US Internal Revenue Service: p560--2000

8/14/2019 US Internal Revenue Service: p560--2000

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Contents

Important Changes ............................ 1

Important Reminder ........................... 2

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

Definitions You Need To Know ........ 3

Simplified Employee Pension (SEP) 5Setting Up a SEP ........................... 5

How Much Can I Contribute? ......... 5

Deducting Contributions ................. 6

Salary Reduction SimplifiedEmployee Pension (SARSEP) . 6

Distributions (Withdrawals) ............. 7

Additional Taxes ............................. 8

Reporting and DisclosureRequirements ........................... 8

SIMPLE Plans ..................................... 8

SIMPLE IRA Plan ........................... 8

SIMPLE 401(k) Plan ....................... 10

Qualified Plans .................................. 10

Kinds of Plans ................................. 10

Setting Up a Qualified Plan ............ 11

Minimum Funding Requirement ..... 11

Contributions ................................... 11

Employer Deduction ....................... 12

Elective Deferrals (401(k) Plans) .... 13

Distributions .................................... 14

Prohibited Transactions .................. 15

Reporting Requirements ................. 16

Qualification Rules .......................... 17

AppendixRate Table, RateWorksheet, and DeductionWorksheet for Self-EmployedIndividuals With Qualified or SEP

Plans ............................................. 18

How To Get Tax Help ......................... 20

Index .................................................... 21

Important Changes

Paid preparer authorization. Beginning withyour return for 2000, you can check a box andauthorize the IRS to discuss your Form 1040with your paid preparer who signed it. If youcheck the Yes box in the signature area ofyour return, the IRS can call your paid

preparer to answer any questions that mayarise during the processing of your return.Also, you are authorizing your paid preparerto perform certain actions. See your incometax package for details.

Photographs of missing children. TheInternal Revenue Service is a proud partnerwith the National Center for Missing and Ex-ploited Children. Photographs of missingchildren selected by the Center may appearin this publication on pages that would other-wise be blank. You can help bring thesechildren home by looking at the photographsand calling 1800THELOST (18008435678) if you recognize a child.

Departmentof theTreasury

InternalRevenueService

Publica tion 560Cat. No. 46574N

RetirementPlansfor Sma llBusiness(SEP, SIM PLE, andQualified Plans)

For use in preparing

2000 Returns


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Important Reminder

Plan amendments required by changes inthe law. If you must revise your qualified planto conform to recent legislation, you maychoose to get a determination letter from theIRS approving the revision. Generally, masterand prototype plans are amended by spon-soring organizations. However, there are in-stances when you may need to request adetermination letter regarding a master orprototype plan that is a nonstandardized planyou maintain. Your request should be madeon the appropriate form (generally Form5300, Application for Determination for Em-ployee Benefit Plan, or Form 5307, Applica-tion for Determination for Adopters of Masteror Prototype, Regional Prototype or VolumeSubmitter Plans. The request should be filedwith Form 8717, User Fee for Employee PlanDetermination Letter Request, and the ap-propriate user fee.

You may have to amend your plan tocomply with tax law changes made by thefollowing laws.

Uruguay Round Agreements Act, Public

Law 103465. Small Business Job Protection Act of

1996, Public Law 104188.

Taxpayer Relief Act of 1997, Public Law10534.

Internal Revenue Service Restructuringand Reform Act of 1998, Public Law105206.

You need to make these amendments by thelast day of the first plan year beginning after2000.

IntroductionThis publication discusses retirement plansyou can set up and maintain for yourself andyour employees. In this publication, you re-fers to the employer. See Definitions YouNeed To Know, later. This publication coversthe following types of retirement plans.

SEP (Simplified Employee Pension)plans.

SIMPLE (Savings Incentive Match Planfor Employees) plans.

Qualified plans (also called H.R. 10 plansor Keogh plans when covering self-employed individuals).

SEP, SIMPLE, and qualified plans offeryou and your employees a tax favored wayto save for retirement. You can deduct con-tributions you make to the plan for your em-ployees. If you are a sole proprietor, you candeduct contributions you make to the plan foryourself. You can also deduct trustees' feesif contributions to the plan do not cover them.Earnings on the contributions are generallytax free until you or your employees receivedistributions from the plan.

Under certain plans, employees can haveyou contribute limited amounts of theirbefore-tax pay to a plan. These amounts (andearnings on them) are generally tax free untilyour employees receive distributions from theplan.

What this publication covers. This publi-cation contains the information you need tounderstand the following topics.

What type of plan to set up.

How to set up a plan.

How much you can contribute to a plan.

How much of your contribution isdeductible.

How to treat certain distributions.

How to report information about the planto the IRS and your employees.

Basic features of retirement plans. Basicfeatures of SEP, SIMPLE, and qualified plansare discussed below. The key rules for SEP,SIMPLE, and qualified plans are outlined inTable 1.

SEP plans. SEPs provide a simplifiedmethod for you to make contributions to aretirement plan for your employees. Insteadof setting up a profit-sharing or money pur-chase plan with a trust, you can adopt a SEPagreement and make contributions directly toa traditional individual retirement account ora traditional individual retirement annuity(SEP-IRA) set up for each eligible employee.

SIMPLE plans. A SIMPLE plan can beset up by an employer who had 100 or feweremployees who earned at least $5,000 incompensation for the preceding calendar yearand meets certain other requirements. Undera SIMPLE plan, employees can choose tomake salary reduction contributions ratherthan receiving these amounts as part of theirregular pay. In addition, you will contributematching or nonelective contributions. Thetwo types of SIMPLE plans are the SIMPLEIRA plan and the SIMPLE 401(k) plan.

Qualified plans. The qualified plan rulesare more complex than the SEP plan andSIMPLE plan rules. However, there are ad-vantages available to qualified plans, such asincreased flexibility in designing plans and

increased contribution and deduction limits insome cases.

What this publication does not cover. Al-though the purpose of this publication is toprovide general information about retirementplans you can set up for your employees, thispublication does not contain all the rules andexceptions that apply to these plans. You mayalso need professional help and guidance.

Also, this publication does not cover all therules that may be of interest to employees.For example, it does not cover the followingtopics.

The comprehensive IRA rules an em-ployee needs to know. These rules are

covered in Publication 590, IndividualRetirement Arrangements (IRAs) (Includ-ing Roth IRAs and Education IRAs).

The comprehensive rules that apply todistributions from retirement plans. Theserules are covered in Publication 575,Pension and Annuity Income.

Comments and suggestions. We welcomeyour comments about this publication andyour suggestions for future editions.

You can e-mail us while visiting our website at www.irs.gov/help/email2.html.

You can write to us at the following ad-dress:

Internal Revenue ServiceTechnical Publications BranchW:CAR:MP:FP:P1111 Constitution Ave. NWWashington, DC 20224

We respond to many letters by telephone.Therefore, it would be helpful if you wouldinclude your daytime phone number, includ-ing the area code, in your correspondence.

Useful Items

You may want to see:

Publications

575 Pension and Annuity Income

590 Individual Retirement Arrange-ments (IRAs) (Including RothIRAs and Education IRAs)

Forms (and Instructions)

Schedule C (Form 1040) Profit or LossFrom Business

Schedule CEZ (Form 1040) Net ProfitFrom Business

Schedule F (Form 1040) Profit or LossFrom Farming

Schedule K1 (Form 1065) Partner'sShare of Income, Credits, De-ductions, etc.

Schedule SE (Form 1040) Self-Employment Tax

W2 Wage and Tax Statement

1040 U.S. Individual Income Tax Return

1065 U.S. Return of Partnership In-come

1099R Distributions From Pensions,Annuities, Retirement or Profit-

Sharing Plans, IRAs, InsuranceContracts, etc.

5304SIMPLE Savings Incentive MatchPlan for Employees of Small Em-ployers (SIMPLE) (Not Subject tothe Designated Financial Institu-tion Rules)

5305SEP Simplified EmployeePension-Individual RetirementAccounts Contribution Agreement

5305ASEP Salary Reduction and OtherElective Simplified EmployeePension-Individual RetirementAccounts Contribution Agreement

5305SIMPLE Savings Incentive Match

Plan for Employees of Small Em-ployers (SIMPLE) (for Use With aDesignated Financial Institution)

5329 Additional Taxes Attributable toIRAs, Other Qualified RetirementPlans, Annuities, Modified En-dowment Contracts, and MSAs

5330 Return of Excise Taxes Relatedto Employee Benefit Plans

Form 5500 Annual Return/Report ofEmployee Benefit Plan

5500EZ Annual Return of One-Participant (Owners and TheirSpouses) Retirement Plan

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Table 1. Key Retirement Plan Rules

Due date of employersreturn (including extensions).

TypeofPlan

Maximum Contribution Maximum Deduction

Same as maximumcontribution.

Smaller of $30,000 or 15%1

of participantscompensation.

2

Last Date for Contribution

Due date of employersreturn (including extensions).

Defined Contribution PlansDefined Contribution Plans

Money Purchase: Smaller of$30,000 or 25%

1of

participants compensation.2

SEP

Qualified

Profit-Sharing: Smaller of$30,000 or 25%

1of

participants compensation.2

Defined Benefit Plans

Amount needed to providean annual benefit no largerthan the smaller of $135,000or 100% of the participants

average taxablecompensation for his or herhighest 3 consecutive years.

