Archive for March 2007

Swap Tactic Lets You Defer Capital-Gains Tax

March 21, 2007 by Ray Perez.

Have you ever called your mutual funds family and exchangedthe share in your growth fund for shares in a value fund? If so, you know that you pay capital gains taxes. A swap like this actually requires selling those growth fund shares.

Or try bartering your professional service. Offer, say,your medical services for a friend’s legal services to avoid income tax. If you’re audited, the IRS will nail you for not reporting the equivalent of wage income.

But if real estate’s your game, then swapping is a way of life. One of the sweetest tax breaks ever devised is the section 1031 exchange, which allows you to swap investment property on a tax-deferred basis.

Although sometimes known as like-kind exchanges, these transactions don’t have to involve identical types of investment property.

You can swap an apartment building for a shopping center, or a piece of raw land for an office building. You can swap a second home that you rent out for a parking lot.

It’s a tremendous deal, you can’t do that with stocks or bonds or personal property.

Originally, Section 1031 transactions were designed for people who wanted to exchange properties of equal value. Suppose you own land in Oregon and you trade it for a shopping center in Rhode Island. If the values are equal, nobody pays taxes even though both properties may have appreciated since they were originally purchased.

One variation involves properties of unequal value. Let’s say you have a small piece of property, and you want to trade up to a bigger one by exchanging it with another party. You can make the transaction without having to pay capital gains tax on the difference between the smaller property’s current market value and your lower original cost.

That’s good for you, but your partner doesn’t make out so well. Presumably, you have to pay cash or assume a mortgage on the bigger property to make up the difference in value. Known as “boot”in the tax trade, your partner must pay tax on that part transaction.
Work Through An Agent

To avoid that, you could work through an intermediary, who is often known as an escrow agent. Instead of a two-way deal involving a one-for-one swap, your transaction becomes a three-way deal.

Your replacement property may come from a third party through the escrow agent. Juggling numerous properties in various combinations, the escrow agent may arrange evenly valued swaps.

Under the right circumstances, you don’t even need to do an equal exchange. You can sell a property at a profit, buy a more expensive one, and defer the tax indefinitely.

You sell a property and have the cash put into an escrow account. Then the escrow agent buys another property that you want. He or she gets the title to the deed and transfers the property to you.

But you need to move fast. You must identify your replacement property within 45 days of selling your estate. Then you must close on that within 180 days. There is no grace period.

If your closing gets delayed by a storm or by other unforeseen circumstances, and you cannot close in time, you’re back to a taxable sale.
Advance Planning Required

Some accountants and lawyers specialize in Section 1031 exchanges to make sure that you qualify.

Because it’s such a significant tax benefit, there are all kinds of restrictions and pitfalls that you’ve got to be careful of. You’ve got to dot all of you i’s and cross all of your t’s.

A Section 1031 transaction takes advance planning. Find an escrow agent that specializes in the transaction. Contact your accountant to set up the IRS form ahead of time. Some people just sell their property, take cash and put it in their bank account. They figure that all they have to do is find a new property within 45 daysand close within 180 days. But that’s not the case.

As soon as (sellers) have cash in their hands, or the paperwork isn’t done right, they’ve lost their opportunity to use this provision of the code.

Section 1031 doesn’t apply to personal residences. But the IRS lets you sell your principle residence tax-free as long as the gain is under $250,000 for individuals and under $500,000 if you’re married.

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What should I include in a business plan? Some simple Q and A’s to get you started!

March 21, 2007 by Ray Perez.

The following outline of a typical business plan can serve as a guide that you can adapt to your specific business:

  • Introduction
  • Marketing
  • Financial Management
  • Operations
  • Concluding Statement

Q: What should be included in the introduction to my business plan?

A: The introductory section of your business plan should give a detailed description of the business and its goals, discuss its ownership and legal structure, list the skills and experience you bring to the business, and identify the competitive advantage your business possesses.

Q: What should be included in the marketing section of my business plan?

