How do I...Set up a retirement plan for employees of my small business?

Many small employers want to offer their employees the opportunity to save for retirement but are unsure of how to go about setting up a retirement plan. In this article, we'll explore three options that are widely used by small businesses: payroll deduction IRAs, SEP plans, and SIMPLE IRAs.

Payroll deduction IRAs
Many small employers find a payroll deduction IRA very attractive because it allows them to offer their employees a retirement savings vehicle at little cost. A business of any size, even self-employed individuals, can establish a payroll deduction IRA. Under a payroll deduction IRA, only your employees make contributions to an IRA. Your responsibility as an employer is simply to transmit the employee's authorized deduction to the financial institution that maintains the IRA.

The IRA is set up with a financial institution, such as a bank, mutual fund or insurance company. You can limit the number of IRA providers to as few as one. The employee establishes a traditional IRA or a Roth IRA (based on the employee's eligibility and personal choice) with the financial institution and authorizes the payroll deductions. As the employer, you withhold the payroll deduction amounts authorized by your employees and send the funds to the financial institution.

An employee's decision to participate in a payroll deduction IRA is entirely voluntarily. If an employee decides to participate, he or she can only contribute up to a certain amount to the payroll deduction IRA every year. For 2010, the contribution limit is $5,000. An employee age 50 or older may make an additional "catch-up" contribution of $1,000 for a yearly total of $6,000. Every employee who participates is 100 percent vested in the contributions to their payroll deduction IRA.

Let's look at an example of a payroll deduction IRA:
Aidan's employer offers its employees the opportunity to have deductions taken from their paychecks to contribute to IRAs that the employees have set up for themselves. Aidan signs up for the program and has $100 from his $1,000 bi-weekly paycheck deposited into his IRA for a yearly total of $2,600. At the end of the year, Aidan's employer would report the full $26,000 he earned on his Form W-2 and Aidan would add the $2,600 to any other IRA contributions he made during the year for Form 1040 deduction purposes.
The costs of a payroll deduction IRA are low. Moreover, payroll deduction IRAs are not subject to the often complex filing, documentation and administration requirements that are imposed on other employer-sponsored retirement arrangements, such as 401(k) plans.

SEP plans
"SEP" stands for "Simplified Employee Pension" plan. While there are filing, administration and documentation requirements for SEP plans, the goal of an SEP plan is to keep these as simple as possible. The IRS has created, for example, model SEP language for plan documents.

An SEP plan is similar to a payroll deduction IRA. Under an SEP plan, employers make contributions to traditional IRAs set up for employees (including self-employed individuals). An SEP-IRA is funded solely by employer contributions whereas a payroll deduction IRA is funded solely by employee contributions.

As the employer, you must select the financial institution for your SEP. This decision must be made carefully because you and the financial institution will very work closely to administer the plan. After you send the SEP contributions to the financial institution, the financial institution will manage the funds. Depending on the financial institution, SEP contributions can be invested in individual stocks, mutual funds, and other similar types of investments.

Federal law requires you and the trustee to keep employees informed about the administration and health of the SEP. Employees must be provided with plan documents, an annual statement that reports the fair market value of each employee's account and a copy of an annual statement that is filed by the financial institution with the IRS. Like a payroll deduction IRA, each employee is 100 percent vested in his or her SEP-IRA.
Generally, the annual contributions an employer makes to an employee's SEP-IRA cannot exceed the lesser of:

-- 25 percent of compensation,or
-- $49,000 for 2010.

Generally, contributions are not required to be made every year to an SEP. In years that contributions are made to an SEP, they must be made to the SEP-IRAs of all eligible employees. Contributions to an SEP-IRA must be made in cash; property cannot be contributed to an SEP-IRA. Special rules apply if you, as the employer, also contribute to a 401(k) or similar plan on the employee's behalf.

All eligible employees must be allowed to participate. An eligible employee is any employee who is at least age 21 and has worked for you in at least three of the immediate past five years.

To encourage employers to establish SEPs, the government offers a tax credit. You may be eligible for a tax credit of up to $500 for each of the first three years for the cost of starting the SEP.

