US Internal Revenue Service: p571--1998

8/14/2019 US Internal Revenue Service: p571--1998

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ContentsImportant Changes for 1998 ............. 1

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

What Is a Tax-Sheltered Annuity(TSA) Plan? .................................. 2

Qualified Employer ............................ 2

Eligible Employees ............................ 3

Contributions ...................................... 3

Salary Reduction Agreement ............ 4

Limit on Elective Deferrals ................ 4

Limit on Employer Contributions ..... 5

The Exclusion Allowance .................. 5

Catch-up Election AlternativeLimits for Certain Employees .... 9

Limit for Contributions to More ThanOne Plan ....................................... 11

Other Rules ......................................... 11

Distributions and Rollovers .............. 13

How to Get More Information ........... 15

Worksheets ......................................... 16

Important Changes for1998

Includible Compensation. Beginning in

1998, your includible compensation for pur-poses of figuring your exclusion allowanceincludes:

1) Elective deferrals (your employer's con-tributions made on your behalf under asalary reduction agreement),

2) Amounts contributed or deferred by youremployer under a Section 125 cafeteriaplan, and

3) Amounts contributed or deferred undera Section 457 plan (state or local gov-ernment or tax-exempt organizationplan).

Your exclusion allowance is the amount ofemployer contributions (including elective

deferrals) to your tax-sheltered annuity thatyou can exclude from income. For more in-formation on includible compensation, seeIncludible Compensation, later.

Contributions Employed Ministers. Be-ginning in 1998, contributions made to achurch plan on behalf of a minister not em-ployed by the church that has the plan maybe excluded from the minister's gross income.They are excluded if they would have beenexcluded had the minister been an employeeof the church.

For more information on exclusion ofcontributions to church plans, see SpecialRules, under Includible Compensation, later.

Departmentof theTreasury

InternalRevenueService

Publica tion 571Cat. No. 46581C

Tax-ShelteredAnnuityPrograms forEmployees ofPublic Schoolsand CertainTax-ExemptOrganizations

For use in preparing

1998 Returns


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IntroductionThis publication explains the Federal tax pro-visions that apply to tax-sheltered annuity(TSA) plans offered to employees of publicschools and certain tax-exempt organizations.The discussions primarily cover employercontributions (elective deferrals) made undera salary reduction agreement. The publicationis for employees who participate in TSAplans. It is not for custodians or plan admin-

istrators because it does not cover many ofthe operating requirements of these plans.

A TSA plan, often referred to as a 403(b)plan, tax-deferred annuity plan, or simplyTSA plan (which is used in this publication),is a retirement plan that, if operated properlyby a qualified employer, is tax-exempt.

A qualified employer can purchase TSAsfor eligible employees. Three types of em-ployers qualify, public schools, certain tax-exempt organizations, and certain employersof ministers. Your employer may be able tohelp you determine whether you are an eligi-ble employee.

The most common way to contribute toTSA plans is through a salary reductionagreement. This is an agreement under which

an employee agrees to take a reduction insalary or to forego a salary increase and theemployer contributes that amount to a TSAplan for that employee. These employer con-tributions made on your behalf are calledelective deferrals. A TSA plan can also befunded through non-elective employer contri-butions, employee contributions, or a combi-nation of these contributions.

There is an annual limit on elective defer-rals. Generally, you cannot defer more than$10,00 for 1998 for all plans covering you,including TSAs. If elective deferral contribu-tions on your behalf are more than the allow-able amount, you must include the excess inyour gross income.

Limits are placed on the contributions thatcan be made by an employer to TSA plans.

Special rules may apply in determining thelimit on employer contributions for you to aTSA plan if you also are covered by a qual-ified plan.

The exclusion allowance is the amount ofemployer contributions (including electivedeferrals) to your TSA that you can excludefrom income. You pay tax on these excludedamounts when you receive a distribution fromthe TSA.

Employees of educational organizations,hospitals, home health service agencies,health and welfare service agencies,churches, and certain church-related organ-izations can make a catch-up election to in-crease the limit on employer contributions forthe exclusion allowance.

The Other Rules section includes dis-cussions on the taxability of the cost of in-surance under a TSA and on employer con-tributions subject to social security andMedicare taxes.

In most cases, the payments you receive,or that are made available to you, under yourTSA contract are taxable in full as ordinaryincome. In general, the same tax rules applyto distributions from TSAs that apply to dis-tributions from other retirement plans. Theserules are explained in Publication 575, Pen-sion and Annuity Income. If you transfer allor part of your interest from a TSA contractor account to another TSA contract or ac-

count, the transfer may be tax free. You cangenerally roll over tax free all or any part ofa distribution from a TSA plan to an IRA oranother TSA plan.