A: In the marketing section, you should discuss what products/services your business offers and the customer demand for them. Furthermore, this section should identify your market and discuss its size and locations. Finally, you should explain various advertising, marketing, and pricing strategies you plan to utilize.

Q: What should be included in the financial management section of my business plan?

A: In this section, explain the source and amount of initial equity capital. Also, develop a monthly operating budget for the first year as well as an expected return on investment, or ROI, and monthly cash flow for the first year. Next, provide projected income statements and balance sheets for a two-year period, and discuss your break-even point. Explain your personal balance sheet and method of compensation. Discuss who will maintain your accounting records and how they will be kept. Finally, provide “what if” statements that address alternative approaches to any problem that may develop.

Q: What should be included in the operations section of my business plan?

A: This section explains how the business will be managed on a day-to-day basis. It should cover hiring and personnel procedures, insurance, lease or rent agreements. It should also account for the equipment necessary to produce your products or services and for production and delivery of products and services.

Q: What should be included in the concluding statement of my business plan?

A: In the ending summary statement, summarize your business goals and objectives and express your commitment to the success of your business. Also be specific as to how you plan to achieve your goals.

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What is “Pass-Through” Taxation? Can it save me taxes?

March 14, 2007 by Ray Perez.

One of the disadvantages of forming a corporation is that you are subject to double taxation and in some states it could be triple taxation. The corporation is considered a separate entity seperate from its stockholders and is taxed on its profits at the Federal level and at the state level again. When these profits are distributed to the shareholders as dividends, they are taxed again (on the personal level.)

You can avoid this double or triple taxation by forming an LLC or by electing to have your corporation treated as an S Corporation (by filing Form 2553 within 75 days of first forming the business or first transacting business and have less than 75 shareholders who all agree to this form of taxation)

S Corporations and LLCs are taxed as if they were partnerships - no tax is due on the entity level. Each partnership engaged in a trade or business must file a return on Form 1065 showing its income, deductions, and other required information. The return shows the names and addresses of each partner and each partner’s distributive share of taxable income and deductions. This is an information return and must be signed by a general partner. If an LLC is treated as a partnership, it must file Form 1065 and one of its members must sign the return. The partnership does not pay any tax on its income but “passes through” its profits or losses to its partners. Partners must include partnership items such as their distributive share of income and deductions on their personal tax returns.

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Coverdell Education Savings Accounts (Section 530 Programs)

March 14, 2007 by Ray Perez.

You can contribute up to $2,000 each year to a Coverdell education savings account (Section 530 program) for a child under 18. These contributions are not deductible, but they grow tax-free until withdrawn. Contributions for any year (say 2007) can be made through the (unextended) due date for the return for that year (April 15, 2008).

Only cash can be contributed to a Section 530 account and you cannot contribute to the account after the child reaches his or her 18th birthday.

Anyone can establish and contribute to a Section 530 account, including the child, as long as the contributor’s modified AGI doesn’t exceed $220,000 for a joint return or $110,000 for a single filer. You may establish 530s for as many children as you wish, and the child need not be a dependent — in fact, he or she need not be related to you. But the amount contributed during the year to each account cannot exceed $2,000. This maximum contribution amount for each child is phased out for AGI between $190,000 and $220,000 (joint) and $95,000 and $110,000 (single).

  Note: A 6% excise tax applies to excess contributions. These are amounts in excess of the applicable contribution limit ($2,000 or phase out amount) and contributions for a year that amounts are contributed to a qualified tuition program for the same child. A qualified tuition program, sometimes called a Section 529 program, is a tax-favored state program to prepay education costs, see below. The 6% tax continues for each year the excess contribution stays in the 530 account.

The child must be named (designated as beneficiary) in the Coverdell document, but the beneficiary can be changed to another family member (for example, to a sibling where the first beneficiary gets a scholarship or drops out). And funds can be rolled over tax-free from one child’s account to another’s. Funds must be distributed not later than 30 days after the beneficiary’s 30th birthday (or 20 days after the beneficiary’s death if earlier). For “special needs” beneficiaries the age limits (no contributions after age 18, distribution by age 30) don’t apply.

