 years ifthe plan is not a 401(k) plan and providesthat after not more than 2 years of servicethe employee has a nonforfeitable rightto all of his or her accrued benefit).

CAUTION

!A plan cannot exclude an employeebecause he or she has reached aspecified age.

Other plan requirements. For informationon other important plan requirements, seeQualification Rules, later.

Minimum FundingRequirementsIn general, if your plan is a money purchasepension plan or a defined benefit plan, youmust actually pay enough into the plan tosatisfy the minimum funding standard foreach year. Determining the amount neededto satisfy the minimum funding standard is

complicated. The amount is based on whatshould be contributed under the plan formulausing actuarial assumptions and formulas.For information on this funding requirement,see section 412 and its regulations.

Quarterly installments of required contri-butions. If your plan is a defined benefit plansubject to the minimum funding requirements,you must make quarterly installment pay-ments of the required contributions. If you donot pay the full installments timely, you mayhave to pay interest on any underpayment forthe period of the underpayment.

Due dates. The due dates for the install-ments are 15 days after the end of eachquarter. For a calendar-year plan, the install-

ments are due April 15, July 15, October 15,and January 15 (of the following year).Installment percentage. Each quarterly

installment must be 25% of the required an-nual payment.

Extended period for making contribu-tions. Additional contributions required tosatisfy the minimum funding requirement fora plan year will be considered timely if madeby 81/2 months after the end of that year.

ContributionsA qualified plan is generally funded by yourcontributions. However, employees partic-ipating in the plan may be permitted to makecontributions.

Contribution deadline. You can makedeductible contributions for a tax year up tothe due date of your return (plus extensions)for that year.

Self-employed individual. You can makecontributions on behalf of yourself only if youhave net earnings (compensation) from self-employment in the trade or business for whichthe plan was set up. Your net earnings mustbe from your personal services, not from yourinvestments. If you have a net loss from self-employment, you cannot make contributionsfor yourself for the year, even if you cancontribute for common-law employees basedon their compensation.

When ContributionsAre Considered MadeYou generally apply your plan contributionsto the year in which you make them. But youcan apply them to the previous year if all thefollowing requirements are met.

1) You make them by the due date of yourtax return for the previous year (plusextensions).

2) The plan was established by the end of

the previous year.3) The plan treats the contributions as

though it had received them on the lastday of the previous year.

4) You do either of the following.

a) You specify in writing to the planadministrator or trustee that thecontributions apply to the previousyear.

b) You deduct the contributions onyour tax return for the previousyear. (A partnership shows contri-butions for partners on Schedule K(Form 1065).)

Employer's promissory note. Yourpromissory note made out to the plan is nota payment that qualifies for the deduction.Also, issuing this note is a prohibited trans-action subject to tax. See Prohibited Trans-actions, later.

Employer ContributionsThere are certain limits on the contributionsand other annual additions you can makeeach year for plan participants. There arealso limits on the amount you can deduct. SeeDeduction Limits, later.

Limits onContributions and BenefitsYour plan must provide that contributions orbenefits cannot exceed certain limits. Thelimits differ depending on whether your planis a defined contribution plan or a definedbenefit plan.

Defined benefit plan. For 1999, the annualbenefit for a participant under a defined ben-efit plan cannot be more than the lesser ofthe following amounts.

1) $130,000.

2) 100% of the participant's average com-pensation for his or her highest 3 con-secutive calendar years.

Defined contribution plan. For 1999, a de-fined contribution plan's annual contributionsand other additions (excluding earnings) tothe account of a participant cannot be morethan the lesser of the following amounts.

1) $30,000.

2) 25% of the compensation actually paidto the participant.

The maximum compensation that can betaken into account for this limit is $160,000.

Excess annual additions. Excess annualadditions are the amounts contributed that aremore than the limits discussed previously. A

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plan can correct excess annual additionscaused by any of the following actions.

A reasonable error in estimating a par-ticipant's compensation.

A reasonable error in determining theamount of elective deferrals permitted(discussed later).

Forfeitures allocated to participants' ac-counts.

Correcting excess annual additions. Aplan can provide for the correction of excessannual additions in the following ways.

1) Allocate and reallocate the excess toother participants in the plan to the ex-tent of their unused limits for the year.

2) If these limits are exceeded, do one ofthe following.

a) Hold the excess in a separate ac-count and allocate (and reallocate)it to participants' accounts in thefollowing year (or years) beforemaking any contributions for thatyear (see also Carryover of ExcessContributions, later).

b) Return employee after-tax contri-butions or elective deferrals (seeEmployee Contributionsand Elec-tive Deferrals (401(k) Plans), later).

Tax treatment of returned contributionsor distributed elective deferrals. The returnof employee after-tax contributions or thedistribution of elective deferrals to correct ex-cess annual additions is considered a cor-rective payment rather than a distribution ofaccrued benefits. The penalties for early dis-tributions and excess distributions do not ap-ply.

These disbursements are not wages re-portable on Form W2. You must report them

on a separate Form 1099R as follows.

Report the total amount of the distribu-tion, including employee contributions, inbox 1. If the distribution includes any gainfrom the contribution, report the gain inbox 2a. Report the return of employeecontributions in box 5. Enter Code E inbox 7.