You can use the worksheets at the endof this publication to figure many of the limitsthat apply to your TSA.

Useful ItemsYou may want to see:

Publication

575 Pension and Annuity Income

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

Form (and Instructions)

W-2 Wage and Tax Statement

1099-R Distributions From Pensions,Annuities, Retirement or Profit-Sharing Plans, IRAs, InsuranceContracts, etc.

5330 Return of Excise Taxes Relatedto Employee Benefit Plans

See How To Get More Information, nearthe end of this publication for informationabout getting these publications and forms.

What Is aTax-Sheltered Annuity(TSA) Plan?A tax-sheltered annuity plan, often referred toas a 403(b) plan, tax-deferred annuityplan, or simply TSA plan (which is used inthis publication), is a retirement plan that, ifoperated properly by a qualified employer, is

tax-exempt.The TSA plan can invest funds for partic-ipating employees in:

Annuity contracts,

Custodial accounts holding mutual fundshares, or

Retirement income accounts (definedcontribution plans maintained bychurches or certain church-related or-ganizations).

Throughout this publication, wherever TSAappears, it refers to any one of these fundingarrangements, unless otherwise specified.

Tax advantage for employee. Generally,contributions by a qualified employer to pur-chase an annuity contract for you under aTSA plan (and earnings on them) are ex-cluded from your taxable income until youbegin to receive annuity payments, usuallyafter retiring, from your TSA. Because of thistax postponement, these plans are describedas tax-deferred or tax-sheltered annuities.

Qualified EmployerA qualified employer can purchase TSAs foreligible employees. Three types of employersqualify public schools, certain tax-exempt

organizations, and certain employers ofministers.

Public SchoolsA state or local government or any of itsagencies or instrumentalities can be a qual-ified employer. For this purpose, an Indiantribal government is a state government. Also,see Indian tribal governments, under Tax-Exempt Organizations, later. These employ-ers are qualified employers only for employ-

ees who perform (or have performed)services, directly or indirectly, for an educa-tional organization.

Educational organization. An educationalorganization is one that normally maintains aregular faculty and curriculum and normallyhas a regularly enrolled body of students inattendance at the place where it regularlycarries on educational activities.

Tax-Exempt OrganizationsGenerally, a qualified employer includes anorganization that is tax exempt because it isorganized and operated exclusively for reli-gious, charitable, scientific, public safety

testing, literary, or educational purposes. Aqualified employer also includes a tax-exemptorganization that is organized and operatedexclusively to encourage national or interna-tional amateur sports competition (but only ifno part of its activities involve the provisionof athletic facilities or equipment), or for theprevention of cruelty to children or animals.The organization can be a corporation, com-munity chest, fund, or foundation.

Indian tribal governments. Any TSA con-tract that was purchased by an Indian tribalgovernment for its employees in a plan yearbeginning before January 1, 1995, is treatedas having been purchased by a tax-exemptorganization that is qualified to provide TSAs

for its employees. An Indian tribal governmentincludes any political subdivisions, agencies,and instrumentalities of it, as well as anycorporations that are chartered under federal,state, or tribal law and owned by it.

Government instrumentalities. Wholly-owned instrumentalities (other than publicschools, described earlier) of state or munici-pal governments generally are not qualifiedemployers. However, if an instrumentality hasbeen separately organized and has beenrecognized as tax-exempt by the InternalRevenue Service because it is organized andoperated exclusively for one or more of theexempt purposes described earlier, it is aqualified employer. A separately organized

school, college, university, or hospital mayqualify if it is not an activity essential to andconducted under a branch or department ofa state or municipal government.

A cooperative hospital service organiza-tion that meets certain requirements is aqualified employer.

Uniformed Services University of theHealth Sciences. This is a federal organ-ization authorized to train medical students forthe uniformed services. The rules in thispublication apply to annuities bought for civil-ian faculty and staff for work they performedafter 1979.

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Certain Employersof MinistersA duly ordained or licensed minister of achurch, who in connection with the exerciseof his or her ministry is either:

1) Self-employed or

2) Employed by an organization other thana tax-exempt organization (a chaplain),

is treated as employed by a tax-exempt or-ganization.

Eligible EmployeesA qualified employer can purchase TSAs onlyfor eligible employees. If you are subject tothe will and control of an employer regardingwhat work you do and how you do it, you arean employee. If you are subject to the controlor direction of another as to the result only,and not how you do the work, you will gen-erally be an independent contractor, and notan eligible employee.

The employer who pays you for servicesyou perform may be able to help you deter-mine whether you are an eligible employee.

