US Internal Revenue Service: p571--1997

8/14/2019 US Internal Revenue Service: p571--1997

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ContentsImportant Changes for 1997 ............. 1

Important Changes for 1998 ............. 2

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

What Is a Tax-Sheltered Annuity(TSA) Plan? .................................. 2

Qualified Employer ............................ 2

Eligible Employees ............................ 3

Contributions ...................................... 3

Salary Reduction Agreement ............ 4

Limit on Elective Deferrals ................ 4

Limit on Employer Contributions ..... 5

The Exclusion Allowance .................. 5

Catch-up Election AlternativeLimits for Certain Employees .... 9

Limit for Contributions to More ThanOne Program ............................... 12

Other Rules ......................................... 12

Distributions and Rollovers .............. 14

How to Get More Information ........... 16

Worksheets ......................................... 16

Important Changes for1997Required beginning date for distributions.Beginning in 1997, required minimum distri-butions of your interest in a tax-sheltered an-

nuity contract generally do not have to bemade until April 1 of the calendar year fol-lowing the later of the calendar year in whichyou become age 701/2 or the calendar year inwhich you retire. See Minimum Distributions,later.

Certain ministers treated as employed bytax-exempt organization. Beginning in1997, a duly ordained or licensed minister ofa church who is working as a minister orchaplain, but is self-employed or is workingfor an employer that is not a qualified tax-exempt organization, is treated as employedby a qualified tax-exempt organization forpurposes of participating in a church plan(tax-sheltered annuity plan). See Employeesof Certain Tax-Exempt Organizations, later.

Contributions by self-employed ministersand chaplains. Beginning in 1997, contri-butions made by a self-employed minister orchaplain who is treated as employed by aqualified tax-exempt organization to a retire-ment income account that is treated as atax-sheltered annuity are deductible up to thelimits for elective contributions to tax-sheltered annuities. For this purpose, all plansin which the minister participates are treatedas one plan. See Exclusion Limits, later.

Includible compensation self-employedminister. Beginning in 1997, compensationof a self-employed minister who is treated as

Departmentof theTreasury

InternalRevenueService

Publica tion 571Cat. No. 46581C

Tax-ShelteredAnnuityPrograms forEmployees ofPublic Schoolsand CertainTax-ExemptOrganizations

For use in preparing

1997 Returns

Get forms and other information faster and easier by:COMPUTER

World Wide Web www.irs.ustreas.gov FTP ftp.irs.ustreas.gov IRIS at FedWorld (703) 321-8020

FAX From your FAX machine, dial (703) 368-9694See How To Get More Information in this publication.


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employed by a tax-exempt organization is theminister's net earnings from self-employmentreduced by contributions to retirement plansand the deduction for one-half of the self-employment tax. See Includible Compen-sation, later.

Years of service self-employedminister. Beginning in 1997, years of servicefor purposes of section 403(b) includes fullyears (and fractional years) in which a self-employed minister is treated as employed by

a qualified tax-exempt organization. SeeYears of Service, later.

Important Changes for1998

Includible Compensation. Beginning in1998, for purposes of figuring your exclusionallowance, which is the amount of employercontributions (including elective deferrals) toyour tax-sheltered annuity that you can ex-clude from income, your includible compen-sation includes:

1) Elective deferrals (your employer's con-tributions made on your behalf under asalary reduction agreement),

2) Amounts contributed or deferred by youremployer under a Section 125 cafeteriaplan, and

3) Amounts contributed or deferred undera Section 457 plan (state or local gov-ernment or tax-exempt organizationplan).

For more information on includible compen-sation, see Includible Compensation, later.

Contributions Employed Ministers. Be-

ginning in 1998, contributions made to achurch plan on behalf of a minister employedby an employer other than the church areexcluded from the minister's gross income ifthey would have been excluded had theminister been an employee of the church.

For purposes of this rule, a minister of achurch also includes:

1) A self-employed minister, and

2) A minister employed by an organizationother than a tax-exempt organizationthat shares a common religious bondwith the minister.

For more information on exclusion ofcontributions to church plans, see SpecialRules, under Includible Compensation, later.

IntroductionThis publication explains the Federal tax pro-visions that apply to tax-sheltered annuity(TSA) plans offered to employees of publicschools and certain tax-exempt organizations.The discussions primarily cover employercontributions (elective deferrals) made undera salary reduction agreement. The publicationis for employees who participate in tax-sheltered annuity plans. It is not for custo-dians or plan administrators because it does

not cover many of the operating requirementsof these plans.

A tax-sheltered annuity plan, often re-ferred to as a 403(b) plan, tax-deferredannuity plan, or simply TSA plan (which isused in this publication), is a retirement planthat, if operated properly by a qualified em-ployer, is tax-exempt.

A qualified employer can purchase tax-sheltered annuities for eligible employees.Three types of employers qualify, publicschools, certain tax-exempt organizations,and certain employers of ministers. Your em-ployer may be able to help you determinewhether you are an eligible employee.

The most common way to contribute totax-sheltered annuity plans is through a sal-ary reduction agreement. A salary reductionagreement is an agreement under which anemployee agrees to take a reduction in salaryor to forego a salary increase and the em-ployer contributes that amount to a tax-sheltered annuity (TSA) plan for that em-ployee. These employer contributions arecalled elective deferrals. A TSA plan canalso be funded through non-elective employercontributions, employee contributions, or acombination of these.

There is an annual limit on electivedeferrals. Generally, you cannot defer more

than $9,500 for 1997 for all plans coveringyou, including TSAs. If elective deferral con-tributions on your behalf are more than theallowable amount, you must include the ex-cess in your gross income.

Limits are placed on the contributionsthat can be made by an employer to tax-sheltered annuity (TSA) programs. Specialrules may apply in determining the limit onemployer contributions for you to a tax-sheltered annuity (TSA) program if you alsoare covered by a qualified plan.

The exclusion allowance is the amountof employer contributions (including electivedeferrals) to your tax-sheltered annuity (TSA)that you can exclude from income. You paytax on these excluded amounts when you

receive a distribtion from the TSA.Employees of educational organizations,hospitals, home health service agencies,health and welfare service agencies,churches, and certain church-related organ-izations can elect to substitute the limit onemployer contributions for the exclusion al-lowance under an alternate rule called theOverall Limit.

The Other Rules section includes dis-cussions on the taxability of the cost of in-surance under a TSA and on employer con-tributions subject to social security andMedicare taxes.

In most cases, the payments you receive,or that are made available to you, under yourTSA contract are taxable in full as ordinaryincome. In general, the same tax rules apply

to distributions from tax-sheltered annuitiesthat apply to distributions from other retire-ment plans. These rules are explained inPublication 575, Pension and Annuity In-come. If you transfer all or part of your interestfrom a tax-sheltered annuity contract or ac-count to another tax-sheltered annuity con-tract or account, the transfer may be tax free.You can generally roll over tax free all or anypart of a distribution from a tax-sheltered an-nuity (TSA) plan to an IRA or another TSAplan.

You can use the worksheetsat the endof this publication to figure many of the limitsthat apply to your tax-sheltered annuity (TSA).

Useful ItemsYou may want to see:

Publication

575 Pension and Annuity Income

590 Individual Retirement Arrange-ments (IRAs)

Form (and Instructions)

W2 Wage and Tax Statement

1099-R Distributions From Pensions,Annuities, Retirement or Profit-Sharing Plans, IRAs, InsuranceContracts, etc.

5330 Return of Excise Taxes Relatedto Employee Benefit Plans

See How To Get More Information, nearthe end of this publication for informationabout getting these publications and forms.

What Is aTax-Sheltered Annuity(TSA) Plan?

A tax-sheltered annuity plan, often re-ferred to as a 403(b) plan, tax-deferredannuity plan, or simply TSA plan (which isused in this publication), is a retirement planthat, if operated properly by a qualified em-ployer, is tax-exempt.

The TSA plan can invest funds for partic-ipating employees in:

Annuity contracts,

Custodial accounts holding mutual fundshares, or

Retirement income accounts (definedcontribution plans maintained bychurches or certain church-related or-ganizations).

Throughout this publication, wherever TSAappears, it refers to any one of these fundingarrangements, unless otherwise specified.

Tax advantage for employee. Generally,contributions by a qualified employer to pur-chase an annuity contract for you under a

TSA plan (and earnings on them) are ex-cluded from your taxable income until youbegin to receive annuity payments, usuallyafter retiring, from your TSA. Because of thistax postponement, these plans are describedas tax-deferred or tax-sheltered annuities.

Qualified EmployerA qualified employer can purchase TSAs foreligible employees. Three types of employersqualify public schools, certain tax-exemptorganizations, and certain employers ofministers.

