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10 retirement plan tax facts you need to know.

Byline: Robert Bloink, William H. Byrnes

You know the stats: 10,000 boomers reach retirement age each and every day. It's the topic that's on everyone's mind, it seems, and tax season can raise additional questions. How are earnings on an IRA taxed? What is the penalty for making excessive contributions to an IRA? How are amounts distributed from a traditional IRA taxed? If your clients come to you with these and other questions, we have the answers.

1. When are funds in an IRA taxed?

Funds accumulated in a traditional IRA generally are not taxable until they actually are distributed. Funds accumulated in a Roth IRA may or may not be taxable on actual distribution. Special rules may treat funds accumulated in an IRA as a "deemed distribution" and, thus, includable in income.

A distribution of a nontransferable, nonforfeitable annuity contract that provides for payments to begin by age 701/2 and not to extend beyond certain limits is not taxable, but payments made under such an annuity would be includable in income under the appropriate rules.

A contribution (excess or otherwise) may be distributed income tax-free (provided, in the case of a traditional IRA, that no deduction was allowed for the contribution). If net income allocable to the contribution is distributed before the due date for filing the tax return for the year in which the contribution was made, it must be included in income for the tax year for which the contribution was made even if the distribution actually was made after the end of that year. With respect to distributions of excess contributions after this deadline, the net income amount is included in income in the year distributed. Any net income amount also may be subject to penalty tax as an early distribution.

An individual may transfer, without tax, the individual's IRA to his or her spouse or former spouse under a divorce or separate maintenance decree or a written instrument incident to the divorce. The IRA then is maintained for the benefit of the former spouse. Any other assignment of an IRA is a deemed distribution of the amount assigned.

See also: IRS issues rollover guidance

Where an individual rolled over his interest in a tax sheltered annuity to an IRA, pursuant to a QDRO, the subsequent transfer of the IRA to the individual's spouse was considered a "transfer incident to a divorce" and, thus, nontaxable to either spouse.

A taxpayer was liable for taxes on a distribution from his IRA that he subsequently turned over to his ex-wife in satisfaction of a family court order because it was not a "transfer incident to divorce" and the family court order was not a QDRO because it did not specifically require the transfer of assets to come from the IRA. A transfer of funds between the IRAs of a husband and wife that does not come within the divorce exception is a deemed distribution despite IRC provisions that provide that no gain is recognized on transfers between spouses.

The transfer of a portion of a husband's IRA to his wife to be placed in an IRA for her benefit that was the result of a private written agreement between the two that was not considered incident to a divorce was not eligible for nontaxable treatment under IRC Section 408(d)(6).

Where a taxpayer received a full distribution from his IRA and endorsed the distribution check over to his soon-to-be-ex-wife, the husband was determined to have failed to satisfy the requirements for a non-taxable transfer incident to divorce and was liable for taxation on the entire proceeds of the IRA distribution.

Where two traditional IRAs were classified as community property, the distributions of the deceased spouse's community interest in the IRAs to relatives other than her surviving husband were taxable only to those recipients and not to the husband.

State community property laws, although disregarded for some purposes, are not preempted by IRC Section 408(g). In a case of first impression, the Tax Court ruled that the recognition of community property interests in IRAs would conflict with existing federal tax rules. IRC Section 408(g) requires application without regard to community property laws. By reason of IRC Section 408(g), the former spouse is not treated as a distributee on any portion of the IRA distribution for purposes of federal income tax rules despite the former spouse's community property interest in the assets. Therefore, a distribution from an IRA to a former spouse is taxable to the account holder unless it is executed pursuant to decree of divorce, or other written maintenance decree under IRC Section 408(d)(6).

Where taxpayers requested that an IRA be reclassified under state marital property law from individual property to marital property, no distribution under IRC Section 408(d)(1) was deemed to have occurred.

The involuntary garnishment of a husband's IRA and resulting transfer of such funds to the former spouse to satisfy arrearages in child support payments was a deemed distribution to the husband because it discharged a legal obligation owed by the husband.