Employees of PublicSchool SystemsYou are considered eligible if you performservices as an employee, either directly orindirectly, for a public school. For example,the principal, clerical employees, custodialemployees, and teachers at a public elemen-tary school are employees performing ser-vices directly for an educational organization.

If you do not work in a school, but areinvolved in the operation or direction of theeducational program carried out in publicschools, you are an eligible employee per-

forming services indirectly for public schools.See Elected or appointed to office, later. Also,you are an eligible employee if you are par-ticipating in an in-home teaching programsince the program is merely an extension ofthe activities carried on by public schools.

Department of Education employees ap-pointed by a state commissioner of edu-cation. Janitorial, custodial, and generalclerical employees indirectly perform servicesfor an educational organization and are eligi-ble employees. If you have a significant de-gree of executive or policymaking authority,and your appointment is based on requiredtraining or experience in the field of educa-tion, you also indirectly perform service for

an educational organization and are an eligi-ble employee.

Elected or appointed to office. If you oc-cupy an elective or appointive office, you maybe an eligible employee. You are an eligibleemployee if your office is one to which aperson is elected or appointed only if he orshe has received training, or is experienced,in the field of education.

A commissioner or superintendent of ed-ucation generally is considered an employeeperforming services for an educational or-ganization. However, a university regent ortrustee, or a member of a board of education,is not an eligible employee.

Employees of a state teachers' retirementsystem. Employees of a retirement systemthat administers a state teachers' retirementprogram are not eligible to participate in aTSA plan because these employees are notperforming services directly or indirectly foran educational organization.

Employees of CertainTax-Exempt OrganizationsCertain tax-exempt organizations (described

under Qualified Employer, earlier) can pur-chase TSAs for some or all of their employ-ees. Employees of these tax-exempt organ-izations include individuals who performservices as social workers, members of theclergy, teachers, professors, clerks, secre-taries, etc.

Physicians Who PerformServices in a HospitalA physician who works in a hospital as anemployee may be eligible. Eligibility dependsupon the amount of supervision and controlof the services performed and other factors.

Employee. A physician is an employee, forexample, if, by agreement, he or she:

Does not take on outside duties thatwould negatively affect primary servicesto the hospital,

Does not furnish services to other hospi-tals without the employer's consent,

Obeys all rules and regulations of thehospital, and

Receives a pay adjustment if the per-centage of pay is less than an amountguaranteed by the agreement.

Not an employee. However, not all physi-cians who perform services for a hospital areemployees. For example, a physician whoperforms services as a director of a hospital's

department of pathology is notan employeeif he or she:

Receives a percentage of the depart-ment's income for the services,

Pays an associate or substitute,

Is allowed to privately practice medicine,

Is not entitled to regular employee fringebenefits, and

Is not subject to the general rules thatapply to the hospital's employees.

Each case must be decided on its ownfacts and circumstances. No set rule will ap-ply to all cases.

Ministers of Certain EmployersA duly ordained or licensed minister of achurch who is working as a minister orchaplain, but is self-employed or is workingfor an employer that is not a qualified tax-exempt organization, is treated as employedby a qualified tax-exempt organization forpurposes of participating in a retirement in-come account (TSA plan).

ContributionsA TSA can be funded by the following contri-butions:

Elective deferrals,

Non-elective employer contributions,

After-tax employee contributions, or

A combination of the above.

Elective deferrals defined. Your employer'splan may permit you to have part of your paycontributed by your employer to a retirementfund, rather than have it paid to you. Theseemployer contributions made on your behalfare called elective deferrals because:

1) You choose (elect) to set aside part ofyour pay, and

2) Payment of tax owed on that part of yourpay is postponed (deferred) until it isdistributed to you.

Non-elective employer contributions de-fined. An employer contribution to a TSA istreated as a non-elective contribution if em-ployees are not required to choose the con-tributions. The employer chooses to makethese contributions to the TSAs and generallymust make them on behalf of all eligible em-ployees. The employer must be a qualifiedemployer (defined earlier) for the contribu-tions to be excluded from the employee'sgross income. These contributions are sub-

ject to the limit on employer contributionsdiscussed later.

After-tax employee contributions. If theplan permits these contributions, an em-ployee contribution made with funds on whichincome taxes have already been paid istreated as an after-tax contribution. A salarypayment on which income tax was withheldis an example of such funds. These contri-butions are subject to the limit on employercontributions.

Funding by elective deferrals. Employerscontribute to a TSA primarily through a salaryreduction agreement (discussed later). Underthis agreement, you (the employee) agree totake a reduction in salary or to forego a salaryincrease and your employer agrees to con-tribute the amount of the salary reduction orthe foregone salary increase toward the pur-chase of your TSA.