1Net earnings from self-employment must take the contribution into account.

2Compensation is generally limited to $170,000.

3Does not apply to SIMPLE 401(k) plans. The deadline for qualified plans applies instead.

Elective employercontributions: 30 daysfollowing the end of the

month for which thecontributions are to bemade.

3

Employee: Salary reductioncontribution, upto $6,000.

SIMPLEIRAand

SIMPLE401(k)

Matching contributions ornonelective contributions:Due date of employersreturn (including extensions).

Employer contribution:Eitherdollar-for-dollarmatching contributions, up to3% of employeescompensation,

4orfixed

nonelective contributions of2% of compensation.

2

15% of all participantscompensation

2excluding

SEP contributions.

When To Set Up Plan

Any time between 1/1 and10/1 of the calendar year.

By the end of the tax year.

For a new employer cominginto existence after 10/1, assoon as administrativelyfeasible.

Any time up to due date ofemployers return (includingextensions).

Same as maximumcontribution.

Money Purchase: Same asmaximum contribution.

Profit-Sharing: 15% of allparticipants compensationexcluding plan contributions.

2

Defined Benefit Plans

Based on actuarialassumptions andcomputations.

Note: For a defined benefitplan subject to minimumfunding requirements,contributions are due inquarterly installments. SeeMinimum FundingRequirementsunder QualifiedPlans.

4Under a SIMPLE 401(k) plan, compensation is generally limited to $170,000.

Help from the Internal Revenue Service(IRS). See How To Get Tax Help near theend of this publication for information aboutgetting publications and forms. Additionally,for further information, contact employeeplans taxpayer assistance telephone servicebetween the hours of 1:30 p.m. and 3:30 p.m.Eastern Time, Monday through Thursday at

(202) 6226074/6075. (These are not toll-freenumbers.) Or you can call customer serviceat 18778295500 (toll-free) from 8:00 a.m.to 4:30 p.m. Eastern Time, Monday throughFriday.

Note: All references to section in thefollowing discussions are to sections of theInternal Revenue Code (which can be foundat most libraries) unless otherwise indicated.

DefinitionsYou Need To KnowCertain terms used in this publication are de-fined below. The same term used in another

publication may have a slightly differentmeaning.

Annual additions. Annual additions are thetotal of all your contributions in a year, em-ployee contributions (not including rollovers),and forfeitures allocated to a participant's ac-count.

Annual benefits. Annual benefits are thebenefits to be paid yearly in the form of astraight life annuity (with no extra benefits)under a plan to which employees do notcontribute and under which no rollover con-tributions are made.

Business. A business is an activity in whicha profit motive is present and economic ac-tivity is involved. Service as a newspapercarrier under age 18 is not a business, butservice as a newspaper dealer is. Service asa sharecropper under an owner-tenant ar-rangement is a business. Service as a publicofficial is not.

Common-law employee. A common-lawemployee is any individual who, under com-mon law, would have the status of an em-ployee. A leased employee can also be acommon-law employee.

A common-law employee is a person whoperforms services for an employer who hasthe right to control and direct the results of thework and the way in which it is done. Forexample, the employer:

Provides the employee's tools, materials,and workplace, and

Can fire the employee.

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Common-law employees are not self-employed and cannot set up retirement plansfor income from their work, even if that in-come is self-employment income for socialsecurity tax purposes. For example, com-mon-law employees who are ministers,members of religious orders, full-time insur-ance salespeople, and U.S. citizens em-ployed in the United States by foreign gov-ernments cannot set up retirement plans fortheir earnings from those employments, eventhough their earnings are treated as self-employment income.

However, a common-law employee canbe self-employed as well. For example, anattorney can be a corporate common-lawemployee during regular working hours andalso practice law in the evening as a self-employed person. In another example, aminister employed by a congregation for asalary is a common-law employee eventhough the salary is treated as self-employ-ment income for social security tax purposes.However, fees reported on Schedule C (Form1040) for performing marriages, baptisms,and other personal services are self-employ-ment earnings for qualified plan purposes.

Compensation. Compensation for plan allo-cations is the pay a participant received from

you for personal services for a year. You cangenerally define compensation as includingall the following payments.

1) Wages and salaries.

2) Fees for professional services.

3) Other amounts received (cash or non-cash) for personal services actually ren-dered by an employee, including, but notlimited to, the following items.

a) Commissions and tips.

b) Fringe benefits.

c) Bonuses.

For a self-employed individual, compen-

sation means the earned income, discussedlater, of that individual.

Compensation also includes amounts de-ferred in the following employee benefit plans,unless you choose not to include any amountcontributed under a salary reduction agree-ment that is not included in the gross incomeof the employee. These amounts are electivedeferrals.

Qualified cash or deferred arrangement(section 401(k) plan).

Salary reduction agreement to contributeto a tax-sheltered annuity (section 403(b)plan), a SIMPLE IRA plan, or a SARSEP.

Section 457 nonqualified deferred com-

pensation plan. Section 125 cafeteria plan.

The limit on elective deferrals is discussedlater under Salary Reduction Simplified Em-ployee Pension (SARSEP) and QualifiedPlans.

Other options. In figuring the compen-sation of a participant, you can treat any ofthe following amounts as the employee'scompensation.

The employee's wages as defined for in-come tax withholding purposes.

The employee's wages you report in box1 of Form W2.

The employee's social security wages(including elective deferrals).

Compensation generally cannot includeeither of the following items.

Reimbursements or other expense al-lowances (unless paid under a nonac-countable plan).

Deferred compensation (either amountsgoing in or amounts coming out) otherthan certain elective deferrals unless you

choose not to include those electivedeferrals in compensation.

Contribution. A contribution is an amountyou pay into a plan for all those participatingin the plan, including self-employed individ-uals. Limits apply to how much, under thecontribution formula of the plan, can be con-tributed each year for a participant.

Deduction. A deduction is the plan contribu-tions you can subtract from gross income onyour federal income tax return. Limits applyto the amount deductible.

Earned income. Earned income is net

earnings from self-employment, discussedlater, from a business in which your servicesmaterially helped to produce the income.

You can also have earned income fromproperty your personal efforts helped create,such as royalties from your books or in-ventions. Earned income includes netearnings from selling or otherwise disposingof the property, but it does not include capitalgains. It includes income from licensing theuse of property other than goodwill.

If you have more than one business, butonly one has a retirement plan, only theearned income from that business is consid-ered for that plan.

Employer. An employer is generally any

person for whom an individual performs or didperform any service, of whatever nature, asan employee. A sole proprietor is treated ashis or her own employer for retirement planpurposes. However, a partner is not an em-ployer for retirement plan purposes. Thepartnership is treated as the employer of eachpartner.

Highly compensated employee. A highlycompensated employee is an individual who:

Owned more than 5% of the capital orprofits in your business at any time duringthe year or the preceding year, or

For the preceding year, received com-pensation from you of more than $80,000

($85,000 for certain non-calendar yearplans making a calendar year dataelection described in Notice 9745 inCumulative Bulletin 19972) and, if youso choose, was in the top 20% of em-ployees when ranked by compensation.

Leased employee. A leased employee whois not your common-law employee must gen-erally be treated as your employee for retire-ment plan purposes if he or she does all thefollowing.

Provides services to you under anagreement between you and a leasingorganization.

Has performed services for you (or foryou and related persons) substantially fulltime for at least 1 year.

Performs services under your primary di-rection or control.

Exception. A leased employee is nottreated as your employee if all the followingconditions are met.

1) Leased employees are not more than20% of your nonhighly compensated

work force.2) The employee is covered by the leasing

organization under its qualified pensionplan.

3) The leasing organization's plan is amoney purchase pension plan that hasall the following provisions.

a) Immediate participation.

b) Full and immediate vesting.

c) A nonintegrated employer contribu-tion rate of at least 10% of com-pensation for each participant.

However, if the leased employee is your

common-law employee, that employee will beyour employee for all purposes, regardlessof any pension plan of the leasing organiza-tion.

Net earnings from self-employment. ForSEP and qualified plans, net earnings fromself-employment is your gross income fromyour trade or business (provided your per-sonal services are a material income-producing factor) minus allowable businessdeductions. Allowable deductions includecontributions to SEP and qualified plans forcommon-law employees and the deductionallowed for one-half of your self-employmenttax.

Net earnings from self-employment do not

include items excluded from gross income (ortheir related deductions) other than foreignearned income and foreign housing costamounts.

For the deduction limits, earned income isnet earnings for personal services actuallyrendered to the business. You take into ac-count the income tax deduction for one-halfof self-employment tax and the deduction forcontributions to the plan made on your behalfwhen figuring net earnings.

Net earnings include a partner's distribu-tive share of partnership income or loss (otherthan separately stated items, such as capitalgains and losses). It does not include incomepassed through to shareholders of S corpo-rations. Guaranteed payments to limitedpartners are net earnings from self-employ-

ment if they are paid for services to or for thepartnership. Distributions of other income orloss to limited partners are not net earningsfrom self-employment.

For SIMPLE plans, net earnings fromself-employment is the amount on line 4 ofShort Schedule SE (Form 1040) before sub-tracting any contributions made to theSIMPLE IRA plan for yourself.