Where a taxpayer transferred funds from a single IRA into two newly-created IRAs, the direct trustee-to-trustee transfers were not considered distributions under IRC Section 408(d)(1). The division of a decedent's IRA into separate subaccounts does not result in current taxation of the IRA beneficiaries.

If any assets of an individual retirement account are used to purchase collectibles (works of art, gems, antiques, metals, etc.), the amount so used will be treated as distributed from the account (and also may be subject to penalty as an early distribution). A plan may invest in certain gold or silver coins issued by the United States , any coins issued under the laws of a state, and certain platinum coins. A plan may buy gold, silver, platinum, and palladium bullion of a fineness sufficient for the commodities market if the bullion remains in the physical possession of the IRA trustee. A plan may purchase shares in a grantor trust holding such bullion.

If any part of an individual retirement account is used by the individual as security for a loan, that portion is deemed distributed on the first day of the tax year in which the loan was made. Amounts rolled over into an IRA from a qualified plan by one of the twenty-five highest paid employees, however, may be pledged as security for repayments that may have to be made to the plan in the event of an early plan termination. A less-than-sixty-day interest-free loan from IRA accumulations is possible under the rollover rules.

If the owner of an individual retirement annuity borrows money under or by use of the contract in any tax year, including a policy loan, the annuity ceases to qualify as an individual retirement annuity as of the first day of the tax year and the fair market value of the contract would be deemed distributed on that day.

If an individual engages in a prohibited transaction during a year, his or her individual retirement account ceases to qualify as such as of the first day of that tax year; the individual is not liable for a prohibited transaction tax. The fair market value of all the assets in the account is deemed distributed on that day. If the account is maintained by an employer, only the separate account of the individual involved is disqualified and deemed distributed.

The transfer to an individual retirement account of a personal note received in a terminating distribution from a qualified plan and the holding of that note is a prohibited transaction.

The use of IRA funds to invest in a personal retirement residence of the taxpayer is considered a prohibited transaction under IRC Section 4975(c)(1)(D) and, thus, is treated as a distribution.

Whether a purchase of life insurance in conjunction with an individual retirement plan but with non-plan funds constitutes a prohibited transaction apparently depends on the circumstances. The IRS has held that the purchase of insurance on the depositor's life by the trustee of the account with non-plan funds amounted to an indirect prohibited transaction by the depositor. The IRS also has ruled that the solicitation by an association of individuals who maintain individual retirement plans with the association for enrollment in a group life plan did not result in a prohibited transaction where premiums would be paid by the individuals and not out of plan funds.

Institutions may offer limited financial incentives to IRA and Keogh holders without running afoul of the prohibited transaction rules provided certain conditions are met. Generally speaking, the value of the incentive must not exceed $10 for deposits of less than $5,000 and $20 for deposits of $5,000 or more. These requirements also are applicable to SEPs that allow participants to transfer their SEP balances to IRAs sponsored by other financial institutions and to SIMPLE IRAs.

A distribution of any amount may be received free of federal income tax to the extent the amount is contributed within sixty days to another plan under the rollover rules.

Distributions from traditional and Roth IRAs are not subject to the 3.8 percent Medicare contribution tax imposed under the Affordable Care Act. The tax equals 3.8 percent of the lesser of a taxpayer's net investment income for the taxable year, or the excess (if any) of the taxpayer's modified adjusted gross income for the year, over a threshold amount ($200,000 for a taxpayer filing an individual return and $250,000 for a taxpayer filing jointly). Internal Revenue Code Sec. 1411 specifically accepts distributions from IRAs and other qualified plans from the definition of "net investment income."

2. How are earnings on an IRA taxed?

An IRA offers tax-free build up on contributions. The earnings on a traditional IRA are tax deferred to the owner; that is, they are not taxed until the owner begins receiving distributions. The earnings on a Roth IRA may or may not be taxed upon distribution. Like a trust that is part of a qualified plan, an individual retirement account is subject to taxes for its unrelated business income.