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Public SchoolsA state or local government or any of itsagencies or instrumentalities can be a qual-ified employer. For this purpose, an Indiantribal government is a state government. Also,see Indian tribal governments, under Tax-Exempt Organizations, later. These employ-ers are qualified employers only for employ-ees who perform (or have performed)services, directly or indirectly, for an educa-tional organization.

Educational organization. An educationalorganization is one that normally maintains aregular faculty and curriculum and normallyhas a regularly enrolled body of students inattendance at the place where it regularlycarries on educational activities.

Tax-Exempt OrganizationsGenerally, a qualified employer includes anorganization that is tax exempt because it isorganized and operated exclusively for reli-gious, charitable, scientific, public safetytesting, literary, or educational purposes. Aqualified employer also includes a tax-exempt

organization that is organized and operatedexclusively to encourage national or interna-tional amateur sports competition (but only ifno part of its activities involve the provisionof athletic facilities or equipment), or for theprevention of cruelty to children or animals.The organization can be a corporation, com-munity chest, fund, or foundation.

Indian tribal governments. Any TSA con-tract that was purchased by an Indian tribalgovernment for its employees in a plan yearbeginning before January 1, 1995, is treatedas having been purchased by a tax-exemptorganization that is qualified to provide TSAsfor its employees. An Indian tribal governmentincludes any political subdivisions, agencies,and instrumentalities of it, as well as anycorporations that are chartered under federal,state, or tribal law and owned by it.

Government instrumentalities. Wholly-owned instrumentalities (other than publicschools, described earlier) of state or munici-pal governments generally are not qualifiedemployers. However, if an instrumentality hasbeen separately organized and has beenrecognized as tax-exempt by the InternalRevenue Service because it is organized andoperated exclusively forone or more of theexempt purposes described earlier, it is aqualified employer. A separately organizedschool, college, university, or hospital may

qualify if it is not an activity essential to andconducted under a branch or department ofa state or municipal government.

A cooperative hospital service organiza-tion that meets certain requirements is aqualified employer.

Uniformed Services University of theHealth Sciences. This is a federal organ-ization authorized to train medical students forthe uniformed services. The rules in thispublication apply to annuities bought for civil-ian faculty and staff for work they performedafter 1979.

Certain Employers ofMinistersA duly ordained or licensed minister of achurch, who in connection with the exerciseof his or her ministry is either:

1) Self-employed or

2) Employed by an organization other thana tax-exempt organization (a chaplain),

is treated as employed by a tax-exempt or-ganization.

Eligible EmployeesA qualified employer can purchase TSAs onlyfor eligible employees. If you are subject tothe will and control of an employer regardingwhat work you do and how you do it, you arean employee. If you are subject to the controlor direction of another as to the result only,and not how you do the work, you will gen-erally be an independent contractor, and notan eligible employee.

Your employer may be able to help you

determine whether you are an eligible em-ployee.

Employees of PublicSchool SystemsYou are considered eligible if you performservices as an employee, either directly orindirectly, for a public school. For example,the principal, clerical employees, custodialemployees, and teachers at a public elemen-tary school are employees performing ser-vices directly for an educational organization.

If you do not work in a school, but areinvolved in the operation or direction of theeducational program carried out in public

schools, you are an eligible employee per-forming services indirectly for public schools.Also, you are an eligible employee if you areparticipating in an in-hometeaching programsince the program is merely an extension ofthe activities carried on by public schools.

Department of Education employees ap-pointed by a state commissioner of edu-cation. Janitorial, custodial, and generalclerical employees indirectly perform servicesfor an educational organization and are eligi-ble employees. If you have a significant de-gree of executive or policymaking authority,and your appointment is based on requiredtraining or experience in the field of educa-tion, you also indirectly perform service for

an educational organization and are an eligi-ble employee.

Elected or appointed to office. If you oc-cupy an elective or appointive office, you maybe an eligible employee. You are an eligibleemployee if your office is one to which aperson is elected or appointed only if he orshe has received training, or is experienced,in the field of education.

A commissioner or superintendent of ed-ucation generally is considered an employeeperforming services for an educational or-ganization. However, a university regent ortrustee, or a member of a board of education,is not an eligible employee.

Employees of a state teachers' retirementsystem. Employees of a retirement systemthat administers a state teachers' retirementprogram are not eligible to participate in aTSA program because these employees arenot performing services directly or indirectlyfor an educational organization.

Employees of CertainTax-Exempt OrganizationsCertain tax-exempt organizations (described

under Qualified Employer, earlier) can pur-chase TSAs for some or all of their employ-ees. Employees of these tax-exempt organ-izations include individuals who performservices as social workers, members of theclergy, teachers, professors, clerks, secre-taries, etc.

A physician who works in a hospital asan employee may be eligible. Eligibility de-pends upon the amount of supervision andcontrol of the services performed and otherfactors.

A physician is an employee, for example,if, by agreement, he or she:

Does not take on outside duties thatwould negatively affect primary services

to the hospital, Does not furnish services to other hospi-

tals without the employer's consent,

Obeys all rules and regulations of thehospital, and

Receives a pay adjustment if the per-centage of pay is less than an amountguaranteed by the agreement.

However, not all physicians who performservices for a hospital are employees. Forexample, a physician who performs servicesas a director of a hospital's department ofpathology is notan employee if he or she:

Receives a percentage of the depart-ment's income for the services,

Pays an associate or substitute,

Is allowed to privately practice medicine,

Is not entitled to regular employee fringebenefits, and

Is not subject to the general rules thatapply to the hospital's employees.

Each case must be decided on its ownfacts and circumstances. No set rule will ap-ply to all cases.

Ministers of Certain EmployersBeginning in 1997, a duly ordained or li-censed minister of a church who is workingas a minister or chaplain, but is self-employedor is working for an employer that is not aqualified tax-exempt organization, is treatedas employed by a qualified tax-exempt or-ganization for purposes of participating in aretirement income account (TSA plan).

ContributionsA TSA can be funded by the following contri-butions:

Elective employer contributions (electivedeferrals),

Non-electiveemployer contributions,

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After-taxemployee contributions, or

A combination of the above.

Elective deferrals defined. Your employer'splan may permit you to have part of your paycontributed by your employer to a retirementfund, rather than have it paid to you. Theseemployer contributions are called electivedeferrals because

1) You choose (elect) to set aside part of

your pay, and2) Payment of tax owed on that part of your

pay is postponed (deferred) until it isdistributed to you.

Non-elective employer contributions de-fined. An employer contribution to a TSA istreated as a non-elective contribution if em-ployees are not required to choose the con-tributions. The employer chooses to makethese contributions to the TSAs and generallymust make them on behalf of all eligible em-ployees. The employer must be a qualifiedemployer (defined earlier) for the contribu-tions to be excluded from the employee'sgross income. These contributions are sub-

ject to the limit on employer contributionsdiscussed later.

After-tax employee contributions. If theplan permits these contributions, an em-ployee contribution made with funds on whichincome taxes have already been paid istreated as an after-tax contribution. A salarypayment on which income tax was withheldis an example of such funds. These contri-butions are subject to the limit on employercontributions.

Funding by elective deferrals. Employerscontribute to a TSA primarily through a salaryreduction agreement. (See Salary Re-duction Agreement, later, for more informa-

tion.) Under this agreement, you (the em-ployee) agree to take a reduction in salary orto forego a salary increase and your employeragrees to contribute the amount of the salaryreduction or the foregone salary increase to-ward the purchase of your TSA.

These employer contributions are ex-cluded (within limits discussed next) fromyour income when made. The excludedamounts are included in your income whenyou withdraw them. These contributions gen-erally are called elective deferrals. See Limiton Elective Deferrals, later, for more infor-mation.

Exclusion From Gross

IncomeGenerally, if you are an eligible employee,you can exclude from gross income yourqualified employer's contributions to yourTSA.

Exclusion LimitsThe amount you exclude for a tax year cannotbe more than any of the following limits:

1) The exclusion allowance(discussedlater) for your tax year,

2) The annual employer contributionlimit(discussed later) for the limitation

year(discussed later) ending with orwithin your tax year, or

3) The limit on elective deferrals(dis-cussed later) for the year.

For purposes of applying these limits, youremployer's contributions do not include arollover contribution from another TSA or anindividual retirement arrangement (IRA).

Alternative limits. You may be able to use

an alternative limit to increase the amount youcan exclude. See Catch-up Election Alter-native Limits for Certain Employees, later.

TIP

Beginning in 1997, contributionsmade by a self-employed minister orchaplain who is treated as employed

by a qualified tax-exempt organization to aretirement income account that is treated asa tax-sheltered annuity are deductible up tothese limits for tax-sheltered annuities.