Participant. A participant is an eligible em-ployee who is covered by your retirementplan. See the discussions of the differenttypes of plans for the definition of an em-ployee eligible to participate in each type ofplan.

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Partner. A partner is an individual who sharesownership of an unincorporated trade orbusiness with one or more persons. For re-tirement plans, a partner is treated as anemployee of the partnership.

Self-employed individual. An individual inbusiness for himself or herself is self-employed. Sole proprietors and partners areself-employed. Self-employment can includepart-time work.

Not everyone who has net earnings fromself-employment for social security tax pur-poses is self-employed for qualified plan pur-poses. See Common-law employee, earlier.Also see Net earnings from self-employment.

In addition, certain fishermen may beconsidered self-employed for setting up aqualified plan. See Publication 595, TaxHighlights for Commercial Fishermen, for thespecial rules used to determine whether fish-ermen are self-employed.

Sole proprietor. A sole proprietor is an in-dividual who owns an unincorporated busi-ness by himself or herself. For retirementplans, a sole proprietor is treated as both anemployer and an employee.

Simplified EmployeePension (SEP)A simplified employee pension (SEP) is awritten plan that allows you to make contri-butions toward your own (if you are self-employed) and your employees' retirementwithout getting involved in a more complexqualified plan.

Under a SEP, you make the contributionsto a traditional individual retirement arrange-ment (called a SEP-IRA) set up by or for eacheligible employee. SEP-IRAs are owned andcontrolled by the employee, and you makecontributions to the financial institution wherethe SEP-IRA is maintained.

SEP-IRAs are set up for, at a minimum,each eligible employee (defined later). ASEP-IRA may have to be set up for a leasedemployee (defined earlier under DefinitionsYou Need To Know), but does not need tobe set up for excludable employees (definedlater).

Eligible employee. An eligible employee isan individual who meets all the following re-quirements.

Has reached age 21.

Has worked for you in at least 3 of the last5 years.

Has received at least $450 in compen-

sation from you for 2000.

TIPYou can use less restrictive partici-pation requirements than those listed,but not more restrictive ones.

Excludable employees. The following em-ployees can be excluded from coverage un-der a SEP.

Employees covered by a union agree-ment and whose retirement benefits werebargained for in good faith by the em-ployees' union and you.

Nonresident alien employees who havereceived no U.S. source wages, salaries,

or other personal services compensationfrom you. For more information aboutnonresident aliens, see Publication 519,U.S. Tax Guide for Aliens.

Setting Up a SEPThere are three basic steps in setting up aSEP.

1) You must execute a formal writtenagreement to provide benefits to all eli-gible employees.

2) You must give each eligible employeecertain information about the SEP.

3) A SEP-IRA must be set up by or for eacheligible employee.

TIPMany financial institutions will helpyou set up a SEP.

Formal written agreement. You must exe-cute a formal written agreement to providebenefits to all eligible employees under aSEP. You can satisfy the written agreementrequirement by adopting an IRS model SEPusing Form 5305SEP. However, see Whennot to use Form 5305SEP, later.

If you adopt an IRS model SEP usingForm 5305SEP, no prior IRS approval ordetermination letter is required. Keep the ori-ginal form. Do not file it with the IRS. Also,using Form 5305SEP will usually relieve youfrom filing annual retirement plan informationreturns with the IRS and the Department ofLabor. See the Form 5305SEP instructionsfor details.

When not to use Form 5305SEP. Youcannot use Form 5305SEP if any of the fol-lowing apply.

1) You currently maintain any other qual-ified retirement plan. This does not pre-vent you from maintaining another SEP.

2) You have any eligible employees for

whom IRAs have not been set up.3) You use the services of leased employ-

ees (as described earlier under Defi-nitions You Need to Know).

4) You are a member of any of the followingunless all eligible employees of all themembers of these groups, trades, orbusinesses participate under the SEP.

a) An affiliated service group de-scribed in section 414(m).

b) A controlled group of corporationsdescribed in section 414(b).

c) Trades or businesses under com-mon control described in section414(c).

5) You do not pay the cost of the SEPcontributions.

Information you must give to employees.You must give each eligible employee a copyof Form 5305SEP, its instructions, and theother information listed in the Form5305SEP instructions. An IRS model SEPis not considered adopted until you give eachemployee this information.

Setting up the employee's SEP-IRA. ASEP-IRA must be set up by or for each eligi-ble employee. SEP-IRAs can be set up withbanks, insurance companies, or other qual-ified financial institutions. You send SEP

contributions to the financial institution wherethe SEP-IRA is maintained.

Deadline for setting up a SEP. You can setup a SEP for a year as late as the due date(including extensions) of your income tax re-turn for that year.

How MuchCan I Contribute?The SEP rules permit you to contribute a

limited amount of money each year to eachemployee's SEP-IRA. If you are self-employed, you can contribute to your ownSEP-IRA. Contributions must be in the formof money (cash, check, or money order). Youcannot contribute property. However, partic-ipants may be able to transfer or roll overcertain property from one retirement plan toanother. See Publication 590 for more infor-mation about rollovers.

You do not have to make contributionsevery year. But if you make contributions,they must be based on a written allocationformula and must not discriminate in favor ofhighly compensated employees (defined ear-lier under Definitions You Need To Know).When you contribute, you must contribute to

the SEP-IRAs of all participants who actuallyperformed personal services during the yearfor which the contributions are made, evenemployees who die or terminate employmentbefore the contributions are made.

The contributions you make under a SEPare treated as if made to a qualified pension,stock bonus, profit-sharing, or annuity plan.Consequently, contributions are deductiblewithin limits, as discussed later, and generallyare not taxable to the plan participants.

A SEP-IRA cannot be designated as aRoth IRA. Employer contributions to aSEP-IRA will not affect the amount an indi-vidual can contribute to a Roth IRA.

Time limit for making contributions. Todeduct contributions for a year, you mustmake the contributions by the due date (in-cluding extensions) of your tax return for theyear.

Contribution LimitsContributions you make for a year to a com-mon-law employee's SEP-IRA cannot exceedthe lesser of 15% of the employee's com-pensation or $30,000. Compensation gener-ally does not include your contributions to theSEP. However, if you have a salary reductionarrangement, see Employee compensationunder Salary Reduction Simplified EmployeePension (SARSEP), later.

Example. Your employee, Mary Plant,earned $21,000 for the year. The maximumcontribution you can make to her SEP-IRA is$3,150 (15% x $21,000).

Contributions for yourself. The annuallimits on your contributions to a common-lawemployee's SEP-IRA also apply to contribu-tions you make to your own SEP-IRA. How-ever, special rules apply when figuring yourmaximum deductible contribution. See De-duction Limit for Self-Employed Individuals,later.

Annual compensation limit. You cannotconsider the part of an employee's compen-sation over $170,000 when figuring yourcontribution limit for that employee. There-

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fore, $25,500 is the maximum contribution foran eligible employee whose compensation is$170,000 or more.

More than one plan. If you contribute to adefined contribution plan (defined later underQualified Plans), annual additions to an ac-count are limited to the lesser of $30,000 or25% of the participant's compensation. Whenyou figure this limit, you must add your con-tributions to all defined contribution plans.Because a SEP is considered a defined con-

tribution plan for this limit, your contributionsto a SEP must be added to your contributionsto other defined contribution plans.

Tax treatment of excess contributions.Excess contributions are your contributions toan employee's SEP-IRA (or to your ownSEP-IRA) for a year that exceed the lesserof the following amounts.

15% of the employee's compensation (or,for you, 13.0435% of your net earningsfrom self-employment).

$30,000.

Excess contributions are included in the em-ployee's income for the year and are treated

as contributions by the employee to his or herSEP-IRA. For more information on employeetax treatment of excess contributions, seechapter 4 in Publication 590.

Reporting on Form W2. Do not includeSEP contributions on your employee's FormW2 unless contributions were made undera salary reduction arrangement (discussedlater).

Deducting ContributionsGenerally, you can deduct the contributionsyou make each year to each employee'sSEP-IRA. If you are self-employed, you candeduct the contributions you make each year

to your own SEP-IRA.

Deduction Limitfor Your Contributionson Behalf of EmployeesThe most you can deduct for your contribu-tions for participants is the lesser of the fol-lowing amounts.

Your contributions (including any electivedeferrals and excess contributionscarryover).

15% of the compensation (limited to$170,000 per participant) paid to themduring the year from the business thathas the plan.

Deduction Limit forSelf-Employed IndividualsIf you contribute to your own SEP-IRA, youmust make a special computation to figureyour maximum deduction for these contribu-tions. When figuring the deduction for con-tributions made to your own SEP-IRA, com-pensation is your net earnings fromself-employment (defined under DefinitionsYou Need To Know), which takes into ac-count both the following deductions.

The deduction for one-half of your self-employment tax.

The deduction for contributions to yourown SEP-IRA.

The deduction for contributions to yourown SEP-IRA and your net earnings dependon each other. For this reason, you determinethe deduction for contributions to your ownSEP-IRA indirectly by reducing the contribu-tion rate called for in your plan. To do this,use the Rate Table for Self-Employedor theRate Worksheet for Self-Employed, which-ever is appropriate for your plan's contributionrate, in the Appendix. Then figure your maxi-mum deduction by using the DeductionWorksheet for Self-Employed in the Appen-dix.