Withdrawals are taxable to the person who gets the money, with these major exceptions: Only the earnings portion is taxable (the contributions come back tax-free). Also, even that part isn’t taxable income, as long as the amount withdrawn doesn’t exceed a child’s “qualified higher education expenses” for that year. The definition of “qualified higher education expenses” includes room and board and books, as well as tuition. In figuring whether withdrawals exceed qualified expenses, expenses are reduced by certain scholarships and by amounts for which tax credits (see Educational Credits, below) are allowed. If the amount withdrawn for the year exceeds the education expenses for the year, the excess is partly taxable under a complex formula. There’s another formula if the sum of withdrawals from this 530 program and from the qualified tuition (Section 529) program exceed education expenses.

You as the person who sets up the Section 530 account may change the beneficiary (the child who will get the funds) or roll the funds over to the account of a new beneficiary, tax-free, if the new beneficiary is a member of your family. But funds you take back (for example, withdrawal in a year when there are no qualified higher education expenses, because the child is not enrolled in higher education) are taxable to you, to the extent of earnings on your contributions, and you will generally have to pay an additional 10% tax on the taxable amount. However, you won’t owe tax on earnings on amounts contributed that are returned to you by June 1 of the year following contribution.

 

Investment policy

 

You may choose and change Section 530 investments freely — in contrast to Section 529 programs and, of course, Series EE bonds.

  Tip: Check with your financial adviser about using both the Section 530 program, which has wide investment options but limited ($2,000 or less) contribution/investment amounts, and the Section 529 program, which has limited investment options but allows higher contribution/investment amounts.

 

Elementary and secondary schools

 

Section 530 programs can be used to build up funds for primary and secondary education. The tax rules are similar to those for higher education: withdrawals taxable to the extent of earnings on contributions, except tax-free up to the child’s qualified elementary and secondary education expenses. These expenses qualify whether the child attends a private, religious or public school. Expenses such as room, board, tuition, transportation and uniforms will qualify only where connected with private or religious schools, but some expenses — books, computers, educational software and internet access — apply as well to children in public school living at home.

The age limits for higher education apply here too: no contribution after child reaches age 18, distribution at age 30 except for special needs beneficiaries. Withdrawals in excess of qualified education expenses are taxable under a special formula.

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What Travel Expenses Are Deductible?

March 14, 2007 by Ray Perez.

The tax law allows you to deduct two types of travel expenses related to your business.

  1. Firstly you can deduct local transportation expenses incurred for business purposes—the expense of getting from one location to another, but not meals or incidentals.
  2. Second, you can deduct away from home travel expenses—including meals and incidentals. Deduction limits can be eased if your employer reimburses your travel expenses.

 

Local Transportation Costs

 

You can deduct the cost of local business transportation. This includes airfare, rail fare, and bus fare, as well as the costs of using and maintaining a business automobile. For those whose main place of business is their personal residence, business trips from that residence, and return trips, are deductible transportation and not non-deductible commuting.

You generally cannot deduct lodging and meals unless you stay away overnight. Meals may be partially deductible as an entertainment expense, as discussed below.

Away From-Home Travel Expenses

 

You can deduct one-half of the cost of meals and all of the expenses of lodging incurred while traveling away from home.

To be deductible, travel expenses must be “ordinary and necessary”—though “necessary” is liberally defined as “helpful and appropriate”, not “indispensable”. Deduction is also denied for that part of any travel expense that is “lavish or extravagant”, though this rule does not bar deducting the cost of first class travel, or deluxe accommodations or (subject to percentage limitations below) deluxe meals.

What does “away from home” mean? To deduct the costs of lodging and meals (and incidentals—see below) you must generally stay somewhere overnight. Otherwise, your costs are considered local transportation costs, and the costs of lodging and meals are not deductible.

Where is your “home” for tax purposes? The general view is that your “home” for travel expense purposes is your place of business or your post of duty. It is not where your family lives. (Some courts say it’s the general area of your residence).