Treatment of excess contributions. If thecontributions to your TSA for a year are morethan any of the limits discussed above underExclusion Limits, you must include the excessin your income for that year. Further, if youhave an excess because the contributions aremore than limit (2), that excess reduces theamount of your exclusion allowance for futureyears, even though the excess has alreadybeen included in your income.

For more information on the treatment ofexcess contributions, see Excess Deferrals,Limit on Employer Contributions, and Tax onExcess Contributions to a Custodial Account,later.

Only elective deferrals. If all of the contri-butions are elective deferrals, the total mustnot be more than the smallest of the threelimits in the preceding list.

Only nonelective contributions. If all of thecontributions are nonelective contributions,only limits (1) and (2) apply.

Both elective deferrals and nonelectivecontributions. If the total contributions in-clude both elective deferrals and nonelectivecontributions and limit (3) is the smallest ofthe limits in the preceding list, the electivedeferrals minus limit (3) is an excess deferral.The total of all contributions (including theelective deferrals) minus the smaller of limit(1) or (2) is an excess contribution.

More than one TSA. If for any tax year

elective deferrals are contributed to more thanone TSA for you (whether or not with thesame employer), you must combine all theelective deferrals to determine whether thetotal is more than the limit for that year. SeeLimit on Elective Deferrals, later.

TIP

You can use the worksheets at theend of this publication to figure thefollowing contribution limits that gen-

erally apply to you. For limit (1), use Work-sheet 1. For limit (2), use Worksheet 2. Forlimit (3), use Worksheet 3. However, you mayqualify to choose an alternative limit (work-sheet 4, 5, or 6). See Catch-up Election Alternative Limits for Certain Employees,later.

Salary ReductionAgreementThe most common way to contribute to TSAsis through a salary reduction agreement. Asalary reduction agreement is an agreementbetween the employer and employee underwhich the employee agrees to take a re-duction in salary or to forego a salary increaseand the employer contributes that amount to

a TSA for that employee.

TIP

You can enter into more than onesalary reduction agreement during atax year. In addition, for salary re-

duction purposes, you can use compensationthat has not yet been made available to you.(However, to determine what compensationcan be used to figure the maximum exclusionallowance, see Includable Compensation,later, underThe Exclusion Allowance.)

Treatment of contributions. Amounts con-tributed by the employer under the salary re-duction agreement and invested in a TSA forthe employee are generally treated as elec-tive deferrals(See Elective deferrals defined

under Limit on Elective Deferralslater.)Exemption. An employer contribution to

a TSA is not treated as an elective deferralifit is made as a condition of employment oras a one-time choice by the employee whenhe or she first becomes eligible to participatein the agreement. But, if the employee canchange or end the election to participate, theelection is not a one-time choice and thecontributions are elective deferrals.

Limit on ElectiveDeferrals

In addition to the exclusion allowance andthe limit on employer contributions (theselimits are discussed later), which apply to TSAcontributions, there is an annual limit oncombined elective deferrals. Elective defer-rals are defined earlier under Contributions.

Deferrals subject to limit. The limit appliesto the total of all elective deferrals contributed(even if contributed by different employers) forthe year on your behalf to:

Cash or deferred arrangements (knownas section 401(k) plans) to the extentexcluded from your gross income,

Section 501(c)(18) plans created beforeJune 25, 1959, and only to the extent

excluded from your gross income, SIMPLE plans,

Simplified employee pension (SEP)plans, and

Tax-sheltered annuities.

Dollar limit. Generally, you cannot defermore than an allowable amount each year forall plans covering you, including TSAs. For1997, the allowable amount (limit) is $9,500.(This limit applies without regard to commu-nity property laws.) If you defer more than theallowable amount for a tax year, you mustinclude the excess in your gross income forthat year (see Excess Deferrals, later).

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Increase for 15-year employees. If youhave a TSA and you have completed at least15 years of service with an educational or-ganization, hospital, home health serviceagency, health and welfare service agency,church, or convention or association ofchurches (or associated organization), the$9,500 limit for the TSA is increased each taxyear. The limit is increased by the smallestof the following:

1) $3,000, or

2) $15,000, reduced by increases to the$9,500 limit you were allowed in earlieryears because of this rule, or

3) $5,000 times the number of your yearsof service for the organization, minus thetotal elective deferrals made by the or-ganization for you for earlier years.

For example, if you qualify, you may in-crease your elective deferrals to $12,500. Forthe computation, see Step 2 of Worksheet 3.

Cost-of-living adjustment. Under cur-rent law, the $9,500 limit is to be increasedto reflect any increases in the ConsumerPrice Index in future years.

WORKSHEET 3at the end of thispublication will help you figure the Limiton Elective Deferrals.

Excess DeferralsExcess deferrals are elective deferrals thatexceed the limit on elective deferrals.

Tax TreatmentIf the total you defer for a tax year is morethan the limit for the year, you must includethe excess in your gross income for that yearon line 7 of Form 1040.

Distribution of excess. If the plan permitsand you want to receive the excess amount,

you must notify the plan as explained next.One plan. If only one plan is involved,

you must notify the plan by March 1 after theend of the tax year that an excess was de-ferred. The plan must then pay you the ex-cess, along with any income on that amount,by April 15.

CAUTION

!Because you are responsible for no-tifying the plan, you must monitorcontributions to the plan.

More than one plan. If more than oneplan is involved, you must notify each planby March 1 of the amount to be paid from thatparticular plan, and the plan must then payyou that amount, along with any income onthat amount, by April 15.

If you take out the excess by the re-quired date, do not include it again in yourgross income and do not subject it to the ad-ditional 10% tax for premature distributions.However, any income earnedon the excessthat is taken out is taxable in the tax year youtake it out.

If you take out partof the excess deferraland the income earned on it, you must treatthe distribution as if ratably received from theexcess deferral and the income earned on it.For example, assume that your excessdeferral is $1,800 and the income earned onit is $200. If your distribution is $1,000, $900is from the excess deferral and $100 is fromthe income earned that must be separatelyreported.

Excess left in the plan. If you leave theexcess deferral in the plan, you must includethe excess amount in your gross income forthe tax year in which the amount was de-ferred. You cannot treat the excess amountas an investment in the contract (tax-free re-turn of cost) when you figure the taxableamount of any future benefits or distributions.Thus, an excess deferral left in the plan wouldbe taxed twice, once when contributed andagain when distributed.

Limit on EmployerContributionsLimits are placed on the contributions that canbe made by an employer to tax-shelteredannuity (TSA) programs for each limitationyear. Every TSA is treated as a defined con-tribution plan for purposes of this limit (whichis also called the general rule). Under thegeneral rule, an employer's contributions(including elective deferrals) to an employee'saccount under a defined contribution planshould not be more than the lesser of:

1) $30,000, or

2) 25% of the employee's compensationfor the year.

This limit is in addition to the exclusion al-lowance (discussed later) and the limit onelective deferrals (discussed earlier). Also,see Catch-up Election Alternative Limits forCertain Employees, later.

WORKSHEET 2at the end of thispublication will help you figure the Limiton Employer Contributions and theamount you can exclude from grossincome.

Limitation year. Generally, your limitation

year is the calendar year. However, you canelect to change to a different limitation yearconsisting of a period of 12 consecutivemonths by attaching a statement to your in-dividual income tax return for the tax year youmake the change.

Contributions in excess of employer limit.An excess employer contribution must be in-cluded in your gross income in the tax yearwhen it is made. For future tax years, theexclusion allowance must be reduced by thisexcess contribution even though it was notexcludable from your gross income in the taxyear when it was made.

TSA and qualified plan. If because youmust combine a TSA with a qualified plan, thelimit is exceeded, the same rule applies. Youmust include the excess in your gross incomefor the tax year the excess contribution ismade and reduce your exclusion allowancefor any future years in which you are a par-ticipant in a TSA program.

If you are a participant in both a TSAprogram and a qualified plan, see Limit forContributions to More Than One Program,later.

Excess contribution in earlier years. Ifin earlier years your employer made annualcontributions to a TSA for you that were morethan the annual maximum permitted underthis limit on employer contributions, your ex-clusion allowance is reduced by the ex-cess.

Reduction procedure. The exclusion al-lowance is reduced by including the excesscontributions from prior years in amountspreviously excludable, discussed later un-der The Exclusion Allowance. Include prioryears' excess contributions in amounts previ-ously excludable only if the limit was ex-ceeded for a tax year beginning after January24, 1980.

Compensation. Generally, for the 25% limit(item (2) at the beginning of this discussion),

compensation includes:

Wages, salaries, and fees for personalservices with the employer maintainingthe plan, even if excludable as foreignearned income,

Certain taxable accident and health in-surance payments,

Moving expense payments or reimburse-ments paid by employer if such paymentsare not deductible by you, and

The value of nonqualified stock optionsgranted to you that are includible in yourgross income in the year granted.