Deduction Limitsfor Multiple PlansFor the deduction limits, treat all your qualifieddefined contribution plans as a single planand all your qualified defined benefit plans asa single plan. See Kinds of Plans, later, underQualified Plans for the definitions of definedcontribution plans and defined benefit plans.If you have both kinds of plans, a SEP istreated as a separate profit-sharing (definedcontribution) plan. A qualified plan is a planthat meets the requirements discussed later

under Qualification Rules. For informationabout the special deduction limits, see De-duction limit for multiple plansunder QualifiedPlans, later.

SEP and profit-sharing plan. If you alsocontribute to a qualified profit-sharing plan,you must reduce the 15% deduction limit forthat profit-sharing plan by the allowable de-duction for contributions to the SEP-IRAs ofthose participating in both the SEP plan andthe profit-sharing plan.

Carryover ofExcess SEP ContributionsIf you made SEP contributions that are more

than the deduction limit (nondeductible con-tributions), you can carry over and deduct thedifference in later years. However, the contri-butions carryover, when combined with thecontribution for the later year, is subject to thededuction limit for that year. If you also con-tributed to a defined benefit plan or definedcontribution plan, see Carryover of ExcessContributionsunder Qualified Plans, later, forthe carryover limit.

Excise tax. If you made nondeductible (ex-cess) contributions to a SEP, you may besubject to a 10% excise tax. For informationabout the excise tax, see Excise Tax forNondeductible (Excess) Contributions underQualified Plans, later.

When To Deduct ContributionsWhen you can deduct contributions made fora year depends on the tax year on which theSEP is maintained.

If the SEP is maintained on a calendaryear basis, you deduct contributionsmade for a year on your tax return for theyear with or within which the calendaryear ends.

If you file your tax return and maintain theSEP using a fiscal year or short tax year,you deduct contributions made for a yearon your tax return for that year.

Example. You are a fiscal year taxpayerwhose tax year ends June 30. You maintaina SEP on a calendar year basis. You deductSEP contributions made for calendar year2000 on your tax return for your tax yearending June 30, 2001.

Where To Deduct ContributionsDeduct contributions for yourself on line 29of Form 1040. You deduct contributions foryour employees on Schedule C (Form 1040),on Schedule F (Form 1040), on Form 1065,

on Form 1120, U.S. Corporation Income TaxReturn, on Form 1120A, U.S. CorporationShort-Form Income Tax Return, or on Form1120S, U.S. Income Tax Return for an SCorporation, whichever applies to you.

If you are a partner, the partnershippasses its deduction to you for the contribu-tions it made for you. The partnership will re-port these contributions on Schedule K1(Form 1065). You deduct the contributions online 29 of Form 1040.

Salary ReductionSimplified EmployeePension (SARSEP)

A SARSEP is a SEP set up before 1997 thatincludes a salary reduction arrangement.(See the Caution, next). Under a SARSEP,your employees can choose to have youcontribute part of their pay to their SEP-IRAsrather than receive it in cash. This contribu-tion is called an elective deferral becauseemployees choose (elect) to set aside themoney, and they defer the tax on the moneyuntil it is distributed to them.

CAUTION

!You are not allowed to set up aSARSEP after 1996. However, par-ticipants (including employees hired

after 1996) in a SARSEP set up before 1997can continue to have you contribute part oftheir pay to the plan. If you are interested insetting up a retirement plan that includes a

salary reduction arrangement, see SIMPLEPlans, later.

Who can have a SARSEP? A SARSEP setup before 1997 is available to you and youreligible employees only if all the following re-quirements are met.

At least 50% of your employees eligibleto participate choose the salary reductionarrangement.

You have 25 or fewer employees whowere eligible to participate in the SEP (orwould have been eligible to participate ifyou had maintained a SEP) at any timeduring the preceding year.

The elective deferrals of your highlycompensated employees meet theSARSEP ADP test.

SARSEP ADP test. Under the SARSEPADP test, the amount deferred each year byeach eligible highly compensated employeeas a percentage of pay (the deferral percent-age) cannot be more than 125% of the aver-age deferral percentage (ADP) of all non-highly compensated employees eligible toparticipate. A highly compensated employeeis defined earlier under Definitions You NeedTo Know.

Deferral percentage. The deferral per-centage for an employee for a year is figuredas follows.

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The elective employer contributionspaid to the SEP for the employee

for the year

The employees compensation(limited to $170,000)

TIPThe instructions for Form 5305ASEPhave a worksheet you can use to de-termine whether the elective deferrals

of your highly compensated employees meetthe SARSEP ADP test.

Who cannot have a SARSEP? A state orlocal government, any of its political subdivi-sions, agencies, or instrumentalities, or atax-exempt organization cannot have a SEPthat includes a salary reduction arrangement.

Limit on Elective DeferralsThe most a participant can choose to deferfor calendar year 2000 is the lesser of thefollowing amounts.

15% of the participant's compensation(limited to $170,000 of the participant'scompensation).

$10,500.

The $10,500 limit applies to the totalelective deferrals the employee makes for theyear to a SEP and any of the following.

Cash or deferred arrangement (section401(k) plan).

Salary reduction arrangement under atax-sheltered annuity plan (section 403(b)plan).

SIMPLE IRA plan.

Overall limit on SEP contributions. If youalso make nonelective contributions to aSEP-IRA, the total of the nonelective andelective contributions to that SEP-IRA cannot

be more than the lesser of 15% of the em-ployee's compensation or $30,000. The samerule applies to contributions you make to yourown SEP-IRA. See Contribution Limits, ear-lier.

Employee compensation. For figuring theelective deferral, compensation is generallythe amount you pay to the employee for theyear. Compensation includes the electivedeferral and other amounts deferred in certainemployee benefit plans. See Compensation,earlier under Definitions You Need To Know.These amounts are included in figuring youremployees' total contributions even thoughthey are not included in the income of youremployees for income tax purposes.

TIP You can choose not to treat thedeferral as compensation, as dis-cussed later.

To figure the deferral, multiply the em-ployee's compensation by the deferral contri-bution rate. However, you must always usethe reduced rate method to determine themaximum deductible contribution (13.0435%of unreduced compensation). This is thesame method you use to figure your de-duction for contributions you make to yourown SEP-IRA.

Example 1. Jim's SARSEP calls for adeferral contribution rate of 10% of his salary.Jim's salary for the year is $30,000 (before

reduction for the deferral). You multiply Jim'ssalary by 10% to get his deferral of $3,000.Your maximum deduction for elective defer-rals and any nonelective contributions wouldbe $3,913.05 ($30,000 .130435).

On Jim's Form W2, you show his totalwages as $27,000 ($30,000 $3,000). Socialsecurity wages and Medicare wages will eachbe $30,000. Jim will report $27,000 as wageson his individual income tax return.

Choice not to treat deferrals as com-pensation. You can choose not to treatelective deferrals (and other amounts de-ferred in certain employee benefit plans) fora year as compensation under your SARSEP.You can use this method for calculatingdeferral percentages for the SARSEP ADPtest defined earlier.

The deferral and the compensation (minusthe deferral) depend on each other. For thisreason, you figure the deferral indirectly byreducing the contribution rate for deferralscalled for under the salary reduction ar-rangement. This method is the same one youuse to figure your deduction for contributionsyou make to your own SEP-IRA. You mustalso use the reduced rate method to deter-mine the maximum deductible contribution(13.0435% of unreduced compensation).

To figure the deferral, use either the ratetable or rate worksheet in the Appendix. Usethe rate table if the deferral contribution ratecalled for under the SARSEP equals a wholepercentage. Otherwise, use the rate work-sheet. When using the rate table, first locatethe deferral contribution rate in Column A.Then read across to find the reduced rate inColumn B. Multiply the reduced rate by youremployee's compensation to get the deferral.

Example 2. The facts are the same as inExample 1 except you chose not to treatdeferrals as compensation under the ar-rangement. To figure the deferral, you multi-ply Jim's salary of $30,000 by 0.090909 (thereduced rate equivalent of 10%) to get the

deferral of $2,727.27. Your maximum de-duction for elective deferrals and any none-lective contributions would be $3,913.05($30,000 .130435).

On Jim's Form W2, you show his totalwages as $27,272.73 ($30,000 $2,727.27).Social security wages and Medicare wageswill each be $30,000. Jim will report$27,272.73 as wages on his individual incometax return.

Alternative definitions of compen-sation. In addition to the general definitionof compensation under Definitions You NeedTo Know and the choice described in thepreceding paragraphs, you can use any defi-nition of compensation that meets all the fol-lowing conditions.

It is reasonable.

It is not designed to favor highly com-pensated employees.

It provides that the average percentageof total compensation used for highlycompensated employees as a group forthe year is not more than minimally higherthan the average percentage of totalcompensation used for all other employ-ees as a group.

Compensation of self-employed indi-viduals. If you are self-employed, compen-sation is your net earnings from self-employ-

ment as defined earlier under Definitions YouNeed To Know.

To figure the deferral, you must use a re-duced rate instead of the deferral contributionrate called for under the SARSEP. Use eitherthe rate table or rate worksheet in the Ap-pendixto get the reduced rate. Then use thededuction worksheet to figure the deferral.