  Example: George’s family lives in Boston and George works in Washington, DC. George spends the weekends in Boston and the weekdays in Washington, where he stays in a hotel and eats out. George’s tax home is Washington, DC—not Boston. Therefore, he cannot deduct any of the following expenses: the costs of traveling back and forth between Washington and Boston, the costs of eating out in Washington, the costs of staying in a hotel in Washington, and the costs of traveling between his hotel in Washington and his job in Washington (the latter are non-deductible commuting costs). The reason: For tax purposes, his “home” is in Washington.

There are some tricky rules in the tax law concerning where a taxpayer’s “home” is for purposes of deducting travel expenses. They come up whenever a taxpayer works at a temporary site, or works in two different places.

We’ll cover these rules briefly in these examples:

  Example: Joe, who lives in Connecticut, works eight months out of the year in Connecticut (from which he usually earns about $50,000) and four months out of the year in Florida (from which he usually earns about $15,000). Joe’s “tax home” for travel expense purposes is Connecticut. Therefore, the costs of traveling to and from the “lesser” place of employment (Florida), as well as meals and lodging costs incurred while working in Florida, are deductible.
  Example: Susan works and lives in New York. Occasionally, she must travel to Maryland on temporary assignments, where she spends up to a week at a time. Result: She can deduct the costs of meals and lodging while she’s in Maryland, as well as the costs of traveling to and from Maryland. The reason: The work assignments in Maryland are temporary, since they will end within a foreseeable time. (Assignments that are realistically expected to last for more than a year are indefinite, not temporary.) If an assignment is considered indefinite under the tax law, travel, meal, and lodging costs are not deductible.

Here’s a list of some deductible away-from-home travel expenses:

  • Meals (limited to 50%) and lodging while traveling or once you get to your away-from-home business destination.
  • The cost of having your clothes cleaned and pressed away from home.
  • Costs for telephone, fax or modem usage.
  • Costs for secretarial services away-from-home.
  • The costs of transportation between job sites or to and from hotels and terminals.
  • Airfare, bus fare, rail fare, and charges related to shipping baggage or taking it with you.
  • The cost of bringing or sending samples or displays, and of renting sample display rooms.
  • The costs of keeping and operating a car, including garaging costs.
  • The cost of keeping and operating an airplane, including hangar costs.
  • Transportation costs between “temporary” job sites and hotels and restaurants.
  • Incidentals, including computer rentals, stenographers’ fees.
  • Tips related to the above.

However, many away-from-home travel expenses are not deductible or are restricted in some way. These include:

  • Commuting expenses. The costs of traveling between your home and your job are not deductible.
  • Travel as a form of education. Trips that are educational in a general way, or improve knowledge of a certain field but are not part of a taxpayer’s job, are not deductible.
  • Costs of looking for a first job. If you are looking for a new job in your current field, you can deduct the travel expenses. Otherwise, you may not deduct them.
  • Seeking a new location. Travel costs (and other costs) incurred while you are looking for a new place for your business, or for a new business, must be capitalized and cannot be deducted currently.
  • Luxury water travel: If you travel using an ocean liner, a cruise ship, or some other type of “luxury” water transportation, the amount you can deduct is subject to a per-day limit.
  • Seeking foreign customers: The costs of traveling abroad to find foreign markets for existing products are deductible.
  Tip: The travel (and other) costs incurred in unsuccessfully trying to acquire a specific business are currently deductible.

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I have a special retirement plan for you if you are self-employed and involved in more than one business.

March 13, 2007 by Ray Perez.

This is for you if you are self-employed and involved in multiple businesses, even with partners.

A new tax act has made a change allowing you to contribute to a self-employed retirement plan, on your own behalf, without requiring you to make contributions on behalf of your employees. The new act has repealed the so-called aggregation rules that previously applied to the self-employed retirement plans.

