Small Office Home Office (SOHO) Tax Tips

Deferred Contribution Plans

Oct 4, 2011 Retirement plans, Tax Strategies

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Defined contribution plans focus on the accumulation rather than eventual distribution of retirement funds. An employee chooses to divert a portion of their wages (called elective deferral) up to some specific annual limit to a specially designated savings plan.  An employee, rather than an employer, assumes all investment risks. The diverted funds affect Social Security and Medicare taxes but are not included as taxable income in the year they are received. An employee pays income tax when the funds are distributed during their retirement years. There is a wide range of defined contribution plans based on an employee’s elective deferral of wages.

 401(k) plans are a common employer-sponsored among private companies.  The allocated funds are reported on IRS Form W-2, Wage and Tax Statement, Box 12.  Beginning after January 1, 2006, employees can contribute additional after-tax funds to a special Roth 401(k) plan that offers eventual tax-free distributions subject to required minimum distribution (RMD) rules.

403(b) (also called tax-sheltered annuities) plans are available to public education employers and 501(c)(3) tax-exempt organizations. Beginning after January 1, 2006, these employees can also contribute after-tax funds to a specially-designated Roth account similar to the saving plan offered under employer-sponsored, private company 401(k) programs. Thrift Savings Plans are also available to those employees who work in public education and religious organizations.

501(c)(18)(D) plans based exclusively on employee contributions were formed before June 25, 1959.  These plans, whether qualified or nonqualified, have a maximum contribution of either employee compensation up to 25% or a maximum $7,000.  The employee contribution is added on IRS Form W-2, Wage and Tax Statement, Box 1 and deducted on IRS Form 1040, US Individual Income Tax Return, line 36.

457(b) and 457(f) plans were established for state and local government employees as well as independent contractors. A 501(c) tax-exempt organization can offer either a qualified or non-qualified retirement saving plan (such as a 457(f) plan) to a specific group of employees.  There is also an after-tax designated Roth option within these plans.

SIMPLE IRA and SEP are deferred contribution plans specifically for SOHO owners and sole proprietors.

Other available retirement plans such as Savings Incentive Match Plans for Employees (referred to as SIMPLE IRA plans) and Simplified Employee Pensions (referred to as SEP) plans that benefit both employer and employees.  These deferred contribution plans replaced Salary Reduction Simplified Employee Pension Plan (referred to as SARSEP) established before 1997.