Compensation does not include tax-freeitems (or deductions related to them) otherthan foreign earned income and housing costamounts.

Compensation of disabled participant.You may be able to choose to use specialrules to determine compensation for a partic-ipant who is permanently and totally disabled.Under these rules, compensation means thecompensation the participant would have re-ceived if paid at the rate paid immediatelybefore becoming permanently and totally dis-abled. See Internal Revenue Code section415(c)(3)(C) for details.

Tax Treatment of DeferralsYou can deduct your deferrals that, whenadded to your other SEP contributions, arenot more than the limits under DeductingContributions, earlier.

Elective deferrals that are not more than

the limit discussed earlier are excluded fromyour employees' wages subject to federal in-come tax in the year of deferral. However,these deferrals are included in wages for so-cial security, Medicare, and federal unem-ployment (FUTA) tax.

Excess deferrals. For 2000, excess defer-rals are the elective deferrals for the year thatare more than the $10,500 limit discussedearlier. The treatment of excess deferralsmade under a SARSEP is similar to thetreatment of excess deferrals made under aqualified plan. See Treatment of ExcessDeferralsunder Qualified Plans, later.

Excess SEP contributions. Excess SEP

contributions are elective deferrals of highlycompensated employees that are more thanthe amount permitted under the SARSEPADP test. You must notify your highly com-pensated employees within 21/2 months afterthe end of the plan year of their excess SEPcontributions. If you do not notify them withinthis time period, you must pay a 10% tax onthe excess. For an explanation of the notifi-cation requirements, see Revenue Procedure9144 in Cumulative Bulletin 19912. If youadopted a SARSEP using Form 5305ASEP,the notification requirements are explained inthe instructions for that form.

Reporting on Form W2. Do not includeelective deferrals in the Wages, tips, othercompensation box of Form W2. You must,however, include them in the Social securitywages and Medicare wages and tips boxes.You must also include them in box 13. Markthe Deferred compensation checkbox in box15. For more information, see the Form W2instructions.

Distributions (Withdrawals)As an employer, you cannot prohibit distribu-tions from a SEP-IRA. Also, you cannot makeyour contributions on the condition that anypart of them must be kept in the account.

Distributions are subject to IRA rules. Forinformation about IRA rules, including the taxtreatment of distributions, rollovers, required

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distributions, and income tax withholding, seePublication 590.

Additional TaxesThe tax advantages of using SEP-IRAs forretirement savings can be offset by additionaltaxes. There are additional taxes for all thefollowing actions.

Making excess contributions.

Making early withdrawals.

Not making required withdrawals.

For information about these taxes, seechapter 1 in Publication 590. Also, a SEP-IRAmay be disqualified, or an excise tax mayapply, if the account is involved in a prohibitedtransaction, discussed next.

Prohibited transaction. If an employee im-properly uses his or her SEP-IRA, such asby borrowing money from it, the employeehas engaged in a prohibited transaction. Inthat case, the SEP-IRA will no longer qualifyas an IRA. For a list of prohibited trans-actions, see Prohibited Transactions underQualified Plans, later.

Effects on employee. If a SEP-IRA is

disqualified because of a prohibited trans-action, the assets in the account will betreated as having been distributed to the em-ployee on the first day of the year in which thetransaction occurred. The employee must in-clude in income the fair market value of theassets (on the first day of the year) that ismore than any cost basis in the account. Also,the employee may have to pay the additionaltax for making early withdrawals. For moreinformation, see Taxes on Prohibited Trans-actionsunder Qualified Plans, later.

Reporting andDisclosure RequirementsIf you set up a SEP using Form 5305SEP

or Form 5305ASEP (for a SARSEP), youmust give your eligible employees certain in-formation about the SEP when you set it up.See Setting Up a SEP, earlier. Also, you mustgive your eligible employees a statementeach year showing any contributions to theirSEP-IRAs. If you set up a salary reductionSEP, you must also give them notice of anyexcess contributions. For details about otherinformation you must give them, see the in-structions for either of these forms.

Even if you did notuse Form 5305SEPor Form 5305ASEP to set up your SEP, youmust give your employees information similarto that described above. For more informa-tion, see the instructions for either Form5305SEP or Form 5305ASEP.

SIMPLE PlansA Savings Incentive Match Plan for Employ-ees (SIMPLE plan) is a written arrangementthat provides you and your employees with asimplified way to make contributions to pro-vide retirement income. Under a SIMPLEplan, employees can choose to make salaryreduction contributions to the plan rather thanreceiving these amounts as part of their reg-ular pay. In addition, you will contributematching or nonelective contributions.

SIMPLE plans can only be maintained ona calendar-year basis.

A SIMPLE plan can be set up in either ofthe following ways.

Using SIMPLE IRAs (SIMPLE IRA plan).

As part of a 401(k) plan (SIMPLE 401(k)plan).

TIPMany financial institutions will helpyou set up a SIMPLE plan.

SIMPLE IRA Plan

A SIMPLE IRA plan is a retirement plan thatuses SIMPLE IRAs for each eligible em-ployee. Under a SIMPLE IRA plan, a SIMPLEIRA must be set up for each eligible em-ployee. For the definition of an eligible em-ployee, see Who Can Participate in a SIMPLEIRA Plan?, later.

Who Can Set Upa SIMPLE IRA Plan?You can set up a SIMPLE IRA plan if youmeet both the following requirements.

You meet the employee limit.

You do not maintain another qualifiedplan unless the other plan is for collective

bargaining employees.

Employee limit. You can set up a SIMPLEIRA plan only if you had 100 or fewer em-ployees who earned $5,000 or more in com-pensation during the preceding year. Underthis rule, you must take into account allem-ployees employed at any time during the cal-endar year regardless of whether they areeligible to participate. Employees includeself-employed individuals who receivedearned income and leased employees (de-fined earlier under Definitions You Need ToKnow).

Once you set up a SIMPLE IRA plan, youmust continue to meet the 100-employee limiteach year you maintain the plan.

Grace period for employers who ceaseto meet the 100-employee limit. If youmaintain the SIMPLE IRA plan for at least 1year and you cease to meet the100-employee limit in a later year, you will betreated as meeting it for the 2 calendar yearsimmediately following the calendar year forwhich you last met it.

A different rule applies if you do not meetthe 100-employee limit because of an acqui-sition, disposition, or similar transaction. Un-der this rule, the SIMPLE IRA plan will betreated as meeting the 100-employee limit forthe year of the transaction and the 2 followingyears if both the following conditions are sat-isfied.

Coverage under the plan has not signif-

icantly changed during the grace period. The SIMPLE IRA plan would have cont-

inued to qualify after the transaction if youhad remained a separate employer.

CAUTION

!The grace period for acquisitions,dispositions, and similar transactionsalso applies if, because of these types

of transactions, you do not meet the rulesexplained underOther qualified plan orWhoCan Participate in a SIMPLE IRA Plan?, be-low.

Other qualified plan. The SIMPLE IRA plangenerally must be the only retirement plan towhich you make contributions, or benefits

accrue, for service in any year beginning withthe year the SIMPLE IRA plan becomes ef-fective.

Exception. If you maintain a qualifiedplan for collective bargaining employees, youare permitted to maintain a SIMPLE IRA planfor other employees.

Who Can Participatein a SIMPLE IRA Plan?

Eligible employee.Any employee who re-ceived at least $5,000 in compensation during

any 2 years preceding the current calendaryear and is reasonably expected to earn atleast $5,000 during the current calendar yearis eligible to participate. The termemployee includes a self-employed individ-ual who received earned income.

You can use less restrictive eligibility re-quirements (but not more restrictive ones) byeliminating or reducing the prior year com-pensation requirements, the current yearcompensation requirements, or both. For ex-ample, you can allow participation for em-ployees who received at least $3,000 incompensation during any preceding calendaryear. However, you cannot impose any otherconditions on participating in a SIMPLE IRA

plan.

Excludable employees. The following em-ployees do not need to be covered under aSIMPLE IRA plan.

Employees who are covered by a unionagreement and whose retirement benefitswere bargained for in good faith by theemployees' union and you.

Nonresident alien employees who havereceived no U.S. source wages, salaries,or other personal services compensationfrom you.

Compensation. Compensation for employ-

ees is the total wages required to be reportedon Form W2. Compensation also includesthe salary reduction contributions made underthis plan, compensation deferred under asection 457 plan, and the employees' electivedeferrals under a section 401(k) plan, aSARSEP, or a section 403(b) annuity con-tract. If you are self-employed, compensationis your net earnings from self-employment(line 4 of Short Schedule SE (Form 1040))before subtracting any contributions made tothe SIMPLE IRA plan for yourself.

How To Set Up a SIMPLE IRA PlanYou can use Form 5304SIMPLE or Form5305SIMPLE to set up a SIMPLE IRA plan.Each form is a model savings incentive matchplan for employees (SIMPLE) plan document.Which form you use depends on whether youselect a financial institution or your employeesselect the institution that will receive the con-tributions.

Use Form 5304SIMPLE if you allow eachplan participant to select the financial institu-tion for receiving his or her SIMPLE IRA plancontributions. Use Form 5305SIMPLE if yourequire that all contributions under theSIMPLE IRA plan be deposited initially at adesignated financial institution.