Generally, compensation does not include:

Contributions toward a tax-sheltered an-nuity contract,

Contributions toward a deferred com-pensation plan if, before applying the limiton employer contributions, the contribu-tions are not taxable,

Distributions from a deferred compen-sation plan,

Proceeds from the disposition of stockacquired under a qualified stock option,and

Certain other amounts that areexcludable from your income, such asgroup term life insurance premiums that

are not taxable.

More than one annuity contract. For eachyear you apply this limit, you must combinethe contributions to all TSAs made on yourbehalf by your employer. This is donewhether or not you elect one of the alternativelimits discussed under Catch-up Election Alternative Limits for Certain Employees,later. You may also have to combine contri-butions to qualified plans of the same em-ployer or an employer that you control (forpurposes of applying this limit). See Limit forContributions to More Than One Program,later.

The ExclusionAllowanceThe exclusion allowance is the amount ofemployer contributions (including electivedeferrals) to your tax-sheltered annuity (TSA)that you can exclude from income. You paytax on these excluded amounts when youreceive a distribution from the TSA.

More than one TSA. If, during any tax year,you have two or more TSA contracts, custo-dial accounts, or retirement income accountsmaintained by your employer, figure only

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one exclusion allowance for the TSAs be-cause you must consider them as one TSA.

More than one employer. If more than onequalified employer contributes to a TSA foryou, you must figure a separate exclusionallowance for each qualified employer. Donot include amounts contributed, compen-sation, or years of service for one qualifiedemployer in the computation for anotherqualified employer. Special rules apply tochurch employees, as discussed under Yearsof Service, later.

Employer must remain qualified. The ex-clusion allowance applies only to those con-tributions made while your employer was aqualified employer. If, for example, your em-ployer loses tax-exempt status and is nolonger qualified, your exclusion allowance willnot apply to the employer's contributionsmade after losing the exemption.

How to FigureYou determine the exclusion allowance at theend of your tax year as follows:

Reduction of the exclusion allowance.You must reduce your exclusion allowanceby the amount that your employer's contribu-tions (for tax years beginning after January24, 1980) were more than the limit on em-ployer contributions for those years. (SeeContributions in excess of employer limit un-der Limit on Employer Contributions, earlier.)For future years, treat the excess as though

it were an amount previously excludable.

Example. At the end of 1997, you hadcompleted 3 years of service with your em-ployer. Your salary for 1997 was $32,000 af-ter being reduced under a revocable salaryreduction agreement by $3,600 to financeyour employer's contributions toward thepurchase of a TSA for you. Your employer'scontributions for the year totaled $3,600, $100of which was for current term life insuranceprotection.

In previous years, your employer's contri-butions to the regular retirement plan totaled$7,200, all of which you properly excludedfrom gross income. You figure your exclusionallowance (the amount excludable from grossincome) and the amount of any employer

contributions includible in your gross incomefor 1997 as follows:

WORKSHEETS 1 through 6at the endof this publication will help you figurethe amount of employer contributionsthat you can exclude from gross incomeand the amount you must include.

Catch-up election for certain employees.Certain employees can elect to substitute thelimit on employer contributions for the exclu-sion allowance under an alternate rule calledthe Overall Limit(explained under Catch-upElection Alternative Limits for Certain Em-

ployees, later). Only employees of educa-tional organizations, hospitals, home healthservice agencies, health and welfare serviceagencies, churches, and certain church-related organizations can make the election.

Minimum exclusion allowance forchurch employees. If you are a churchemployee (defined later under Years of Ser-vice) and your adjusted gross income (figuredwithout regard to community property laws)is not more than $17,000, you are entitled toexclude from your gross income a certainminimum amount called a minimum exclusionallowance. The minimum is your exclusionallowance figured as explained earlier, but notless than the smaller of:

1) $3,000, or

2) Your includible compensation(definednext).

Includible CompensationAs a first step in figuring your exclusion al-lowance for a tax year, you must figure 20%of your includible compensation.

Generally, your includible compensationis the salary (not including employer contri-butions to your TSA) from your employer whomade contributions to your TSA that is:

1) Earned during your most recentperiodthat may be counted as one year ofservice, and

Step 2Contributions in Excess of EmployerLimit

2) Includible in your gross income.

TIP

Beginning in 1998, for purposes offiguring your exclusion allowance,which is the amount of employer

contributions (including elective deferrals) toyour tax-sheltered annuity that you can ex-clude from income, your includible compen-sation includes:

1) Elective deferrals (employer's contribu-tions made on your behalf under a salaryreduction agreement),

2) Amounts contributed or deferred by youremployer under a Section 125 cafeteriaplan, and

3) Amounts contributed or deferred undera Secion 457 nonqualified deferredcompensation plan (state or local gov-ernment or tax-exempt organizationplan).

Self-employed ministers. Beginning in1997, compensation of a self-employedminister who is treated as employed by atax-exempt organization, is the minister'searnings from self-employment reduced bycontributions to retirement plans and the de-

duction for one-half of the self-employmenttax.

Special RulesWhen figuring your includible compensationyou should examine the following exceptionsand definitions.

Employer not qualified. Only the compen-sation earned from the qualified employerpurchasing your TSA contract can qualify asincludible compensation. Do not countcom-pensation earned while your employer wasnot a qualified employer. However, your em-ployer's status when you actually receive thecompensation does not matter.

Other employers. Compensation from

other employers who either are not qualifiedor are not purchasing your TSA contract, andcompensation from other sources generallyis not includible compensation. However, seeService with one employer, under Years ofService, later.

Contributions for a TSA. Contributions byyour employer (including elective deferrals)for a tax-sheltered annuity are not part ofincludible compensation.

However, If you are a foreign missionaryduring the tax year, your includible compen-sation includes contributions by the churchduring the year toward your tax-shelteredannuity.

You are a foreign missionary if your prin-

cipal duties are spreading religious doctrineor performing sacerdotal functions orhumanitarian good works for the church out-side the United States.

TIP

Beginning in 1998, contributionsmade to a church plan on behalf of aduly ordained, commissioned, or li-

censedminister employed by an employerother than the churchare excluded from theminister's gross income if they would havebeen excluded had the minister been an em-ployee of the church.

For purposes of this rule, a minister of achurch also includes:

1) A self-employed minister, and

2) 1997 contribution forpurchase of TSA .................. $3,600

3) Minus: Portion of line 2,if any, representing cost ofterm life insurance (treatedas paid by employee) .......... 100

4) Employer contribution ......................... $3,5005) Minus: Limit on employer contributions

[line 1(c)] ............................................. 8,0006) Excess contribution (if any) ............. $ 0

Step 3Exclusion Allowance7) Includible compensation ..................... $32,000

8) Percentage limit .................................. 20%9) Years of serv ice ... .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. 3

10) Multiply (7) (8) (9) ........................ $19,20011) Minus: Amounts previously

excludable .......................................... 7,20012) Exclusion allowance ........................ $12,000

Step 4Amount Excludable From Gross Income13) a) Employer contribution

[line 4] .................................. $3,500b) Limit on employer contri-butions [line 1(c)] ................. $8,000c) Exclusion allowance[line 12] ................................ $12,000d) Limit on electivedeferrals ............................... $9,500

14) Amount excludable[least of 13(a), (b), (c), or (d)] ............ $3,500

1) Includible compensation (discussedlater) ...................................................... $

Step 5Amount Includible in Gross Income15) Employer contribution [line 4] ............. $3,500

16) Minus: Amount excludable [line 14] .. 3,5002) Percentage limit .................................... 20%17) Amount includible ........................... $ 0

3) Years of service (discussed later) ......

4) Multiply (1) (2) (3) ........................... $

5) Minus: Amounts previouslyexcludable (discussed later) ................

6) Exclusion allowance (before reductionfor any excess contributions) ................ $

Step 1Limit on Employer Contributions1) a) Maximum ......................... $30,000

b) 25% of employee's com-pensation (25% $32,000 =$8,000) ................................. $8,000c) Limit (Lesser of (a) or (b)). ... ... ... .. ... ... ... ... ... ... ... ... ... ... ... . $8,000

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2) A minister employed by an organizationother than a tax-exempt organizationthat shares a common religious bondwith the minister.

Contributions to a TSA and a qualified re-tirement plan. If your employer makes con-tributions for you toward both a TSA contractand a qualified retirement plan, the contri-butions to the qualified retirement plan are notpart of includible compensation for figuringyour exclusion allowance.

Contributions that are more than your ex-clusion allowance. Contributions that aremore than your exclusion allowance are notpart of compensation for figuring your exclu-sion allowance, but they must be included inyour gross income.