Tax deferral is lost if an individual engages in a prohibited transaction or borrows under or by use of an individual retirement annuity. The loss occurs as of the first day of the tax year in which the prohibited transaction or borrowing occurred. For an account established by an employer or association of employees, only the separate account of the individual loses its deferred status.

3. What is "compensation" for purposes of IRA eligibility rules and deduction limits?

For purposes of the eligibility rules and deduction limits applicable to IRAs, "compensation" means wages, salary, professional fees, or other amounts derived from, or received for, personal services actually rendered. "Compensation" also includes alimony paid under a divorce or separation agreement that is includable in the income of the recipient under IRC Section 71.

In the case of a self-employed individual, "compensation" includes earned income from personal services, but in computing the maximum IRA or SEP contribution, such income must be reduced by (1) any qualified retirement plan contributions made by such individual on his or her own behalf and (2) the 50 percent of self-employment taxes deductible by the individual.

Earned income not subject to self-employment tax because of an individual's religious beliefs is "compensation."

An individual whose income for the tax year consists solely of interest, dividend, and pension income has no "compensation" and cannot deduct any portion of a traditional IRA contribution. In addition, such a person may not make a Roth IRA contribution.

Compensation does not include earnings and profits from property, such as rental income, interest, and dividend income, or any amount received as pension or annuity income, or as deferred compensation (See IRS Tax Topics No. 451)

Nor does "compensation" include any Social Security or railroad retirement benefits required to be included in gross income. Payments made to employees terminated because of a restructuring of the company are deferred compensation and may not be used as a basis for IRA contributions. Amounts received from an employer as deferred incentive awards, whether in the form of cash, stock options, or stock appreciation rights, also are not "compensation."

Incentive pay awarded in one year for services performed in that year but paid in the following year is considered "compensation" in that second year, however.

The IRS has ruled that disability income payments, whether made under public or private plans, do not constitute "compensation." Also, unemployment benefits do not constitute "compensation" because they are paid due to an inability to earn wages and not for personal services actually rendered. Additionally, the IRS has issued a compensation "safe harbor." The amount properly shown in the box for "wages, tips, other compensation," less any amount properly shown in the box for "nonqualified plans," on Form W-2 is considered compensation for purposes of calculating an individual's IRA contribution.

Amounts paid by a husband to his wife to manage their jointly-owned investment property may not be treated by the wife, on a joint return, as compensation for purposes of an IRA contribution. Similarly, wages paid to a wife by her spouse and deposited in their joint account are not considered compensation because deposit in a joint account does not constitute actual payment of wages to the wife.

Payment in hogs rather than cash by a husband to his wife for her services in running their farm, however, was considered to be compensation for purposes of making an IRA contribution.

A self-employed individual who shows a net loss for the tax year cannot take any IRA deduction. A salaried employee who also is self-employed should disregard net losses from self-employment when computing his or her maximum deduction.

4. Are fees or commissions paid in connection with an IRA deductible?

The IRS has ruled that the payment of administrative or trustee fees incurred in connection with an individual retirement account may be claimed as a miscellaneous itemized deduction (i.e., for the production or collection of income) if such fees are separately billed and paid. Furthermore, if separately billed and paid, the payment of such fees does not constitute a contribution to the individual retirement account and thus will not be an excess contribution or reduce the amount that may be contributed to the account or, in the case of a traditional IRA, deducted. Deduction of administrative fees is subject to the 2 percent floor on miscellaneous itemized deductions.

See also: The good-sense IRA

Sales commissions on individual retirement annuities that are billed directly by an insurance agent to the client and paid separately by the client are not separately deductible, but are subject to the overall limits on contributions and deductions.

Similarly, broker's commissions incurred in connection with the purchase of securities on behalf of an IRA are not separately deductible, but are subject to the overall limits.