Report a distribution of an elective defer-ral in boxes 1 and 2a. Include any gainfrom the contribution. Leave box 5 blankand enter Code E in box 7.

Participants must report these amountson the line for Total pensions and annuitieson Form 1040 or Form 1040A.

Employee ContributionsParticipants may be permitted to make non-deductible contributions to a plan in additionto your contributions. Even though these em-ployee contributions are not deductible, theearnings on them are tax free until distributedin later years. Also, these contributions mustsatisfy the nondiscrimination test of section401(m). See Notice 981 for further guidanceand transition relief relating to recent statutoryamendments to the nondiscrimination rulesunder sections 401(k) and 401(m). Notice981 is in Internal Revenue Bulletin No.19983.

Employer DeductionYou can usually deduct, subject to limits,contributions you make to a qualified plan,including those made for your own retirement.The contributions (and earnings and gains onthem) are generally tax free until distributedby the plan.

Deduction LimitsThe deduction limit for your contributions toa qualified plan depends on the kind of plan

you have.

Defined contribution plans. The deductionlimit for a defined contribution plan dependson whether it is a profit-sharing plan or amoney purchase pension plan.

Profit-sharing plan. Your deduction forcontributions to a profit-sharing plan cannotbe more than 15%of the compensation paid(or accrued) during the year to your eligibleemployees participating in the plan. You mustreduce this 15% limit in figuring the deductionfor contributions you make for your own ac-count. See Deduction Limit for Self-Employed Individuals, later.

Money purchase pension plan. Yourdeduction for contributions to a money pur-

chase pension plan is generally limited to25% of the compensation paid (or accrued)during the year to your eligible employees.You must reduce this 25% limit in figuring thededuction for contributions you make foryourself, as discussed later.

Defined benefit plans. The deduction forcontributions to a defined benefit plan isbased on actuarial assumptions and compu-tations. Consequently, an actuary must figureyour deduction limit.

CAUTION

!In figuring the deduction for contribu-tions, you cannot take into accountany contributions or benefits that are

more than the limits discussed earlier underLimits on Contributions and Benefits.

Deduction limit for multiple plans. If youcontribute to both a defined contribution planand a defined benefit plan and at least oneemployee is covered by both plans, your de-duction for those contributions is limited. Yourdeduction cannot be more than the greaterof the following amounts.

25% of the compensation paid (or ac-crued) during the year to your eligibleemployees participating in the plan. Youmust reduce this 25% limit in figuring thededuction for contributions you make foryour own account.

Your contributions to the defined benefitplans, but not more than the amountneeded to meet the year's minimumfunding standard for any of these plans.

CAUTION

!For this rule, a simplified employeepension (SEP) plan is treated as aseparate profit-sharing (defined con-

tribution) plan.

Deduction Limit forSelf-Employed IndividualsIf you make contributions for yourself, youneed to make a special computation to figureyour maximum deduction for these contribu-tions. Compensation is your net earnings fromself-employment, defined earlier under Defi-

nitions You Need To Know. This definitiontakes into account both the following items.

The deduction for one-half of your self-employment tax.

The deduction for contributions on behalfof yourself to the plan.

The deduction for your own contributionsand your net earnings depend on each other.For this reason, you determine the deductionfor your own contributions indirectly by re-

ducing the contribution rate called for in yourplan. To do this, use either the Rate Table forSelf-Employed or the Rate Worksheet forSelf-Employed in the Appendix. Then figureyour maximum deduction by using the De-duction Worksheet for Self-Employed in theAppendix.

Multiple plans. The deduction limit for mul-tiple plans (discussed earlier) also applies tocontributions you make as an employer onyour own behalf.

Where To Deduct ContributionsDeduct the contributions you make for yourcommon-law employees on Schedule C(Form 1040), on Schedule F (Form 1040), or

on Form 1065, whichever applies.You take the deduction for contributions

for yourself on line 29 of Form 1040.If you are a partner, the partnership

passes its deduction to you for the contribu-tions it made for you. The partnership will re-port these contributions on Schedule K1(Form 1065). You deduct them on line 29 ofForm 1040.

Carryover ofExcess ContributionsIf you contribute more to the plans than youcan deduct for the year, you can carry overand deduct the excess in later years, com-bined with your contributions for those years.

Your combined deduction in a later year islimited to 25% of the participating employees'compensation for that year. The limit is 15%if you have only profit-sharing plans (includingSEPs). Remember that these percentagelimits must be reduced to figure your maxi-mum deduction for contributions you make foryourself. See Deduction Limit for Self-Employed Individuals, earlier. The amountyou carry over and deduct may be subject tothe excise tax discussed next.

Table 2illustrates the carryover of excesscontributions to a profit-sharing plan.

Excise Tax for Nondeductible(Excess) ContributionsIf you contribute more than your deductionlimit to a retirement plan, you have madenondeductible contributions and you may beliable for an excise tax. In general, a 10%excise tax applies to nondeductible contribu-tions made to qualified pension, profit-sharing, stock bonus, or annuity plans and tosimplified employee pension plans (SEPs).

Special rule for self-employed individuals.The 10% excise tax does not apply to anycontribution made to meet the minimumfunding requirements in a money purchasepension plan or a defined benefit plan.

Documents

US Internal Revenue Service: p560--1999