Example. After taking a reduction in sal-ary to pay for your employer's contribution foran annuity during your first year of employ-ment, you received a salary of $12,000. Ac-cording to your agreement, $2,800 ($400more than your exclusion allowance) is con-tributed for your annuity. Use $12,000 asincludible compensation in figuring the exclu-sion allowance, even though you must include

$12,400 in gross income.

The cost of incidental life insurance. Thecost of incidental life insurance provided un-der a TSA contract is not includible compen-sation even though this cost is taxable to you.This part of the cost of your TSA contract istreated as contributed by you, rather thanyour employer, and is part of your cost (basis)in the contract.

Foreign earned income exclusion.Excludable foreign earned income is part ofincludible compensation.

Most Recent One-Year Period of

ServiceYour includible compensation is only thecompensation earned during your most re-cent period of service that ends on or beforethe end of the tax year for which the exclusionallowance is being determined. The periodmust be a full year of service if the total timeyou worked for your employer equals at leastone full year. A part-time employee or a full-time employee who works part of a year,discussed below, must combine earnings forfractional parts of a year until they equal a fullyear's earnings. Your most recent period ofservice will include more than one tax year ifyou were a part-time employee or if you werea full-time employee who worked only part ofa tax year and you worked for your employerat least one full year over a period of morethan one tax year.

If you worked less than a full year foryour employer by the end of a tax year forwhich you are figuring the exclusion allow-ance, consider the actual period of your em-ployment as your most recent one-year periodof service for figuring your includible com-pensation.

For example, if you became employed onOctober 1, 1997, your most recent one-yearperiod of service for figuring your includiblecompensation for your 1997 exclusion allow-ance is the period from October 1 throughDecember 31, 1997. If your annual salary is$20,000, your includible compensation wouldbe $5,000 (1/4 of $20,000).

Earned in a prior tax year. Yourincludible compensation may include all orpart of your compensation earned in a taxyear before the one for which the exclusionallowance is being determined. What is im-portant is when you perform the service, notwhen you actually receive the compensationor the tax year in which it is includible in yourgross income.

For example, if you are figuring your ex-clusion allowance for your 1997 tax year, andyou were employed half time by your em-ployer for all of 1996 and 1997, your includiblecompensation will include the amountsearned in 1996 and 1997.

In figuring your includible compensation,you must first take into account the serviceyou performed during the tax year for whichthe exclusion allowance is being determined.Therefore, your most recent one-year periodof service may not be the same as your em-ployer's most recent annual work period.

Example. You are employed as a pro-fessor at a university and you use the calen-dar year as your tax year. You are employedon a full-time basis during the university's199697 and 199798 academic years (Oc-tober through May). In figuring your exclusionallowance for your 1997 tax year, your most

recent one-year period of service consists ofthe service performed from January throughMay 1997 (which is part of the 199697 aca-demic year), and the service performed fromOctober through December 1997 (which ispart of the 199798 academic year).

CAUTION

!Your most recent one-year period ofservice for figuring includible com-pensation may not be the same pe-

riod as your limitation year for figuring the limiton employer contributions. See the dis-cussion of Limitation year, under Limit onEmployer Contributions, earlier.

Full-time employee for a full year. If youare a full-time employee for the full year, yourmost recent one-year period of service gen-

erally will be your current tax year.To determine whether you are employedfull time, compare the amount of work you arerequired to do with that required of individualsholding the same position with the same em-ployer and who receive most of their com-pensation from that position. If your positionwith your employer is the only one of its kindwith your employer, you cannot make thiscomparison. You should consider the sameposition with similar employers, or similar po-sitions with your employer.

In measuring the amount of work requiredby a particular position, any method that rea-sonably and accurately reflects the amountof work can be used. For example, the factthat a full-time English professor at yourschool normally performs 16 hours of class-room teaching each week may be used as ameasure of the amount of work required in theposition.

A full year of servicefor a particular po-sition means the usual annual work period ofindividuals employed full time in that generaltype of employment at the place of employ-ment. For example, if you are a doctor em-ployed by a hospital 12 months of the year,except for a one-month vacation, and theother doctors at the hospital work 11 monthsof the year with a one-month vacation, youwill be considered employed for a full year.Similarly, if the usual annual work period ata university consists of the fall and springsemesters, and you teach at the university

during these semesters, you will be consid-ered as working a full year.

Part-time employee, or full-time em-ployee working for part of a year treat-ment of fractional years. If you are a part-time employee, or a full-time employee whoworked for part of a year, you are treated ashaving a fraction of a year of service for eachyear you were so employed. You must totalthese fractional periods of service to deter-mine your most recent one-year period ofservice. You first take into account your ser-vice during the current tax year, then the nextpreceding tax year, and so forth, until yourservice equals one year of service.

Example. You are figuring your exclusionallowance for your 1997 tax year (which alsois a calendar year). You worked full timeone-fourth of a year for the last 10 years. Yourmost recent one-year period of service in-cludes the service you performed in the pe-riod 1994 through 1997, figured as follows:

Full-time employee for part of a year.

If you were a full-time employee for part of ayear, the numerator of the fraction that rep-resents your fractional year of service is thenumber of weeks (or months) that you werea full-time employee during that year. Thedenominator is the number of weeks (ormonths) considered to be the usual work pe-riod for your position.

Example. You are employed full time asan instructor by a university for the 1997spring semester (which lasts from Februarythrough May). The academic year of the uni-versity is 8 months long, beginning in Octoberand ending the following May. You are con-sidered as having completed four-eighths ofa year of service.

Part-time employee for a full year. Ifyou are a part-time employee for a full year,the numerator of the fraction that representsyour fractional year of service is the amountof work you are required to perform. The de-nominator is the amount of work normally re-quired of individuals who hold the same po-sition.

Example. You are a practicing physicianteaching one course at a local medical school3 hours a week for two semesters. Otherfaculty members at that medical school teach9 hours a week for two semesters. You areconsidered to have completed three-ninthsof a year of service.

Part-time employee for part of a year.

If you are a part-time employee for part of ayear, you figure the fraction that representsyour fractional year of service by:

1) Figuring a fractional year as if you werea full-timeemployee for part of a year,

2) Figuring a fractional year as if you werea part-timeemployee for a full year,and

3) Multiplying the fractions in (1) and (2).

Example. You are an attorney and aspecialist in federal tax law. In addition to yourprivate practice, you teach tax law for 3 hoursa week for one semester (the 4-month spring

1997 fractional period of service .................. 1/41996 fractional period of service .................. 1/41995 fractional period of service .................. 1/41994 fractional period of service .................. 1/41 year of service equals ............................... 4/4

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semester) at a nearby law school. Full-timeinstructors at the law school teach 12 hoursa week for two semesters (or an 8-monthacademic year).

A fractional year of service figured as ifyou were a full-time employee for part of ayear is four-eighths or one-half (the numeratorbeing the period you worked, 4 months, andthe denominator being the usual work period,8 months).

A fractional year of service figured as ifyou were a part-time employee for a full yearis three-twelfths of a year (the numerator be-ing the number of hours you are employed,and the denominator being the usual numberof hours required for that position).

Your fractional year of service as a part-time employee for part of the year is 3/24 (1/2

3/12) or one-eighth of a year.

Years of ServiceYour next step in figuring your exclusion al-lowance is to figure your years of service withthe employer that contributes to a TSA onyour behalf.

Your years of service are the total num-ber of years you worked for your employerfigured as of the end of the tax year for which

you are figuring an exclusion allowance. Youryears of service cannot be less than one year(if your most recent one-year period of ser-vice (discussed earlier) is less than a year,your years of service is one year). The ser-vice need not be continuous.

Self-employed ministers. Beginning in1997, years of service includes full years (andfractional years) in which a self-employedminister is treated as employed by a qualifiedtax-exempt organization.

Rules for FiguringThe following rules must be taken into ac-count when figuring years of service.

Status of employer. Your years of servicewill only include periods that your employerwas a qualified employer, as defined ear-lier.

Service with one employer. Generally, youcannot count service for any other employer.

However, if you are a church employee,treat all of your years of service with relatedchurch organizations as years of service withone employer. If during your church careeryou transfer from one organization to anotherwithin that church or to an associated organ-ization, treat all this service as service with asingle employer. When these organizationsmake contributions to your annuity contracts,

treat them as made by the same employer.Church employee. This is anyone whois an employee of a church or a conventionor association of churches. This includes anemployee of a tax-exempt organization con-trolled by or associated with a church or aconvention or association of churches.

Full-time employee for a full year. Counta year of service for each full year you haveworked full-time for the employer that con-tributes to the tax-sheltered annuity on yourbehalf. See the discussions of full-time em-ployee for a full yearand a full year of serviceearlier under Most Recent One-Year Periodof Service.

Part-time or full-time employee for part ofa year. You must figure the fraction thatrepresents your fractional year of service. Therules for doing this are the same as those forfiguring your Most Recent One-Year Periodof Service, discussed earlier.