An annual maintenance fee charged for self-directed brokerage accounts that did not vary with the number of transactions, the number of securities involved, or the dollar amount and that was paid to the trustee, not the broker, was not treated as a commission but was separately deductible as an administrative fee.

In addition, brokerage account "wrap fees" that were based on a percentage of assets under management, but that did not vary based on the number of trades in the account, were not treated as a commission and were separately deductible as an administrative fee.

The IRS has held that the payment of fees associated with flexible premium variable annuity contracts that are paid directly from subaccounts within the contract would not be considered a distribution from the contract.

The IRS ruled that assessing expenses against the contract is unrelated to whether or not the participant is currently entitled to benefits under the contract. Therefore, such payments are an expense of the contract and not a distribution.

5. Is interest paid on amounts borrowed to fund an IRA deductible?

The IRS has ruled that because interest paid on amounts borrowed to fund an IRA is not allocable to tax-exempt income. The deduction of such interest is not subject to the general prohibition against deducting interest incurred or carried to purchase tax-exempts. Because such interest is "on amounts borrowed to buy or carry property held for investment," it would seem that it should be classified as "investment interest expense" and the deduction limited.

Interest paid on money borrowed to buy property held for investment is investment interest. Such interest is deductible but generally limited to the taxpayer's net investment income for the year. However, interest incurred to produce tax-exempt income is not deductible.

Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity).

6. What is the penalty for making excessive contributions to an IRA?

If contributions are made in excess of the maximum contribution limit for traditional IRAs or for Roth IRAs, the contributing individual is liable for a nondeductible excise tax of 6 percent of the amount of the excess (not to exceed 6 percent of the value of the account or annuity, determined as of the close of the tax year). A contribution by a person ineligible to make the contribution is an excess contribution even if it is made through inadvertence.

In the case of an endowment contract described in IRC Section 408(b), the tax does not apply to amounts allocable to life, health, accident, or other insurance. It also does not apply to premiums waived under a disability waiver of premium feature in an individual retirement annuity.

It also does not apply to "rollover" contributions to a traditional IRA or "qualified rollover contributions" to a Roth IRA. It does apply, however, if the "rollover" contribution does not qualify for rollover. The Tax Court did not accept the argument that an IRA created in a failed rollover attempt is not a valid IRA and, thus, the 6 percent penalty should not apply. Likewise, a failed Roth IRA conversion that is not recharacterized is subject to the 6 percent penalty.

The IRS has ruled that earnings credited to an IRA that are attributable to a non-IRA companion account maintained at the same financial institution (a "super IRA") are treated as contributions to the IRA; when coupled with a cash contribution, these amounts may be an excess contribution subject to the penalty tax. An interest bonus credited to an individual retirement account, however, is not included in the calculation of an excess contribution.

7. When can IRA contributions be withdrawn or reduced?

Any IRA contribution (excess or otherwise) may be withdrawn, together with the net income attributable to such contribution, on or before the due date (including extensions of time) for filing the federal income tax return of the contributing individual and the amount will be treated as if never contributed, regardless of the size of the contribution. Thus, such a distribution is not included in gross income and is not subject to the 10 percent early distribution excise tax. Such a distribution of an excess contribution also is not subject to the 6 percent excess contribution excise tax. The accompanying distribution of the net income is includable in income and is subject to penalty as an early distribution. Net income attributable to a contribution is determined by allocating to the contribution a pro-rata portion of the earnings or losses accrued by the IRA during the period the IRA held the contribution. Net income may be a negative amount.

Relief may be granted for failure to meet the above deadline if the taxpayer has taken all necessary and reasonable steps, such as properly notifying the financial institution, to comply with the law. Excess amounts that are not withdrawn by this method are subject to the 6 percent excise tax in the year of contribution and are carried over and taxed each year until the year the excess is eliminated.