Under the old rules, if a self-employed person owned, or was a part owner of more than one business, and a retirement plan was provided for the employees in one business, law required that a retirement plan be provided for the employees of the other business(es). Beginning in 1997, this law removed this requirement!

If you own two businesses, the law allows you the option of establishing a retirement plan for only one business (with the fewest employees), even if you work by yourself in that business! The only limitation for this new law is that the amount of money you can contribute to a retirement plan is based on the self-employment earnings generated by the business with the retirement plan.

In other words, if the business you own with (no employees) has smaller net earnings than the other business (with employees), the amount you can contribute to a retirement plan will be based on the smaller net earnings.

While the rule change allows you to avoid contributing to a plan for your employees, it also means that you would be limited to making the smallest (rather than the largest) potential contributions to your personal retirement plan.

I want to make sure you are getting the most out of your financial future, so contact us or your accountant to determine your eligibility and to optimize the plan for you.

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Did you know you can use your previously funded IRA to fund the current year’s deductible contributions?

March 13, 2007 by Ray Perez.

Well, you can. If you don’t have enough cash to make a deductible contribution to your IRA by April 15th, here is how you can still take the tax deduction. And have until June 12th to make the full 4,000 contribution! To get started, all you need is a previously started IRA.

You begin by having $4,800 distributed to you from your IRA on April 15th. Your bank is required to hold 20% (income tax withholding), so you’ll actually receive $4,000. Once you have the $4,000, immediately deposit it back into your IRA. If you do this before April 15th, this counts as your deductible contribution for the year. The best part of this is that you have 59 days to “make up” the withdrawal-or to be taxed. Simply deposit $4,800 “rollback” into the same IRA account by June 12th to avoid taxes on the original $4,000 distribution made to you.

This is a type of short-term loan from your IRA to make this year’s deductible contribution before the April 15th due date.

  Note: Not all banks realize it is required to withhold the 20% from the original $4,800 withdrawn from your IRA. Call to find out which way we can help you work with this “extra” amount. There are many options, so get informed before you miss out on the full benefits of your retirement plan.

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Successfully Pass On Your Family Business To Next Generation

March 9, 2007 by Ray Perez.

Starting a family business is a difficult adventure, especially when day-to-day tasks can overshadow your goals. We know your business is something you want to last, and planning ahead will help you achieve that success.

Old wisdom is clear: The critical issue concerning succession was to identify, develop, and install the successor to the business’s top executive. That seems simple, but most people don’t consider all the other elements like non-family executives and advisors.

The predominant family business statistic has been that only 30 percent of family businesses survive the second generation. The need for succession planning to avoid becoming a victim of that dismal statistic was the reason for developing the family-business field.

But family business experts have come to realize that a 30 percent “survival” rate rather than being a symbol of failure is actually a phenomenal success achieved by the advantages that family strength brings to business enterprises.

We now know that the analogy of “passing the baton” is terribly inadequate. We now understand that succession rarely involves an incumbent and a successor. Instead, the process involves all of the key players, including family members, executives and advisors.

Not just a matter of successor development and the incumbent’s preparedness to let go, the process is a complex stew of social, cultural, financial, legal, strategic, moral, and other dimensions that resist logical, “businesslike” thinking.

Success, we came to recognize, depends on being able to combine and balance businesslike thinking with family-like thinking. Clearly, “succession” is inadequate to describe the process. Among the many categories of planning - besides succession - too often neglected in family business were strategic, estate, operational, and governance.

Failure to plan in any of these areas can be fatal. In many instances, the issue was not “how to” but “why not?” What would keep a family business from doing what it should and could to achieve its goal of self-preservation?

The need to develop processes dealing with the massive complexity of changes relating to personal, family, and corporate finances (including the effort to deal with the estate-tax issue) is key. This includes issues of strategy and structure in the business, family values in relationships and structure, governance and accountability, and each of the key players’ personal journeys.

If you run a family business it’s extremely important to start the planning process now.

Please call us and we’d be happy to talk to you about how to get started.

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The Secret of Creating Wealth

March 9, 2007 by Ray Perez.