Amounts PreviouslyExcludableThe next step in figuring your exclusion al-lowance is to subtract the amounts previouslyexcludable from the result of multiplying 20%of includible compensation by your years ofservice.

Amounts previously excludable defined.Amounts previously excludable refers to thetotal of all contributions for retirement benefitsmade for you by your employer that wereexcludable from your gross income. Includeonly amounts for tax years before the one forwhich the current exclusion allowance is be-ing figured.

Amounts previously excludable includecontributions in earlier years by your em-ployer to:

A tax-sheltered annuity, A qualified annuity plan or a qualified

pension, profit-sharing, or stock bonustrust,

A qualified bond-purchase plan,

A retirement plan under which the contri-butions originally were excludable by youonly because your rights to the contribu-tions were forfeitable when made, andwhich also were excludable by you whenyour rights became nonforfeitable (Thisdoes not apply to contributions made af-ter 1957 to purchase an annuity contractif your employer was an exempt organ-ization when the contributions weremade.), or

An eligible deferred compensation plan(under Code section 457) of a state orlocal government or tax-exempt organ-ization, even if maintained by a separateemployer.

You must treat contributions to a stateteachers retirement system made for you inearlier tax years, up to the amount that wasexcludable, as amounts previouslyexcludable.

You must treat employer contributions andother additions in earlier years (beginning af-ter January 24, 1980) that were more than thelimit as if they were amounts previouslyexcludable. See Limit on Employer Contribu-tions, earlier.

Contributed amount unknown.

If you do not know the amount thatan employer contributes to a plan onyour behalf, you can figure your part

of your employer's contributions by anymethod using recognized actuarial principlesthat are consistent with your employer's planand the method used by your employer forfunding the plan. You may also use the fol-lowing formula.

Formula to figure. The contributionsyour employer made for you as of the end ofany tax year are the result of multiplying thefollowing four items:

1) The projected annual amount of yourpension (as of the end of the tax year)to be provided at normal retirement agefrom employer contributions, based onyour plan in effect at that time and as-suming your continued employment withthat employer at your then current salaryrate,

2) The value from Table I based on thenormal retirement age as defined in theplan,

3) The amount from Table II for the sum ofthe following two items:

a) The number of years remainingfrom the end of the tax year tonormal retirement age, plus

b) The lesser of the number of yearsof service credited through the endof the tax year or the number ofyears that the plan has been in ex-istence at that time, and

4) The lesser of the number of years ofservice credited through the end of thetax year or the number of years that theplan has been in existence at that time.

An example of the use of these four items tofigure an employer's contribution for you fora year follows Table I and Table II.

Note: If the normal form of retirementbenefit under the plan is other than astraight-life annuity, divide the value fromTable I by the appropriate figure as follows:

Table I

[Value at normal retirement ages of annuity of $1per year payable in equal monthly installmentsduring the life of the employee.][For tax years beginning after July 1, 1986.]

Ages Value40 ................................................................. 11.4941 ................................................................. 11.4042 ................................................................. 11.3143 ................................................................. 11.2244 ................................................................. 11.1245 ................................................................. 11.0146 ................................................................. 10.9147 ................................................................. 10.7948 ................................................................. 10.6849 ................................................................. 10.5650 ................................................................. 10.4351 ................................................................. 10.3052 ................................................................. 10.1853 ................................................................. 10.0454 ................................................................. 9.8955 ................................................................. 9.7556 ................................................................. 9.6057 ................................................................. 9.4458 ................................................................. 9.2859 ................................................................. 9.1360 ................................................................. 8.9661 ................................................................. 8.7962 ................................................................. 8.6263 ................................................................. 8.4464 ................................................................. 8.2565 ................................................................. 8.0866 ................................................................. 7.8867 ................................................................. 7.70

68 ................................................................. 7.5069 ................................................................. 7.2970 ................................................................. 7.1071 ................................................................. 6.8872 ................................................................. 6.6873 ................................................................. 6.4674 ................................................................. 6.2575 ................................................................. 6.0376 ................................................................. 5.8277 ................................................................. 5.6178 ................................................................. 5.4079 ................................................................. 5.2080 ................................................................. 4.99

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The term cash refund refers to a refundof accumulated employer contributions, not toa refund of employee contributions only, oftenreferred to as modified cash refund.

Example. Joe Blue, who was 29 at theend of 1997, has been employed by the OakCounty school system since 1994. In 1994,Joe's employer contributed to a TSA program.Since 1994, Joe's employer has contributedto both the TSA program and a statewide re-tirement system that provides a straight-lifeannuity upon retirement. Joe is covered byboth plans.

For 1997, Joe wishes to figure theamounts previously excludable under bothplans so that he can figure the exclusion al-lowance for that year. His employer's contri-butions to the statewide retirement systemwere not allocated among the individual em-ployees.

Joe's employer gives him the followinginformation:

Employer contributions to the TSA thatwere excludable from gross income in prioryears:

The projected annual amount of Joe's re-tirement system pension (as of the end of19965 when Joe was 28) is $12,000. Thepension begins at age 65 from his employer'scontributions. This is based on 1996 planprovisions and assumes that Joe works forthe same employer until age 65 at his 1996salary. Normal retirement age is 65.

Annuity for 5 years certain and life there-after ............................................................ 0.97

Joe figures the amounts previouslyexcludable under the pension plan as fol-lows:

Joe multiplies A times B times C times D.$12,000 x 8.08 x .0039 x 3 = $1,134.43Joe then adds $1,134.43 to the amounts

($7,200) contributed to the tax-sheltered an-nuity plan in years prior to the 1997 tax yearto determine the amounts previouslyexcludableof $8,334.43.

Note: See Contributions in excess ofemployer limit, earlier under Limit on Em-ployer Contributions.

Catch-up Election Alternative LimitsforCertain EmployeesIf you are an employee of an educational or-ganization, a hospital, a home health serviceagency, a health and welfare service agency,or a church or church-related organizationthat contributes to a tax-sheltered annuity(TSA) for you, you can make a catch-upelection (see Background, later) to increase

the limit on your employer's contributions byusing one of three alternative limits. See alsoSpecial Election for Church Employees, later.

An educational organization and achurch employee have been defined earlier.

A home health service agency is a tax-exempt organization that has been deter-mined by the Secretary of Health and HumanServices to be a home health agency as de-fined in section 1861(o) of the Social SecurityAct.

A church, for this purpose, includes achurch, convention or association ofchurches, or a tax-exempt organization con-trolled by or associated with a church or aconvention or association of churches.

Background. Employees of these organiza-tions typically have a pattern of low employercontributions in the early years of their ca-reers and relatively high catch-up contribu-tions later. The three alternative limits wereestablished for these employees to allowthem to elect these higher catch-up contribu-tions.

Alternative limits. The three alternativelimits are:

1) The year of separation from service limit,

2) The any year limit, and

3) The overall limit (general rule).

Electing (choosing) a limit. You can electany one of the three limits, but with certainrestrictions, as explained later under Makingthe Election. For example, you cannot makemore than one election and, once one ismade, it is irrevocable and limits elections forfuture years.

Effect of election. Generally, the election touse one of the first two alternative limits listedabove will permit you to exclude from grossincome a larger amount of employer contri-

butions than allowed under the part of theoverall limit that limits employer contribu-tions to 25% of your compensation. Theoverall limit is sometimes referred to as thegeneral rule (discussed earlier under Limiton Employer Contributions). If you elect touse the overall limit, you may be able to ex-clude a larger amount because you can dis-regard the exclusion allowance (discussedearlier) that would otherwise apply.

Excess contributions. If employer contri-butions are included in your income for a taxyear because they exceed any of these al-ternative limits for that year, the excess re-duces the amount of your exclusion allow-ance for future years, even though the excesshas already been included in your income.

Year of Separationfrom Service LimitFor the limitation year (defined under Limiton Employer Contributions, earlier) that endswith or within the tax year you separate fromthe service of an educational organization,hospital, church, or other organization listedabove, you can elect to substituteyour ex-clusion allowance (modified as discussedbelow) for the 25% of your compensation limiton employer contributions under the generalrule. (See Limit on Employer Contributions,earlier.) The $30,000 limit on employer con-tributions still applies. The limit on elective

deferrals also still applies to the extent thecontributions consist of elective deferrals. SeeLimit on Elective Deferrals, earlier.

Figuring the limit.

Figure your exclusion allowance asexplained earlier, except, for youryears of service, count only the ser-

vice you performed during the 10-year periodending on the date of separation. Do not usea period longer than 10 years even if the10-year period is less than your actual num-ber of years of service. Your amounts previ-ously excludable are the amounts excludableduring your years of service (limited to 10years). All service for your employer per-formed within the 10-year period must be

taken into account.