The SIMPLE IRA plan is adopted whenyou have completed all appropriate boxesand blanks on the form and you (and thedesignated financial institution, if any) have

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signed it. Keep the original form. Do not fileit with the IRS.

Other uses of the forms. If you set up aSIMPLE IRA plan using Form 5304SIMPLEor Form 5305SIMPLE, you can use the formto satisfy other requirements, including thefollowing.

Meeting employer notification require-ments for the SIMPLE IRA plan. Page 3of Form 5304SIMPLE and Page 3 ofForm 5305SIMPLE contain a ModelNotification to Eligible Employeesthatprovides the necessary information to theemployee.

Maintaining the SIMPLE IRA plan recordsand proving you set up a SIMPLE IRAplan for employees.

Deadline for setting up a SIMPLE IRA plan.You can set up a SIMPLE IRA plan effectiveon any date between January 1 and October1 of a year, provided you did not previouslymaintain a SIMPLE IRA plan. If you previ-ously maintained a SIMPLE IRA plan, youcan set up a SIMPLE IRA plan effective onlyon January 1 of a year. This requirement doesnot apply if you are a new employer that

comes into existence after October 1 of theyear the SIMPLE IRA plan is set up and youset up a SIMPLE IRA plan as soon as ad-ministratively feasible after you come intoexistence. A SIMPLE IRA plan cannot havean effective date that is before the date youactually adopt the plan.

Setting up a SIMPLE IRA. SIMPLE IRAsare the individual retirement accounts or an-nuities into which the contributions are de-posited. A SIMPLE IRA must be set up foreach eligible employee. Forms 5305S,SIMPLE Individual Retirement Trust Account,and 5305SA, SIMPLE Individual RetirementCustodial Account, are model trust and cus-todial account documents the participant and

the trustee (or custodian) can use for thispurpose.A SIMPLE IRA cannot be designated as

a Roth IRA. Contributions to a SIMPLE IRAwill not affect the amount an individual cancontribute to a Roth IRA.

Deadline for setting up a SIMPLE IRA.A SIMPLE IRA must be set up for an em-ployee before the first date by which a con-tribution is required to be deposited into theemployee's IRA. See Time limits for contrib-uting funds, later, under Contribution Limits.

Notification RequirementIf you adopt a SIMPLE IRA plan, you mustnotify each employee of the following infor-mation before the beginning of the election

period.

1) The employee's opportunity to make orchange a salary reduction choice undera SIMPLE IRA plan.

2) Your choice to make either reducedmatching contributions or nonelectivecontributions (discussed later).

3) A summary description and the locationof the plan. The financial institutionshould provide you with this information.

4) Written notice that his or her balance canbe transferred without cost or penalty ifyou use a designated financial institu-tion.

Election period. The election period is gen-erally the 60-day period immediately preced-ing January 1 of a calendar year (November2 to December 31 of the preceding calendaryear). However, the dates of this period aremodified if you set up a SIMPLE IRA plan inmid-year (for example, on July 1) or if the60-day period falls before the first day anemployee becomes eligible to participate inthe SIMPLE IRA plan.

A SIMPLE IRA plan can provide longerperiods for permitting employees to enter intosalary reduction agreements or to modify prioragreements. For example, a SIMPLE IRAplan can provide a 90-day election period in-stead of the 60-day period. Similarly, in addi-tion to the 60-day period, a SIMPLE IRA plancan provide quarterly election periods duringthe 30 days before each calendar quarter,other than the first quarter of each year.

Contribution LimitsContributions are made up of salary reductioncontributions and employer contributions.You, as the employer, must make eithermatching contributions or nonelective contri-butions, defined later. No other contributionscan be made to the SIMPLE IRA plan. Thesecontributions, which you can deduct, must be

made timely. See Time limits for contributingfunds, later.

Salary reduction contributions. Theamount the employee chooses to have youcontribute to a SIMPLE IRA on his or herbehalf cannot be more than $6,000 for 2000.These contributions must be expressed as apercentage of the employee's compensationunless you permit the employee to expressthem as a specific dollar amount. You cannotplace restrictions on the contribution amount(such as limiting the contribution percentage),except to comply with the $6,000 limit.

If an employee is a participant in any otheremployer plan during the year and has elec-tive salary reductions or deferred compen-

sation under those plans, the salary reductioncontributions under a SIMPLE IRA plan alsoare elective deferrals that count toward theoverall $10,500 annual limit on exclusion ofsalary reductions and other elective deferrals.

If the other plan is a deferred compen-sation plan of a state or local government ora tax-exempt organization, the limit on elec-tive deferrals is $8,000.

Employer matching contributions. You aregenerally required to match each employee'ssalary reduction contributions on a dollar-for-dollar basis up to 3% of the employee'scompensation. This requirement does notapply if you make nonelective contributionsas discussed later.

Example. In 2000, your employee, JohnRose, earned $25,000 and chose to defer 5%of his salary. Your net earnings from self-employment are $40,000, and you choose tocontribute 10% of your earnings to yourSIMPLE IRA. You make 3% matching contri-butions. The total contribution you can makefor John is $2,000, figured as follows.

The total contribution you can make for your-self is $5,200, figured as follows.

Lower percentage. If you choose amatching contribution less than 3%, the per-centage must be at least 1%. You must notifythe employees of the lower match within areasonable period of time before the 60-dayelection period (discussed earlier) for thecalendar year. You cannot choose a per-

centage less than 3% for more than 2 yearsduring the 5-year period that ends with (andincludes) the year for which the choice is ef-fective.

Nonelective contributions. Instead ofmatching contributions, you can choose tomake nonelective contributions of 2% ofcompensation on behalf of each eligible em-ployee who has at least $5,000 (or somelower amount you select) of compensationfrom you for the year. If you make this choice,you must make nonelective contributionswhether or not the employee chooses tomake salary reduction contributions. Only$170,000 of the employee's compensationcan be taken into account to figure the con-

tribution limit.If you choose this 2% contribution formula,

you must notify the employees within a rea-sonable period of time before the 60-dayelection period (discussed earlier) for thecalendar year.

Example 1. In 2000, your employee,Jane Wood, earned $36,000 and chose tohave you contribute 10% of her salary. Yournet earnings from self-employment are$50,000, and you choose to contribute 10%of your earnings to your SIMPLE IRA. Youmake a 2% nonelective contribution. The totalcontribution you can make for Jane is $4,320,figured as follows.

The total contribution you can make for your-self is $6,000, figured as follows.

Example 2. Using the same facts as inExample 1, above, the maximum contributionyou can make for Jane or for yourself if youeach earned $75,000 is $7,500, figured asfollows.

Time limits for contributing funds. Youmust make the salary reduction contributionsto the SIMPLE IRA within 30 days after theend of the month in which the amounts wouldotherwise have been payable to the employeein cash. You must make matching contribu-tions or nonelective contributions by the duedate (including extensions) for filing your fed-eral income tax return for the year.

Salary reduction contributions($40,000 .10) ............................................ $4,000Employer matching contribution($40,000 .03) ............................................ 1,200Total contributions .................................... $5,200

Salary reduction contributions($36,000 .10) ............................................ $3,6002% nonelective contributions($36,000 .02) ............................................ 720Total contributions .................................... $4,320

Salary reduction contributions($50,000 .10) ............................................ $5,0002% nonelective contributions($50,000 .02) ............................................ 1,000Total contributions .................................... $6,000

Salary reduction contributions(maximum amount) ...................................... $6,0002% nonelective contributions($75,000 .02) ............................................ 1,500Total contributions .................................... $7,500

Salary reduction contributions($25,000 .05) ............................................ $1,250Employer matching contribution($25,000 .03) ............................................ 750Total contributions .................................... $2,000

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When To Deduct ContributionsYou can deduct SIMPLE IRA contributions inthe tax year with or within which the calendaryear for which contributions were made ends.You can deduct contributions for a particulartax year if they are made for that tax year andare made by the due date (including exten-sions) of your federal income tax return forthat year.

Example 1. Your tax year is the fiscalyear ending June 30. Contributions under a

SIMPLE IRA plan for the calendar year 2000(including contributions made in 2000 beforeJuly 1, 2000) are deductible in the tax yearending June 30, 2001.

Example 2. You are a sole proprietorwhose tax year is the calendar year. Contri-butions under a SIMPLE IRA plan for thecalendar year 2000 (including contributionsmade in 2001 by April 16, 2001) are deduct-ible in the 2000 tax year.

Where To Deduct ContributionsDeduct the contributions you make for yourcommon-law employees on your tax return.For example, sole proprietors deduct them

on Schedule C (Form 1040) or Schedule F(Form 1040), partnerships deduct them onForm 1065, and corporations deduct them onForm 1120, Form 1120A, or Form 1120S.

Sole proprietors and partners deduct con-tributions for themselves on line 29 of Form1040. (If you are a partner, contributions foryourself are shown on the Schedule K-1(Form 1065) you get from the partnership.)

Tax Treatment of ContributionsYou can deduct your contributions and youremployees can exclude these contributionsfrom their gross income. SIMPLE IRA contri-butions are not subject to federal income taxwithholding. However, salary reduction con-

tributions are subject to social security, Med-icare, and federal unemployment (FUTA)taxes. Matching and nonelective contributionsare not subject to these taxes.