By contributing less than the maximum limit in a year, an excess contribution in a previous year may be absorbed up to the unused maximum limit for the year. With respect to traditional IRAs, both the amount contributed and the amount of excess absorbed may be deductible subject to the active participant rules and no taxable income or early distribution tax is involved. The deduction must be reduced if the excess was improperly deducted in a year closed to IRS challenge.

Where all or a portion of the excess is attributable to an excess "rollover" contribution that resulted from the individual's reliance on erroneous information supplied by the plan, trust, or institution making the distribution, distribution of the portion of the excess attributable to the erroneous information is not included in income and is not subject to the 10 percent early distribution tax. It is not necessary to withdraw earnings on the excess, but any earnings withdrawn would be taxable income and subject to the 10 percent tax if early.

The excess also may be reduced by a distribution includable in income. Such a distribution is subject to the 10 percent excise tax if it is an early distribution, as well as income tax.

Where a taxpayer amended his tax return to include an excess contribution in income in the year contributed, the Tax Court ruled that the distribution of the excess in a later year was not includable under the rules of IRC Section 72, that the excess contribution included in income in the prior year constituted an "investment in the contract," and that as a result it was not taxable a second time on the actual distribution of such excess. The phrase "aggregate amount of * * * consideration paid for the contract" found in IRC section 72(e)(6) encompassed the excess contribution made by the taxpayer. The contribution was therefore considered to be an amount paid in consideration for an IRA and, thus, an "investment in the contract." As a consequence, section 72 would provide a basis for the excess contribution and, upon distribution, such amount would be distributed tax-free.

There is no 6 percent excess contributions excise tax on the amount of the reduction in the year of withdrawal.

For purposes of the excess contribution rules, if an excess contribution is invested in a time deposit (such as a CD) that is subject to an early withdrawal penalty of the trustee, the amount reportable as an excess contribution on distribution of the excess is the total amount actually distributed from the plan after the imposition of the early withdrawal penalty.

A decline in asset value does not remove an excess contribution.

8. How are amounts distributed from a traditional IRA taxed?

Distributions from a traditional IRA generally are taxed under IRC Section 72 (relating to the taxation of annuities). Under these rules, a portion of the distribution may be excludable from income. The amount excludable from the taxpayer's income for a year is that portion of the distribution that bears the same ratio to the amount received as the taxpayer's investment in the contract (i.e., nondeductible contributions) bears to the expected return under the contract. In no case will the total amount excluded exceed the unrecovered investment in the contract.

All traditional IRAs are treated as one contract, all distributions during the year are treated as one distribution, and the value of the contract, income on the contract, and investment in the contract are computed as of the close of the calendar year with or within which the taxable year begins. Thus, the nontaxable portion of a distribution (whether from a traditional individual retirement annuity or account) is equal to the following:

The total IRA account balance is the balance in all traditional IRAs owned by the taxpayer, as of December 31 of the year of the distribution. To this amount is added the amount of any distributions made (i.e., the amounts for which the nontaxable portion is being computed) and any outstanding rollover amounts (i.e., any amount distributed by a traditional IRA within sixty days of the end of the year, which has not yet been rolled over into another plan, but which is rolled over in the following year). If it is not rolled over, the amount is not treated as an outstanding rollover.

Nondeductible contributions will not be excluded from gross income as investment in the contract where the taxpayer is unable to document the nontaxable basis through the filing of Form 8606, Nondeductible IRAs (Contributions, Distributions and Basis) for the year in which such nondeductible contributions were made and the year in which they were distributed.

An individual may recognize a loss on a traditional IRA, but only when all amounts have been distributed from all traditional IRAs and the total distributed is less than the individual's unrecovered basis. The deduction for the loss is a miscellaneous itemized deduction.