SIMPLE IRAs
A "SIMPLE IRA" is a Savings Incentive Match Plan for Employees IRA. Like an SEP plan, a SIMPLE IRA is intended to be easily created and administrated.

A SIMPLE IRA is funded both by employer and employee contributions. As the employer, you can choose either to (1) match the contributions of employees who decide to participate or (2) contribute a fixed percentage of all eligible employees' pay. Under option (2), which is known as the nonelective contribution formula, even if an eligible employee does not contribute to his or her SIMPLE IRA, you must make a contribution to the employee's SIMPLE IRA equal to a fixed percent of the employee's salary. Each employee is 100 percent vested in his or her SIMPLE IRA.

While similar to a payroll deduction IRA, a SIMPLE IRA has additional requirements. One important requirement is the number of employees. Generally, your business must have 100 or fewer employees to be eligible for a SIMPLE IRA.

Let's look at an example of a SIMPLE IRA. In this example, the employer matches the employee contributions of employees who decide to participate.

Allison's employer has established a SIMPLE IRA plan for its employees. The employer will match its employees' contributions dollar-for-dollar up to three percent of each employee's salary. If an employee does not contribute to his or her SIMPLE IRA, then that employee does not receive a matching employer contribution. Allison decides to contribute five percent ($2,500) of her annual salary of $50,000 to a SIMPLE IRA. The employer's matching is $1,500 (three percent of $50,000). Therefore, the total contribution to Allison's SIMPLE IRA that year is $4,000.

There are contribution limits for SIMPLE IRAs. For employees, the annual contribution limit is $11,500 in 2010. Employees age 50 and older may make additional catch-up contributions of $2,500 in 2010.
The SIMPLE IRA contribution for the employer is dependent upon which contribution formula you select. If you decide to make matching contributions, only eligible employees who have elected to make contributions will receive an employer contribution. If you decide to make a nonelective contribution, each eligible employee must receive a contribution regardless of whether the employee makes contributions.

As with an SEP plan, a SIMPLE IRA creates a relationship between you and the financial institution that manages the funds. SIMPLE IRA plan contributions can be invested in individual stocks, mutual funds and similar types of investments. Each participating employee must receive an annual statement indicating the amount contributed to his or her SIMPLE IRA for the year.

As with SEP plans, you may be eligible for a tax credit to help you offset start-up costs. The tax credit can reach up to $500 per year for each of the first three years for the cost of starting a SIMPLE IRA plan.
We've covered a lot of material about retirement plans for small businesses. There are more detailed requirements, especially for SEP plans and SIMPLE IRAs, which we can discuss in depth. Please contact our office to set up an appointment to explore these and other retirement arrangements for small businesses.

Doeren Mayhew

Doeren Mayhew: Deducting receivables as bad business debts

While the economy continues to slowly recover, many businesses continue to face customers struggling to pay outstanding bills for services or goods. The Tax Code provides relief to businesses faced with the inability to collect on accounts receivable. Businesses that are unable to get customers to pay the bill can claim a deduction for the "bad debt."

Business bad debt deduction

Taxpayers may deduct any business receivable that becomes totally or partially worthless during the tax year under Tax Code Sec. 166(a). However, the business bad debt deduction is limited to the taxpayer's adjusted basis in the receivable.

The deduction allowed for bad debts is an ordinary deduction. To claim the deduction, you must establish that the debt is genuine and that the amount cannot be recovered from the debtor. You must also make a reasonable attempt to collect the debt (however, you do not have to turn the debt over to a collection agency or file a lawsuit in an attempt to collect on the debt if doing so has little probability of success). The law requires most taxpayers to use the specific charge-off method of accounting for bad debts. Under the specific charge-off method, the taxpayer must specifically identify the accounts or notes charged off as partially or completely worthless (it is also referred to as the direct write-off method).

If you meet these conditions, you can take the deduction in the year in which the debts became worthless. This includes certain previous years since, for some debts, worthlessness may not be immediately apparent. You can deduct a bad debt before the debt is due if you can establish the partial or complete worthlessness of the debt.

Partially worthless. If you failed to claim the bad debt deduction for a receivable that became partially worthless in a prior tax year, you have until the later of (1) three years after you file the tax return (including extensions) or (2) two years from the time you paid the tax to file an amended return and deduct the bad debt.