Reporting on Form W2. Do not includeSIMPLE IRA contributions in the Wages, tips,other compensation box of Form W2.However, salary reduction contributions mustbe included in the boxes for social securityand Medicare wages. Also include the propercode in Box 13. For more information, seethe instructions for Forms W2 and W3.

Distributions (Withdrawals)Distributions from a SIMPLE IRA are subjectto IRA rules and generally are includible in

income for the year received. Tax-freerollovers can be made from one SIMPLE IRAinto another SIMPLE IRA. However, a rolloverfrom a SIMPLE IRA to a non-SIMPLE IRA canbe made tax free only after a 2-year partici-pation in the SIMPLE IRA plan.

Early withdrawals generally are subject toa 10% additional tax. However, the additionaltax is increased to 25% if funds are withdrawnwithin 2 years of beginning participation.

More information. See Publication 590 forinformation about IRA rules, including thoseon the tax treatment of distributions, rollovers,required distributions, and income tax with-holding.

More Informationon SIMPLE IRA PlansIf you need more help to set up and maintainSIMPLE IRA plans, see the following IRSnotice and revenue procedure.

Notice 984. This notice contains questionsand answers about the implementation andoperation of SIMPLE IRA plans, including theelection and notice requirements for theseplans. Notice 984 is in Cumulative Bulletin19981.

Revenue Procedure 9729. This revenueprocedure provides guidance to drafters ofprototype SIMPLE IRAs on obtaining opinionletters. Revenue Procedure 9729 is in Cu-mulative Bulletin 19971.

SIMPLE 401(k) PlanYou can adopt a SIMPLE plan as part of a401(k) plan if you meet the 100-employeelimit as discussed earlier under SIMPLE IRAplans. A SIMPLE 401(k) plan is a qualifiedretirement plan and generally must satisfy therules discussed in Qualification Rules underQualified Plans, later. However, a SIMPLE401(k) plan is not subject to the nondiscrimi-

nation and top-heavy rules in that discussionprovided the plan meets the conditions listedbelow.

1) Under the plan, an employee canchoose to have you make salary re-duction contributions for the year to atrust in an amount expressed as a per-centage of the employee's compen-sation, but not more than $6,000 for2000.

2) You must make either:

a) Matching contributions up to 3% ofcompensation for the year, or

b) Nonelective contributions of 2% ofcompensation on behalf of each el-

igible employee who has at least$5,000 of compensation from youfor the year.

3) No other contributions can be made tothe trust.

4) No contributions are made, and no ben-efits accrue, for services during the yearunder any other qualified retirement planof the employer on behalf of any em-ployee eligible to participate in theSIMPLE 401(k) plan.

5) The employee's rights to any contribu-tions are nonforfeitable.

No more than $170,000 of the employee'scompensation can be taken into account infiguring salary reduction contributions,matching contributions, and nonelective con-tributions.

Employee notification. The notification re-quirement that applies to SIMPLE IRA plansalso applies to SIMPLE 401(k) plans. SeeNotification Requirement, earlier.

More Information onSIMPLE 401(k) PlansIf you need more help to set up and maintainSIMPLE 401(k) plans, see Revenue Proce-dure 979. Revenue Procedure 979 is inCumulative Bulletin 19971. This revenue

procedure provides a model amendment youcan use to adopt a plan with SIMPLE 401(k)provisions. This model amendment providesguidance to plan sponsors for incorporating401(k) SIMPLE provisions in plans containingcash or deferred arrangements.

Qualified PlansQualified retirement plans set up by self-employed individuals are sometimes called

Keogh or H.R. 10 plans. A sole proprietor ora partnership can set up a qualified plan. Acommon-law employee or a partner cannotset up a qualified plan. The plans describedhere can also be set up and maintained byemployers that are corporations. All the rulesdiscussed here apply to corporations exceptwhere specifically limited to the self-employed.

The plan must be for the exclusive benefitof employees or their beneficiaries. A qual-ified plan can include coverage for a self-employed individual. A self-employed indi-vidual is treated as both an employer and anemployee.

As an employer, you can usually deduct,subject to limits, contributions you make to a

qualified plan, including those made for yourown retirement. The contributions (andearnings and gains on them) are generally taxfree until distributed by the plan.

Kinds of PlansThere are two basic kinds of qualified plans

defined contribution plans and definedbenefit plansand different rules apply toeach. You can have more than one qualifiedplan, but your contributions to all the plansmust not total more than the overall limitsdiscussed under Contributionsand EmployerDeduction, later.

Defined Contribution Plan

A defined contribution plan provides an indi-vidual account for each participant in the plan.It provides benefits to a participant largelybased on the amount contributed to that par-ticipant's account. Benefits are also affectedby any income, expenses, gains, losses, andforfeitures of other accounts that may be al-located to an account. A defined contributionplan can be either a profit-sharing plan or amoney purchase pension plan.

Profit-sharing plan. A profit-sharing plan isa plan for sharing your business profits withyour employees. However, you do not haveto make contributions out of net profits tohave a profit-sharing plan.

The plan does not need to provide a defi-nite formula for figuring the profits to beshared. But, if there is no formula, there mustbe systematic and substantial contributions.

The plan must provide a definite formulafor allocating the contribution among the par-ticipants and for distributing the accumulatedfunds to the employees after they reach acertain age, after a fixed number of years, orupon certain other occurrences.

In general, you can be more flexible inmaking contributions to a profit-sharing planthan to a money purchase pension plan (dis-cussed next) or a defined benefit plan (dis-cussed later). But the maximum deductiblecontribution may be less under a profit-sharing plan (see Limits on Contributions andBenefits, later).

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Forfeitures under a profit-sharing plan canbe allocated to the accounts of remainingparticipants in a nondiscriminatory way orthey can be used to reduce your contribu-tions.

Money purchase pension plan. Contribu-tions to a money purchase pension plan arefixed and are not based on your businessprofits. For example, if the plan requires thatcontributions be 10% of the participants'compensation without regard to whether you

have profits (or the self-employed person hasearned income), the plan is a money pur-chase pension plan. This applies even thoughthe compensation of a self-employed individ-ual as a participant is based on earned in-come derived from business profits.

Defined Benefit PlanA defined benefit plan is any plan that is nota defined contribution plan. Contributions toa defined benefit plan are based on what isneeded to provide definitely determinablebenefits to plan participants. Actuarial as-sumptions and computations are required tofigure these contributions. Generally, you willneed continuing professional help to have adefined benefit plan.

Forfeitures under a defined benefit plancannot be used to increase the benefits anyemployee would otherwise receive under theplan. Forfeitures must be used instead to re-duce employer contributions.

Setting Up a Qualified PlanThere are two basic steps in setting up aqualified plan. First you adopt a written plan.Then you invest the plan assets.

You, the employer, are responsible forsetting up and maintaining the plan.

TIPIf you are self-employed, it is notnecessary to have employees be-sides yourself to sponsor and set up

a qualified plan. If you have employees, seeEligible Employee, later.

Set-up deadline. To take a deduction forcontributions for a tax year, your plan mustbe set up (adopted) by the last day of thatyear (December 31 for calendar year em-ployers).

Adopting a Written PlanYou must adopt a written plan. The plan canbe an IRS-approved master or prototype planoffered by a sponsoring organization. Or itcan be an individually designed plan.

Written plan requirement. To qualify, the

plan you set up must be in writing and mustbe communicated to your employees. Theplan's provisions must be stated in the plan.It is not sufficient for the plan to merely referto a requirement of the Internal RevenueCode.

Master or prototype plans. Most qualifiedplans follow a standard form of plan (a masteror prototype plan) approved by the IRS.Master and prototype plans are plans madeavailable by plan providers for adoption byemployers (including self-employed individ-uals). Under a master plan, a single trust orcustodial account is established, as part ofthe plan, for the joint use of all adopting em-

ployers. Under a prototype plan, a separatetrust or custodial account is established foreach employer.

Plan providers. The following organiza-tions generally can provide IRS-approvedmaster or prototype plans.

Banks (including some savings and loanassociations and federally insured creditunions).

Trade or professional organizations.

Insurance companies.

Mutual funds.

Individually designed plan. If you prefer,you can set up an individually designed planto meet specific needs. Although advanceIRS approval is not required, you can applyfor approval by paying a fee and requestinga determination letter. You may need profes-sional help for this. Revenue Procedure20006 may help you decide whether to applyfor approval of your plan. Revenue Procedure20006 is in Internal Revenue Bulletin No.20001. It is also available at most IRS officesand at certain libraries.

Internal Revenue Bulletins are avail-

able on the IRS web site atwww.irs.gov. Select Tax Info For Youto view Internal Revenue Bulletins publishedin the last few years.

Investing Plan AssetsIn setting up a qualified plan, you arrange howthe plan's funds will be used to build its as-sets.

You can establish a trust or custodialaccount to invest the funds.

You, the trust, or the custodial accountcan buy an annuity contract from an in-surance company. Life insurance can beincluded only if it is incidental to the re-

tirement benefits. You, the trust, or the custodial account

can buy face-amount certificates from aninsurance company. These certificatesare treated like annuity contracts.