Despite the pro-rata rule applicable generally to distributions from a traditional IRA, distributions after 2001 that are rolled over to a qualified plan, an IRC Section 403(b) tax sheltered annuity, or an eligible IRC Section 457 governmental plan are treated as coming first from all non-after-tax contributions and earnings in all of the IRAs of the owner. Because after-tax contributions cannot be rolled over to eligible retirement plans other than another IRA, this ordering rule effectively allows the owner to rollover the maximum amount permitted. Appropriate adjustments must be made in applying IRC Section 72 to other IRA distributions in the same taxable year and subsequent years.

The fact that IRA funds were distributed by the financial institution's receiver following insolvency proceedings did not change the nature of the distribution. The taxpayers were taxed on the distribution since a timely rollover was not made.

Likewise, the transfer of IRA funds by a financial institution into a "trust account" was a taxable distribution to the taxpayer even though the taxpayer had intended to transfer the IRA funds to another IRA and had named the account a "trust IRA" because the money was transferred into the trust account.

In addition, a failed Roth IRA conversion that is not recharacterized is treated as a distribution from a traditional IRA and taxed accordingly.

Taxpayers who were defrauded of their account balances by their investment advisor, who convinced them to make IRA rollover investments that the advisor subsequently embezzled, were liable for taxes on the amount of assets stolen because the account holders failed to take the necessary steps required to properly set up IRA rollover accounts.

Unless a taxpayer elects otherwise, any amount of a qualified hurricane distribution required to be included in gross income shall be so included ratably over the three year taxable period beginning with such year.

If a qualified hurricane distribution is an eligible rollover distribution, it may be recontributed to an eligible rollover plan no later than three years from the day after such distribution was received.

9. How are amounts distributed from a Roth IRA taxed?

Where a Roth IRA contains both contributions and conversion amounts, there are ordering rules that apply in determining which amounts are withdrawn. In applying the ordering rules, traditional IRAs are not aggregated with Roth IRAs. All Roth IRAs are aggregated with each other. Regular Roth IRA contributions are deemed to be withdrawn first, then converted amounts second (in order if there has been more than one conversion). Withdrawals of converted amounts are treated first as coming from converted amounts that were includable in income. The ordering rules continue to treat earnings as being withdrawn after contributions.

"Qualified distributions" from a Roth IRA are not includable in gross income. Thus, earnings are tax-free, not tax deferred as with traditional IRAs. A "qualified distribution" is any distribution made after the five-taxable year period beginning with the first taxable year for which the individual made a contribution to a Roth IRA (or such individual's spouse made a contribution to a Roth IRA) established for such individual andsuch distribution meets one of the following requirements.

(1) It is made on or after the date on which the individual attains age 591/2

(2) It is made to a beneficiary (or to the estate of the individual) on or after the death of the individual

(3) It is attributable to the individual's being disabled (within the meaning of IRC Section 72(m)(7)).

(4) It is a "qualified first-time homebuyer distribution" (see below).

A "qualified first-time homebuyer distribution" is any payment or distribution that is used within 120 days after the day it was received by the individual to pay the qualified acquisition costs of a principal residence of a first-time homebuyer. The aggregate amount of payments or distributions received by an individual from all Roth and traditional IRAs that may be treated as qualified first-time homebuyer distributions is limited to a lifetime maximum of $10,000. The first-time homebuyer may be the individual, his or her spouse, any child, grandchild, or ancestor of the individual or his or her spouse. A first-time homebuyer is further defined as an individual (and, if married, such individual's spouse) who has had no present ownership interest in a principal residence during the two year period ending on the date of acquisition of the residence for which the distribution is being made. The date of acquisition is the date on which a binding contract to acquire the residence is entered into or the date construction or reconstruction of the residence begins. Qualified acquisition costs are defined as the costs of acquiring, constructing, or reconstructing a residence, including reasonable settlement, financing, or other closing costs.

In calculating the five-taxable-year period, it is important to remember that contributions to Roth IRAs, as with traditional IRAs, may be made as late as the due date for filing the individual's tax return for the year (without extensions). Thus, if a contribution is made to a Roth IRA between January 1, 2013 and April 17, 2013 for the 2012 taxable year, the five-taxable-year holding period begins to run in 2012.