Limit. Compare this modifiedexclusionallowance to the $30,000 limit on employercontributions and the limit on elective defer-rals, if it applies. Your year of separation fromservice limit is the least of these.

If your employer's contributions for theyear are more than the least of:

1) Your modified exclusion allowance,

2) $30,000, or

3) The limit on elective deferrals, if it ap-plies,

Annuity for 10 years certain and life there-after ............................................................ 0.90Annuity for 15 years certain and life there-after ............................................................ 0.80

A. Projected annual amount of pension atnormal retirement age (65) .................. $12,000

Annuity for 20 years certain and life there-after ............................................................ 0.70

B. Table I value at normal retirement age(65) ....................................................... 8.08

Life annuity with installment refund ........... 0.80 C. Table II amount for the sum of:Life annuity with cash refund ..................... 0.75 1) Number of years from

end of the preceding taxyear (1996) to normal re-tirement age (65 minus 28) . 372) Plus: Lesser of years of

plan existence or years ofservice ................................ 3Table II 40

Table II amount for total of 40 ............. .0039[Level annual contribution which will accu-mulate to $1.00 at the end of a number ofyears.]

D. Lesser of years of plan existence oryears of service .................................... 3

[For tax years beginning after July 1, 1986.]

Numberof years Amount

Numberof years Amount

1 .......... $1.0000 26 ........ $ .01252 .......... .4808 27 ........ .01143 .......... .3080 28 ........ .01054 .......... .2219 29 ........ .00965 .......... .1705 30 ........ .00886 .......... .1363 31 ........ .00817 .......... .1121 32 ........ .00758 .......... .0940 33 ........ .0069

9 .......... .0801 34 ........ .006310 ........ .0690 35 ........ .005811 ........ .0601 36 ........ .005312 ........ .0527 37 ........ .004913 ........ .0465 38 ........ .004514 ........ .0413 39 ........ .004215 ........ .0368 40 ........ .003916 ........ .0330 41 ........ .003617 ........ .0296 42 ........ .003318 ........ .0267 43 ........ .003019 ........ .0241 44 ........ .002820 ........ .0219 45 ........ .002621 ........ .0198 46 ........ .002422 ........ .0180 47 ........ .002223 ........ .0164 48 ........ .002024 ........ .0150 49 ........ .001925 ........ .0137 50 ........ .0017

1994 ............................................................. $2,0001995 ............................................................. 2,4001996 ............................................................. 2,800

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you must include the excess in gross income.

Example. Frank Green, who is presidentof a university, plans to retire on December31, 1997, after 20 years of service. His com-pensation for 1997, which was not reducedby any elective deferrals, is $100,000. Duringthe 10-year period before the date of sepa-ration from service, Frank's employer con-tributed $40,000 to Frank's TSA. The contri-butions, which were non-elective, wereexcludable from Frank's gross income. During

all his years of service, his employer contrib-uted a total of $60,000 that was excludablefrom Frank's gross income. For 1997, Frankelects to have his employer contribute themaximum amount permitted for non-electiveemployer contributions to his TSA. He fig-ures that amount using the Year of Sepa-ration from Service Limitas follows:

Because Frank elected this alternativelimit, and because there are no electivedeferrals, his employer can contribute$30,000 to Frank's TSA during the year of hisseparation from service without making anexcess contribution. In Step 1, Frank's unad-

justed exclusion allowance is $340,000. In

Step 2, employer contributions to Frank's TSAare limited to $25,000. If it were not for thiselection, the limit on employer contributionsfor Frank would be $25,000 (Step 2). Instead,the limit is $30,000.

WORKSHEET 4at the end of thispublication will help you figure the Yearof Separation from Service Limit andthe amount you can exclude from grossincome.

Any Year LimitFor any limitation year (defined under Limiton Employer Contributions, earlier), you cansubstitute for the 25% of employee's com-pensation limit the leastof the following:

1) $4,000, plus 25% of your includiblecompensation for the tax year in whichthe limitation year ends;

2) The exclusion allowance for the tax yearin which the limitation year ends; or

3) $15,000.

If you elect this limit, the maximum per-mitted contribution to your TSA is $15,000,not the $30,000 that may apply under otherlimits.

If your employer's annual contributions aremore than the least of:

1) Your Any Year Limit,

2) Exclusion allowance, or

3) The limit on elective deferrals (to theextent the contributions are electivedeferrals),

you must include the excess in your grossincome.

Example. Bill Black is a principal with theMaple County school system. In 1997, his17th year of service, Bill's salary is $39,000without reduction for an amount under a sal-ary reduction agreement. Bill's employer hadcontributed $34,400 to the tax-sheltered an-nuity program in earlier years and all thecontributions were excluded from Bill's in-come. Under a salary reduction agreement,Bill and his employer agree to elective defer-ral contributions of $9,000 that may be ex-cluded from Bill's gross income. To find themaximum employer contribution allowed, Bill

figured the Any Year Limitas follows:

Under this alternative limit, Bill's employercan contribute $11,500 to the annuity pro-gram.

In Step 1, the exclusion allowance is$67,600; in Step 2, the maximum amount theemployer can contribute on Bill's behalf is$11,500. Since the $9,000 contribution is lessthan the limit in Step 1, the limit in Step 2, andthe limit on elective deferrals, $9,000 can beexcluded from gross income.

If it were not for the alternative limit (theany year limit), the maximum amount Bill'semployer could contribute under the generalrule would be $7,500 (the lesser of $30,000or $7,500 (25% $30,000)). See also Exam-ples of Catch-up Elections, later.

WORKSHEET 5at the end of thispublication will help you figure the AnyYear Limit and the amount you canexclude from gross income.

Overall LimitYou can elect to have the limit on your em-ployer's contributions and your exclusion al-lowance be equal to the lesser of $30,000 or

25% of compensation (See Compensationunder Limit on Employer Contributions, ear-lier.) for the limitation year ending in the taxyear. Under this election, you disregard thecomputation of the exclusion allowance dis-cussed under The Exclusion Allowance, ear-lier.

Include in your gross income any contri-bution to your TSA that is more than thelesser of the limit on employer contributions($30,000 or 25% of compensation) or theelective deferral limit ($9,500), if it applies.

If you elect the Overall Limit as your al-ternative limit, you must combine employercontributions to your TSA with your employ-er's contributions to a qualified plan to deter-mine whether the limits on employer contri-

butions have been exceeded. See Limit forContributions to More Than One Program,later.

Example. Mary White is employed as anurse with Apple City General Hospital. In her11th year of service, she agrees to have heremployer contribute additional amounts to hertax-sheltered annuity program for catch-upcontributions.

Her compensation for 1997 is $35,000.She figures the overall limit on contributionsto be $8,750, as follows:

WORKSHEET 6at the end of thispublication will help you figure theOverall Limit and the amount you canexclude from gross income.

Examples of Catch-upElectionsThe following examples show how you canuse the three alternative limits just discussedto maximize the amount of employer contri-

butions to a tax-sheltered annuity (TSA) thatyou can exclude from income.

Example 1. Eli Green was an employeeof Maple Hospital, a tax-exempt charitableorganization, for the entire 1997 calendaryear. His employer's contributions to a TSAfor him are not subject to the elective deferrallimit. Eli has a salary of $30,000 for the year.He has 4 years of service with his employeras of December 31, 1997. During Eli's priorservice with Maple Hospital, his employer hadcontributed $12,000 on Eli's behalf to a TSA,and Eli excluded the amount from gross in-come in earlier years. Thus, for 1997, Eli'sexclusion allowance is $12,000, figured asfollows:

Step 1Exclusion Allowance (before modifica-tion)

1) Includible compensation ................ $100,0002) Percentage limit ............................. 20%3) Years of serv ice .. .. .. .. .. .. .. .. .. .. .. .. .. .. . 204) Multiply (1) (2) (3) .................... $400,0005) Minus: Amounts previously

excludable ...................................... 60,0006) Exclusion allowance ....................... $340,000

Step 2Limit on Employer Contributions1) Maximum ........................................ $30,0002) 25% of compensation limit .............