There are few books of basic wisdom that endure for generations. One of these books is The Richest Man In Babylon, first published in 1926.

We have heard, again and again, the critical importance of putting aside a share of our income for investment.

There are a lot of ways to build wealth, but there is a simple, sure way that can always work. It is simply to develop the habit from a young age of saving a share of your income, say 10%. Paying this amount to your investment account must become the same as paying your monthly rent or mortgage payment.

Developing the habit of saving money should be developed the same as the habits of bathing, washing hands before a meal, or shaving.

If you can’t have certain luxuries now and maintain your savings ritual, postpone the luxuries now so you can enjoy them and financial security later.

I said this method is simple, I didn’t say it was easy.

These are the lessons that George S. Clason drives home again and again in the parables of The Richest Man In Babylon.

Here is an excellent graduation gift for your child or grandchild.

If you haven’t heard of or read The Richest Man In Babylon yet, maybe this is a good time to get a copy for yourself and read it.

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Retirement Plan Options For Small Businesses

March 8, 2007 by Ray Perez.

According to The Pension & Welfare Benefits Administration, small businesses employ nearly 40% of the private-sector workforce in the United States. However, a majority of small businesses do not offer their workers retirement savings benefits.

If you’re like many other small business owners in the United States, you may be considering the various retirement plan options available for your company. Employer-sponsored retirement plans have become a key component for retirement savings. They are also an increasingly important tool for attracting and retaining the high-quality employees you need to compete in today’s competitive environment.

Besides helping employees save for the future, however, instituting a retirement plan can provide you, as the employer, with benefits that enable you to make the most of your business’s assets. Such benefits include:

  • Tax-deferred growth on earnings within the plan
  • Current tax savings on individual contributions to the plan
  • Immediate tax deductions for employer contributions
  • Easy to establish and maintain
  • Low-cost benefit with a highly-perceived value by your employees

Types of Plans

Most private sector retirement plans are either defined benefit plans or defined contribution plans. Defined benefit plans are designed to provide a desired retirement benefit for each participant. This type of plan can allow for a rapid accumulation of assets over a short period of time. The required contribution is actuarially determined each year, based on factors such as age, years of employment, the desired retirement benefit, and the value of plan assets. Contributions are generally required each year and can vary widely.

A defined contribution plan, on the other hand, does not promise a specific amount of benefit at retirement. In these plans, employees or their employer (or both) contribute to employees’ individual accounts under the plan, sometimes at a set rate (such as 5 percent of salary annually). A 401(k) plan is one type of defined contribution plan. Other types of defined contribution plans include profit-sharing plans, money purchase plans, and employee stock ownership plans.

Small businesses may choose to offer a defined benefit plan or any of these defined contribution plans. Many financial institutions and pension practitioners make available both defined benefit and defined contribution “prototype” plans that have been pre approved by the IRS. When such a plan meets the requirements of the tax code it is said to be qualified and will receive four significant tax benefits.

  1. The income generated by the plan assets is not subject to income tax, because the income is earned and managed within the framework of a tax-exempt trust.
  2. An employer is entitled to a current tax deduction for contributions to the plan.
  3. The plan participants (the employees or their beneficiaries) do not have to pay income tax on the amounts contributed on their behalf until the year the funds are distributed to them by the employer.
  4. Under the right circumstances, beneficiaries of qualified plan distributors are afforded special tax treatment.

It is necessary to note that all retirement plans have important tax, business and other implications for employers and employees. Therefore, you should discuss any retirement savings plan that you consider implementing with your accountant or other financial advisor.

Here’s a brief look at some plans that can help you and your employees save.

SIMPLE: Savings Incentive Match Plans for Employees of Small Employers

A SIMPLE plan allows employees to contribute a percentage of their salary each paycheck and to have their employer match their contribution. Under SIMPLE plans, employees can set aside up to $10,000 in 2006 (increasing to $10,500 in 2007) by payroll deduction. If the employee is 50 or older then they may contribute an additional $2,500. Employers can either match employee contributions dollar for dollar – up to 3 percent of an employees wage – or make a fixed contribution of 2 percent of pay for all eligible employees instead of a matching contribution.