For purposes of determining whether a distribution from a Roth IRA that is allocable to a "qualified rollover contribution" from a traditional IRA is a "qualified distribution," the five-taxable-year period begins with the taxable year for which the conversion applies. A subsequent conversion will not start the running of a new five-taxable-year period.

The five-taxable-year period for determining a "qualified distribution" is not recalculated on the death of the Roth IRA owner; the five-taxable-year period of the beneficiary includes the period the Roth IRA was held by the decedent.

Any nonqualified distribution will be includable in income, but only to the extent that the distribution, along with all previous distributions from the Roth IRA, exceeds the aggregate amount of contributions to the Roth IRA. For this purpose, all Roth IRAs are aggregated. To the extent such distributions are taxable, the 10 percent early distribution penalty may apply. Distributions allocable to "qualified rollover contributions" will be subject to the early distribution penalty regardless of whether the distribution is taxable if the distribution is made within the five-year period beginning with the tax year in which the contribution was made. Distributions of excess contributions and earnings on these contributions are not qualified distributions.

An individual may recognize a loss on a Roth IRA, but only when all amounts have been distributed from all Roth IRAs and the total distributed is less than the individual's unrecovered Roth IRA contributions. The deduction for the loss is a miscellaneous itemized deduction.

A transfer of a Roth IRA by gift would constitute an assignment of the Roth IRA, with the effect that the assets of the Roth IRA would be deemed to be distributed to the Roth IRA owner and, accordingly, treated as no longer held in a Roth IRA.

Unless a taxpayer elects otherwise, any amount of a qualified hurricane distribution required to be included in gross income shall be so included ratably over the three year taxable period beginning with the year of distribution.

If a qualified hurricane distribution is an eligible rollover distribution, it may be recontributed to an eligible rollover plan no later than three years from the day after such distribution was received.

10. How are SIMPLE IRA plan contributions taxed?

There are four possible types of contributions to a SIMPLE IRA plan.

(1) Salary reduction contributions

(2) Catch-up contributions

(3) Matching contributions

(4) Nonelective contributions

Catch-up contributions are additional elective deferrals (not subject to the $12,000 ceiling in 2013) for individuals age fifty or over. All SIMPLE IRA contributions are excludable from the employee's income, provided they meet certain design requirements set forth in the IRC. Moreover, certain lower income taxpayers may be eligible to claim the saver's credit for salary reduction contributions to a SIMPLE IRA.

Contributions to a SIMPLE IRA are not subject to income tax withholding, but salary reduction contributions are included in wages for purposes of Social Security tax and federal unemployment tax (i.e., FICA and FUTA). Consequently, salary deferrals are subject to FICA and FUTA withholding. It appears that "salary deferrals," for this purpose, would include catch-up contributions. By contrast, matching contributions and nonelective contributions are excluded from wages for purposes of Social Security tax and federal unemployment tax; they are not subject to FICA or FUTA withholding.

Employer contributions to a SIMPLE IRA generally are deductible by the employer. Matching and nonelective contributions can be made after the close of the tax year to which they are attributable, provided they are made before the due date for filing the employer's federal income tax return for the taxable year (including extensions). Contributions to a SIMPLE IRA are not subject to the annual dollar limit for traditional or Roth IRAs. Nondeductible contributions are subject to a 10 percent penalty.

SIMPLE IRA accounts themselves are not subject to tax. The taxation of distributions from a SIMPLE IRA is the same as under a traditional IRA; thus, contributions generally are not taxable until withdrawn. The early distribution penalty is increased to 25 percent during the first two years of participation in a SIMPLE IRA; after the two year period has elapsed, the penalty is 10 percent.

A SIMPLE IRA may not be designated as a Roth IRA.

For more tax planning coverage, visit: www.LifeHealthPro.com/taxplanning

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Date:Mar 3, 2014
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