(a) Compensation ...................... $100,000(b) Percentage limit ................... 25%(c) Limit ...................................... $25,000

3) Limit on Employer Contributions(lesser of (1) or (2)) ....................... $25,000

Step 3Year of Separation from Service Limit1) Employer Limit on Contributions

Maximum ........................................ $30,0002) Exclusion allowance (modified)

(a) Includible com-pensation .................. $100,000

1) Maximum employer contributions ......... $30,0002) 25% of compensation

(25% $35,000) ................................... $8,750(b) Percentage limit . . 20%(c) Years of service(Limited to 10 years) . 10

3) Overall limit on employer

contributions(lesser of (1) or (2)) .............................. $8,750(d) Multiply (a) (b) (c) .............................. $200,000

Step 1Exclusion Allowance(e) Minus: Amountspreviously excludableduring 10-year period................................... 40,000

1) Includible compensation ..................... $30,0002) Percentage limit .................................. 20%3) Years of service .................................. 174) Multiply (1) (2) (3) ......................... $102,000(f) Exclusion allowance (modi-

fied) ............................................ $160,000 5) Minus: Amounts previously excludable............................................................. 34,4003) Alternative Limit Year of Sepa-

ration from Service Limit [lesser of(1) or (2)(f)] .................................... $30,000

6) Exclusion allowance ............................ $67,600

Step 2Any Year Limit7) a) $4,000 plus 25% of includible com-

pensation ($4,000 + $7,500 (25% $30,000)) ............................................. $11,500b) Exclusion allowance (from Line (6) . $67,600c) Maximum under this election .......... $15,000d) Alternative limit (Least of (a), (b), or(c)) ....................................................... $11,500

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The limit under the general rule (see Limiton Employer Contributions, earlier) is $7,500(the lesser of $30,000 or $7,500 (25% $30,000).

Without the catch-up elections providedfor certain employees, $7,500 would be themaximum contribution Maple Hospital could

make for TSAs on behalf of Eli for 1997without increasing Eli's gross income for thatyear.

Since Eli is an employee of a hospital, hecan elect one of the catch-up limits. Eli canelect either the Any Year Limitor the OverallLimit. He cannot elect the Year of Separationfrom Service Limitsince he does not separatefrom service in 1997.

If Eli elects the Any Year Limit, MapleHospital could contribute $11,500 on his be-half for 1997 to a TSA, figured as follows:

If Eli elects the Overall Limit, Maple Hos-pital could contribute only a maximum of$7,500 without increasing Eli's gross incomefor the year figured as follows:

Example 2. Assume the same facts asin Example 1, except that Maple Hospitalcontributed $18,000 on Eli's behalf in earlieryears to the TSA. The contributions wereexcludable from his gross income. Thus, for1997, Eli's exclusion allowance is $6,000 fig-ured as follows:

The limit under the general rule (the limiton employer contributions) for 1997 is thelesser of $30,000 or $7,500 (25% $30,000).

Without the catch-up elections, $6,000(the lesser of the two limits that apply) wouldbe the maximum amount Maple Hospitalcould contribute on Eli's behalf for TSAswithout increasing Eli's gross income. How-ever, if Eli elects the Overall Limit, MapleHospital could contribute up to $7,500 without

increasing Eli's gross income for 1997. Thisis because the election of this limit substitutesthe limit under the general rule for the exclu-sion allowance.

Example 3. Bob White, a teacher, isemployed by Elm School, a tax-exempt edu-cational organization. Bob has a salary, afterreduction for elective deferrals, of $44,000 for1997.

Bob has 20 years of service with ElmSchool as of May 30, 1997, the date he sep-arates from the service of Elm School. DuringBob's service with Elm School before tax year1997, Elm School had contributed electivedeferrals of $68,000 toward the purchase of

1) Includible compensation ....................... $30,000 TSAs on behalf of Bob. The amount wasexcludable from his gross income for the prioryears. Of this amount, $38,000 was contrib-uted and excluded during the 10-year periodending on May 30, 1997. Bob's electivedeferrals limit is increased because he hascompleted at least 15 years of service. Forthe tax year 1997, Bob's limit on electivedeferrals is $12,500 determined as follows:

Bob's limit on employer contributions is$11,000 determined as follows:

Bob's exclusion allowance is $108,000figured as follows:

Bob's limit under the general rule (limit onemployer contributions) is the lesser of$30,000 or $11,000 (25% of $44,000).

Without the catch-up elections, $11,000

would be the maximum excludable contribu-tion Elm School could make to a TSA onBob's behalf for 1997. This is the least of theexclusion allowance ($108,000), the generalrule ($11,000), or the increased electivedeferral limit ($12,500).

However, because Bob was an employeeof an educational organization and has sep-arated from service, he can elect any one ofthe three catch-up elections (alternative lim-its) to increase his allowable 1997 contribu-tion.

Before deciding which catch-up electionto make, Bob considers the following.

If Bob elects the Year of Separation fromService Limit for 1997, Elm School couldcontribute up to $30,000 for that year without

increasing Bob's gross income, figured asfollows:

If Bob elects the Any Year Limitfor 1997,Elm School could contribute up to $15,000,which is the least of the following:

If Bob elects the Overall Limit for 1997,Elm School could contribute up to $11,000,which is the lesser of the following:

Special Electionfor Church EmployeesIf you are a church employee and you electthe minimum exclusion allowance for churchemployees (described earlier under The Ex-clusion Allowance) applies to you, your em-ployer can make contributions for the year upto the minimum exclusion allowance eventhough the contributions would otherwise bemore than the limit on employer contributionsto a defined contribution plan, discussed ear-lier.

In addition to the any year or overalllimit, you can make a special election thatallows your employer to contribute up to$10,000 for the year, even if this is more than25% of your compensation for the year. Thetotal contributions over your lifetime under thiselection cannot be more than $40,000. In thissituation, the exclusion allowance limit stillapplies, unless you also elect the OverallLimit, described earlier. If the contributionsare elective deferrals, they are also subjectto the limit on elective deferrals, discussedearlier.

You cannot make this special election fora tax year in which you use the Year of Sep-aration from Service Limit, described earlier.

Making the ElectionYou make the election to apply one of thethree alternative limits by figuring your taxusing the limit you choose. However, theelection is treated as made only when neededto support the exclusion from gross incomereflected on the income tax return.

Election is irrevocable. If you elect to usean alternative limit, you cannot change theelection.

If you elect one of the alternative limits,you cannot elect to have any of the othersapply for any future year for any TSA pur-chased for you by any employer.

If you elect the Any Year Limit or theOverall Limit, it is the only alternative limit youcan use for later years.

If you elect the Year of Separation fromService Limit, you cannot elect any alternativelimit in any later year for any tax-shelteredannuity. You can use this limit only once.

Failure to pay estimated income tax. If youamend an earlier year's return to elect an al-ternative limit, and that limit increases yourtax for that year, the difference in tax due tothe use of the alternative limit is not treatedas an underpayment of tax for the penalty forfailure to pay estimated income tax.

1) $4,000, plus 25% of includible com-pensation ............................................. $15,0002) Percentage limit .................................... 20%

3) Years of service .................................... 4 2) Exclusion allowance ............................ $108,0004) (1) (2) (3) ........................................ $24,000 3) Maximum under this alternative .......... $15,0005) Minus: Amounts previously excludable . 12,000 4) Maximum contribution under Any Year

Limit(least of lines 1, 2, or 3) ............. $15,0006) Exclusion allowance .............................. $12,000

1) Maximum under this alternative ............ $30,0001) General limit .......................................... $9,5002) 25% of compensation ........................... $11,0002) Maximum additional .............................. 3,0003) Maximum contribution under the Overall

Limit(lesser of line 1 or 2) .................... $11,000

3) $15,000 less additional deferrals al-

lowed in prior years .............................. $15,0004) Prior year deferrals limit:

a) Annual amount ................. $5,000b) Years of service ... ... ... ... ... 20c) Multiply (a) x (b) ............... $100,000d) Less elective deferrals

made under plan forearlier years .....................

68,000

e)...

Balance .............................................32,000

5) Least of lines 2, 3, or 4(e) .................... 3,0006) Increased elective deferrals limit (line 1

plus line 5) ............................................ $12,500

1) $4,000, plus 25% of includible compen-sation ..................................................... $11,500

2) Exclusion allowance .............................. $12,000 1) Maximum ............................................... $30,0003) Maximum ............................................... $15,000 2) 25% of compensation ($44,000 x 25%)

............................................................... 11,0004) Any year limit [least of (1), (2), or (3)] .. $11,500

3) Lesser of line 1 or 2 .............................. $11,000

1) Includible compensation ..................... $44,0001) Maximum ............................................... $30,000 2) Percentage limit .................................. 20%2) 25% of compensation ........................... $7,500 3) Years of service .................................. 203) Overall limit [lesser of (1) or (2)] ........... $7,500 4) Multiply (1) (2) (3) ......................... $176,000

5) Minus: Amounts previously excludable............................................................. 68,000

6) Exclusion allowance ............................ $108,000

1) Includible compensation ....................... $30,0002) Percentage limit .................................... 20%3) Years of service .................................... 44) (1) (2) (3) ........................................ $24,0005) Minus: Amounts previously excludable . 18,0006) Exclusion allowance .............................. $6,000

1) Includible compensat

Documents

US Internal Revenue Service: p571--1997