Totally worthless. If you failed to claim a deduction for a receivable that became completely worthless in a previous tax year, you have until the later of (1) seven years after the due date of the tax return (not including extensions) or (2) two years from the time you paid the tax to file an amended return and claim a deduction for the worthless receivable.

Cash basis taxpayers
Cash basis taxpayers cannot claim a bad debt deduction for accounts receivable that are not collectible. However, notes received by a cash basis taxpayer in the ordinary course of business are treated as the equivalent of cash to the extent of the note's fair market value (FMV) at the time received. Thus, the initial basis in such a note is its FMV. Cash basis taxpayers may claim a bad debt deduction for uncollectible notes receivable if they have included the FMV of the notes in gross income.

Accrual and hybrid taxpayers
Accrual basis taxpayers may claim a bad debt deduction for accounts receivable that become partially or completely worthless during the tax year. Accrual basis taxpayers must include the face value of a note receivable in gross income if a reasonable expectancy of collection exists at the time it is received. Taxpayers that use a hybrid method of accounting may deduct bad debts if they have included the revenue from the receivable in gross income.

Reporting
For self-employed taxpayers, the bad business debt deduction is reported on Schedule C, Profit or Loss from Business (Sole Proprietorship), or Schedule F (Profit or Loss from Farming (for self-employed farmers)). Corporations report bad debts on Line 15 of Form 1120, U.S. Corporation Income Tax Return. S corporations report bad debts on Line 10 of Form 1120S, U.S. Income Tax Return for an S Corporation. Partnerships report bad debts on Line 12 of Form 1065, U.S. Return of Partnership Income.

Recovering bad debts
If you recover a bad debt during the year, the amount recovered is gross income to the extent that you claimed the deduction for the bad debt in a previous tax year, reducing your taxable income. This is called the tax benefit rule. The bad debt you recovered may not be offset against the bad debt deduction for the tax year of the recovery.

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This data is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional advice or opinions on specific facts or matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the content contained within this article, it is recommended that a Doeren Mayhew representative be contacted.

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Preparing for the possible return of pre-EGTRRA individual tax rates

In less than six months, unless Congress acts, the individual marginal income tax rate reductions under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) will expire. While the timetable for addressing the EGTRRA tax cuts is not certain, the approaching sunset of the individual rate reductions, the possibility for their extension, and the fate of the limit on itemized deductions and the personal exemption phase-out will touch all taxpayers. The potential rate change makes tax planning all the more important.

Individual income tax rates

EGTRRA set in motion a gradual reduction of the individual marginal income tax rates. EGTRRA also created a new and temporary 10 percent regular income tax bracket for a portion of taxable income that was previously taxed at 15 percent.

The federal individual income tax rates for 2010 are:

Single individuals: If taxable income is not over $8,375: 10% of the taxable income; Over $8,375 but not over $34,000: $837.50 plus 15% of the excess over $8,375; Over $34,000 but not over $82,400: $4,681.25 plus 25% of the excess over $34,000; Over $82,400 but not over $171,850: $16,781.25 plus 28% of the excess over $82,400; Over $171,850 but not over $373,650: $41,827.25 plus 33% of the excess over $171,850; and Over $373,650: $108,421.25 plus 35% of the excess over $373,650.

Married couples filing a joint return: If taxable income is not over $16,750: 10% of the taxable income; Over $16,750 but not over $68,000: $1,675 plus 15% of the excess over $16,750; Over $68,000 but not over $137,300: $9,362.50 plus 25% of the excess over $68,000; Over $137,300 but not over $209,250: $26,687.50 plus 28% of the excess over $137,300; Over $209,250 but not over $373,650: $46,833.50 plus 33% of the excess over $209,250; and Over $373,650: $101,085.50 plus 35% of the excess over $373,650.

Unless extended or made permanent, the individual marginal income tax rates will all rise after December 31, 2010 when EGTRRA sunsets. The 10 percent regular income tax bracket will also disappear after December 31, 2010 and the first portion of an individual's taxable income will be taxed at 15 percent rather than at 10 percent.