You set up a trust by a legal instrument(written document). You may need profes-sional help to do this.

You can set up a custodial account witha bank, savings and loan association, creditunion, or other person who can act as theplan trustee.

You do not need a trust or custodial ac-count, although you can have one, to investthe plan's funds in annuity contracts or face-amount certificates. If anyone other than a

trustee holds them, however, the contractsor certificates must state they are nottransferable.

Eligible EmployeeAn employee must be allowed to participatein your plan if he or she meets both the fol-lowing requirements.

Has reached age 21.

Has at least 1 year of service (2 years ifthe plan is not a 401(k) plan and providesthat after not more than 2 years of servicethe employee has a nonforfeitable rightto all his or her accrued benefit).

CAUTION

!A plan cannot exclude an employeebecause he or she has reached aspecified age.

Other plan requirements. For informationon other important plan requirements, seeQualification Rules, later.

Minimum FundingRequirementIn general, if your plan is a money purchase

pension plan or a defined benefit plan, youmust actually pay enough into the plan tosatisfy the minimum funding standard foreach year. Determining the amount neededto satisfy the minimum funding standard iscomplicated. The amount is based on whatshould be contributed under the plan formulausing actuarial assumptions and formulas.For information on this funding requirement,see section 412 and its regulations.

Quarterly installments of required contri-butions. If your plan is a defined benefit plansubject to the minimum funding requirements,you must make quarterly installment pay-ments of the required contributions. If you donot pay the full installments timely, you may

have to pay interest on any underpayment forthe period of the underpayment.

Due dates. The due dates for the install-ments are 15 days after the end of eachquarter. For a calendar year plan, the install-ments are due April 15, July 15, October 15,and January 15 (of the following year).

Installment percentage. Each quarterlyinstallment must be 25% of the required an-nual payment.

Extended period for making contribu-tions. Additional contributions required tosatisfy the minimum funding requirement fora plan year will be considered timely if madeby 81/2 months after the end of that year.

ContributionsA qualified plan is generally funded by yourcontributions. However, employees partic-ipating in the plan may be permitted to makecontributions.

Contributions deadline. You can makedeductible contributions for a tax year up tothe due date of your return (plus extensions)for that year.

Self-employed individual. You can makecontributions on behalf of yourself only if youhave net earnings (compensation) from self-employment in the trade or business for whichthe plan was set up. Your net earnings mustbe from your personal services, not from your

investments. If you have a net loss from self-employment, you cannot make contributionsfor yourself for the year, even if you cancontribute for common-law employees basedon their compensation.

When ContributionsAre Considered MadeYou generally apply your plan contributionsto the year in which you make them. But youcan apply them to the previous year if all thefollowing requirements are met.

1) You make them by the due date of yourtax return for the previous year (plusextensions).

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2) The plan was established by the end ofthe previous year.

3) The plan treats the contributions asthough it had received them on the lastday of the previous year.

4) You do either of the following.

a) You specify in writing to the planadministrator or trustee that thecontributions apply to the previousyear.

b) You deduct the contributions onyour tax return for the previousyear. (A partnership shows contri-butions for partners on Schedule K(Form 1065), Partners' Shares ofIncome, Credits, Deductions, etc.)

Employer's promissory note. Yourpromissory note made out to the plan is nota payment that qualifies for the deduction.Also, issuing this note is a prohibited trans-action subject to tax. See Prohibited Trans-actions, later.

Employer ContributionsThere are certain limits on the contributionsand other annual additions you can make

each year for plan participants. There arealso limits on the amount you can deduct. SeeDeduction Limits, later.

Limits onContributions and BenefitsYour plan must provide that contributions orbenefits cannot exceed certain limits. Thelimits differ depending on whether your planis a defined contribution plan or a definedbenefit plan.

Defined benefit plan. For 2000, the annualbenefit for a participant under a defined ben-efit plan cannot exceed the lesser of the fol-lowing amounts.

1) 100% of the participant's average com-pensation for his or her highest 3 con-secutive calendar years.

2) $135,000.

Defined contribution plan. For 2000, a de-fined contribution plan's annual contributionsand other additions (excluding earnings) tothe account of a participant cannot exceedthe lesser of the following amounts.

1) 25% of the compensation actually paidto the participant.

2) $30,000.

The maximum compensation that can betaken into account for this limit is $170,000.

Excess annual additions. Excess annualadditions are the amounts contributed that aremore than the limits discussed previously. Aplan can correct excess annual additionscaused by any of the following actions.

A reasonable error in estimating a par-ticipant's compensation.

A reasonable error in determining theelective deferrals permitted (discussedlater).

Forfeitures allocated to participants' ac-counts.

Correcting excess annual additions. Aplan can provide for the correction of excessannual additions in the following ways.

1) Allocate and reallocate the excess toother participants in the plan to the ex-tent of their unused limits for the year.

2) If these limits are exceeded, do one ofthe following.

a) Hold the excess in a separate ac-count and allocate (and reallocate)

it to participants' accounts in thefollowing year (or years) beforemaking any contributions for thatyear (see also Carryover of ExcessContributions, later).

b) Return employee after-tax contri-butions or elective deferrals (seeEmployee Contributionsand Elec-tive Deferrals (401(k) Plans), later).

Tax treatment of returned contributionsor distributed elective deferrals. The returnof employee after-tax contributions or thedistribution of elective deferrals to correct ex-cess annual additions is considered a cor-rective payment rather than a distribution ofaccrued benefits. The penalties for early dis-

tributions and excess distributions do not ap-ply.These disbursements are not wages re-

portable on Form W2. You must report themon a separate Form 1099R as follows.

Report the total distribution, includingemployee contributions, in box 1. If thedistribution includes any gain from thecontribution, report the gain in box 2a.Report the return of employee contribu-tions in box 5. Enter Code E in box 7.

Report a distribution of an elective defer-ral in boxes 1 and 2a. Include any gainfrom the contribution. Leave box 5 blankand enter Code E in box 7.

Participants must report these amountson the line for Total pensions and annuitieson Form 1040 or Form 1040A, U.S. IndividualIncome Tax Return.

Employee ContributionsParticipants may be permitted to make non-deductible contributions to a plan in additionto your contributions. Even though these em-ployee contributions are not deductible, theearnings on them are tax free until distributedin later years. Also, these contributions mustsatisfy the nondiscrimination test of section401(m). See Notice 981 for further guidanceand transition relief relating to recent statutoryamendments to the nondiscrimination rulesunder sections 401(k) and 401(m). Notice981 is in Cumulative Bulletin 19981.

Employer DeductionYou can usually deduct, subject to limits,contributions you make to a qualified plan,including those made for your own retirement.The contributions (and earnings and gains onthem) are generally tax free until distributedby the plan.

Deduction LimitsThe deduction limit for your contributions toa qualified plan depends on the kind of planyou have.

Defined contribution plans. The deductionlimit for a defined contribution plan dependson whether it is a profit-sharing plan or amoney purchase pension plan.

Profit-sharing plan. Your deduction forcontributions to a profit-sharing plan cannotbe more than 15% of the compensation paid(or accrued) during the year to your eligibleemployees participating in the plan. You mustreduce this 15% limit in figuring the deductionfor contributions you make for your own ac-count. See Deduction Limit for Self-Employed Individuals, later.

Money purchase pension plan. Yourdeduction for contributions to a money pur-chase pension plan is generally limited to25% of the compensation paid (or accrued)during the year to your eligible employees.You must reduce this 25% limit in figuring thededuction for contributions you make foryourself, as discussed later.

Defined benefit plans. The deduction forcontributions to a defined benefit plan isbased on actuarial assumptions and compu-tations. Consequently, an actuary must figureyour deduction limit.

CAUTION

!In figuring the deduction for contribu-tions, you cannot take into account

any contributions or benefits that aremore than the limits discussed earlier underLimits on Contributions and Benefits.

Deduction limit for multiple plans. If youcontribute to both a defined contribution planand a defined benefit plan and at least oneemployee is covered by both plans, your de-duction for those contributions is limited. Yourdeduction cannot be more than the greaterof the following amounts.

25% of the compensation paid (or ac-crued) during the year to your eligibleemployees participating in the plan. Youmust reduce this 25% limit in figuring thededuction for contributions you make foryour own account.

Your contributions to the defined benefitplans, but not more than the amountneeded to meet the year's minimumfunding standard for any of these plans.

CAUTION

!For this rule, a SEP is treated as aseparate profit-sharing (defined con-tribution) plan.

Deduction Limit forSelf-Employed IndividualsIf you make contributions for yourself, youneed to make a special computation to figureyour maximum deduction for these contribu-tions. Compensation is your net earnings fromself-employment, defined earlier under Defi-nitions You Need To Know. This definitiontakes into account both the following items.

The deduction for one-half of your self-employment tax.

The deduction for contributions on behalfof yourself to the plan.

The deduction for your own contributionsand your net earnings depend on each other.For this reason, you determine the deductionfor your own contributions indirectly by re-ducing the contribution rate called for in yourplan. To do this, use either the Rate Table forSelf-Employed or the Rate Worksheet forSelf-Employed in the Appendix. Then figure

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your maximum deduction by using the De-duction Worksheet for Self-Emp

Documents

US Internal Revenue Service: p560--2000