SIMPLE plans are easy to set up – you fill out a short form, administrative costs are low, and much of the paperwork is done by the financial institution that handles the SIMPLE plan accounts. Employers may choose either to permit employees to select the IRA to which their contributions will be sent, or to send contributions for all employees to one financial institution. Employees are 100% vested in contributions, get to decide how and where the money will be invested, and keep their IRA accounts even when they change jobs.

SEPs: Simplified Employee Pensions

A SEP allows employers to set up a type of individual retirement account – known as a SEP-IRA – for themselves and their employees. Employers must contribute a uniform percentage of pay for each employee. Employer contributions are limited to the lesser of 25 percent of an employee’s annual salary or $44,000 in 2006 (increasing to $45,000 in 2007. This amount is indexed for inflation and will vary each year). SEPs can be started by most employers, including those that are self-employed.

SEPs have low start-up and operating costs and can be established using a single quarter-page form. Businesses are not locked into making contributions every year. You can decide how much to put into a SEP each year – offering you some flexibility when business conditions vary.

401(k)Plans

401(k) plans have become a widely accepted savings vehicle for small businesses. Today, an estimated 25 million American workers are enrolled in 401(k) plans that hold total assets of about $1 trillion.

A 401(k) Plan allows employees to contribute a portion of their own incomes toward their retirement. The employee contributions, not to exceed $15,000 in 2006 (increasing to $15,500 in 2007), reduce a participant’s pay before income taxes, so that pre-tax dollars are invested. If the employee is 50 or older then they may contribute another $5,000. Employers may offer to match a certain percentage of the employees’ contribution, increasing participation in the plan.

While more complex, 401(k)plans offer higher contribution limits than SIMPLE plans and IRAs, allowing employees to accumulate greater savings.

Profit-Sharing Plans

Employers also may make profit-sharing contributions to a plan that are unrelated to any amounts an employee chooses to contribute. Profit-sharing Plans are well suited for businesses with uncertain or fluctuating profits. In addition to the flexibility in deciding the amounts of the contributions, a Profit-Sharing Plan can include options such as service requirements, vesting schedules and plan loans that are not available under SEPs.

Contributions may range from 0% to 25% of eligible employees’ compensation, to a maximum of $44,000 in 2006 ($45,000 in 2007) per employee. The contribution in any one year cannot exceed 25% of the total compensation of the employees participating in the plan. Contributions need not be the same percentage for all employees. Key employees may actually get as much as 25%, while others may get as little as 3%. A plan may combine these profit-sharing contributions with 401(k) contributions (and matching contributions).

Your Goals for a Retirement Plan

Business owners setup retirement plans for different reasons. Why are you considering one? Do you want to:

  • Take advantage of the tax breaks, to save more money than you’d otherwise be able to?
  • Provide competitive benefits in addition to – or in lieu of – high pay to employees?
  • Primarily save for your own retirement?

You might say “all of the above.” Small employers who want to set up retirement plans generally fall into one of two groups. The first group includes those who want to set up a retirement plan primarily because they want to create a tax-advantage savings vehicle for themselves and thus want to allocate the greatest possible part of the contribution to the owners. The second group includes those who just want a low-cost, simple retirement plan for employees.

If there were one plan that was most efficient in doing all these things, there wouldn’t be so many choices. That’s why it’s so important to know what your goal is. Each type of plan has different advantages and disadvantages, and you can’t really pick the best ones unless you know what your real purpose is in offering a plan. Once you have an idea of what your motives are, you’re in a better position to weigh the alternatives and make the right pension choice.

If you do decide that you want to offer a retirement plan, you are definitely going to need some professional advice and guidance. Pension rules are complex, and the tax aspects of retirement plans can also be confusing. Make sure you confer with your accountant before deciding which plan is right for you and your employees.

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