According to the Joint Committee on Taxation (JCT), after EGTRRA sunsets and with no modification by Congress, the federal individual income tax rates for 2011 will be:

Single individuals: If taxable income is not over $34,850: 15% of the taxable income; Over $34,850 but not over $84,350: $5,227.50 plus 28% of the excess over $34,850; Over $84,350 but not over $176,000: $19,087.50 plus 31% of the excess over $84,350; Over $176,000 but not over $382,650: $47,499 plus 36% of the excess over $176,000; and Over $382,650: $121,893 plus 39.6% of the excess over $382,650

Married couples filing a joint return: If taxable income is not over $58,200: 15% of the taxable income; Over $58,200 but not over $140,600: $8,730 plus 28% of the excess over $58,200; Over $140,600 but not over $214,250: $31,802 plus 31% of the excess over $140,600; Over $214,250 but not over $382,650: $54,633.50 plus 36% of the excess over $214,250; and Over $382,650: $115,257.50 plus 39.6% of the excess over $382,650.

President Obama has asked Congress to permanently extend the current 10, 15, 25, and 28 percent rates. Under the president's proposal, these rates would continue for individuals without interruption after December 31, 2010. However, the president's proposal would allow the 33 percent rate bracket and the 35 percent rate brackets to become 36 percent and 39.6 percent, respectively, after December 31, 2010.

The president has also asked Congress to expand the tax rate bracket for the 28 percent rate so that individuals with less than $195,550 of taxable income in 2011 ($200,000 of AGI), assuming one personal exemption and the basic standard deduction, indexed from 2009) will not be subject to the 36 percent rate that applies after December 31, 2010. For married individuals filing joint returns and surviving spouses, the dollar threshold for the 36 percent bracket would be set so that married couples and surviving spouses with AGI below $237,300 of taxable income in 2011 ($250,000 of AGI, assuming two personal exemptions and the basic standard deduction, indexed from 2009), subject to the 33 percent rate in 2010, will not become subject to the 36 percent rate after December 31, 2010.

Capital gains/dividends

At the same time taxpayers are looking at higher individual marginal income tax rates, the capital gains and dividend tax rates will also increase after December 31, 2010. For 2010, the maximum capital gains and dividends tax rate is 15 percent (zero percent for taxpayers in the 10 and 15 percent brackets). Effective January 1, 2011, the tax rate on qualified long-term capital gains will be 20 percent and taxpayers will pay tax on dividends at the same rates that apply to ordinary income.

President Obama has asked Congress to impose a 20 percent capital gains and dividends tax rate on individuals with incomes above $200,000 (less the standard deduction and one personal exemption indexed from 2009). The 20 percent rate would also apply to married couples filing a joint return with income above $250,000 (less the standard deduction and two personal exemptions indexed from 2009). All other taxpayers would pay capital gains and dividends taxes of 15 percent unless they qualify for the zero percent tax rate.

If Congress does not act, the tax rate on dividends after December 31, 2010 will be the same as that currently for dividends failing to qualify for the current 15 percent rate; that is, the same as a taxpayer's personal income tax bracket.

Limitation on itemized deductions

Along with reducing the individual marginal income tax rates, EGTRRA also repealed the limitation on itemized deductions for 2010, but only for 2010. President Obama has asked Congress to allow the limitation on itemized deductions to return but to modify it for 2011 and beyond. Under the president's proposal, the limitation on itemized deductions would apply to an AGI threshold determined by taking a 2009 dollar amount and adjusting for subsequent inflation. The Obama administration has proposed a dollar amount of $200,000 for single individuals and $250,000 for married couples filing a joint return.

Also impacting higher-income taxpayers is repeal of the personal exemption phase-out. Under EGTRRA, the personal exemption phase-out is repealed for 2010 - but only for 2010.

What's next

Congress likely will vote on the administration's proposal to raise only the top two tax brackets this fall. Whether that vote will come in September or in a lame-duck session after the mid-term elections remains uncertain at this time, as does the outcome of that vote. In the interim, our office will continue to monitor the debate and, as Congress gets closer to a decision, prepare year-end tax strategies that respond most effectively to what Congress decides.

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This data is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional advice or opinions on specific facts or matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the content contained within this article, it is recommended that a Doeren Mayhew representative be contacted.

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