These employer contributions made onyour behalf are excluded (within limits dis-cussed next) from your income when made.The excluded amounts are included in yourincome when you withdraw them. Thesecontributions generally are called electivedeferrals. See Limit on Elective Deferrals,later, for more information.

Exclusion From Gross

IncomeGenerally, if you are an eligible employee(defined earlier), you can exclude from grossincome your qualified employer's (definedearlier) contributions to your TSA.

TIP

Contributions made by a self-employed minister or chaplain who istreated as employed by a qualified

tax-exempt organization to a retirement in-come account that is treated as a TSA aredeductible (rather than excludible) up to theexclusion limits for TSAs (discussed next).This is true unless the contributions are madeby the employer of a chaplain and excludedfrom the chaplain's income as discussed un-

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der Specials Rules under Includible Com-pensation, later.

Exclusion LimitsThe amount you exclude for a tax year cannotbe more than any of the following limits:

1) The exclusion allowance (discussedlater) for your tax year,

2) The annual employer contribution limit(discussed later) for the limitation year

(discussed later) ending with or withinyour tax year, or

3) The limit on elective deferrals (discussedlater) for the year.

Alternative limits. You may be able to usean alternative limit to increase the amount youcan exclude. See Catch-up Election Alter-native Limits for Certain Employees, later.

TIP

You can use the worksheets at theend of this publication to figure thefollowing contribution limits that gen-

erally apply to you. For limit (1), use Work-sheet 1. For limit (2), useWorksheet 2. Forlimit (3), use Worksheet 3. If you qualify tochoose an alternative limit, use Worksheet

4, 5, or 6, whichever applies. See Catch-upElection Alternative Limits for Certain Em-ployees, later.

Rollover contributions. For purposes ofapplying these limits, your employer's contri-butions do not include a rollover contributionfrom another TSA or a traditional individualretirement arrangement (IRA). A traditionalIRA is any IRA that is not a Roth, SIMPLE,or education IRA.

Only elective deferrals. If all of the contri-butions are elective deferrals, the total mustnot be more than the smallest of the threelimits in the preceding list.

Only nonelective contributions. If all of thecontributions are nonelective contributions,only limits (1) and (2) apply.

Both elective deferrals and nonelectivecontributions. If the total contributions in-clude both elective deferrals and nonelectivecontributions and limit (3) is the smallest ofthe limits in the preceding list, the electivedeferrals minus limit (3) is an excess deferral.The total of all contributions (including theelective deferrals) minus the smaller of limit(1) or (2) is an excess contribution.

More than one TSA. If for any tax yearelective deferrals are contributed to more thanone TSA for you (whether or not with the

same employer), you must combine all theelective deferrals to determine whether thetotal is more than the limit for that year. SeeLimit on Elective Deferrals, later.

Treatment of ExcessContributionsIf the contributions to your TSA for a year aremore than any of the limits discussed aboveunder Exclusion Limits, you must include theexcess in your income for that year. Further,if you have an excess because the contribu-tions are more than limit (2), that excess re-duces the amount of your exclusion allow-ance for future years, even though the excesshas already been included in your income.

For more information on the treatment ofexcess contributions, see Excess Deferrals,Limit on Employer Contributions, and Tax onExcess Contributions to a Custodial Account,later.

Salary ReductionAgreementThe most common way to contribute to TSAs

is through a salary reduction agreement. Asalary reduction agreement is an agreementbetween the employer and employee underwhich the employee agrees to take a re-duction in salary or to forego a salary increaseand the employer contributes that amount toa TSA for that employee.

TIP

You can enter into more than onesalary reduction agreement during atax year. In addition, for salary re-

duction purposes, you can use compensationthat has not yet been made available to you.(However, to determine what compensationcan be used to figure the maximum exclusionallowance, see Includible Compensation,later, underThe Exclusion Allowance.)

Treatment of contributions. Amounts con-tributed by the employer under the salary re-duction agreement and invested in a TSA forthe employee are generally treated as elec-tive deferrals (defined under Contributionsearlier.)

Exemption. An employer contribution toa TSA is not treated as an elective deferral ifit is made as a condition of employment oras a one-time choice by the employee whenhe or she first becomes eligible to participatein the agreement. But, if the employee canchange or end the election to participate, theelection is not a one-time choice and thecontributions are elective deferrals.

Limit on ElectiveDeferralsIn addition to the exclusion allowance and thelimit on employer contributions (both dis-cussed later), which apply to TSA contribu-tions, there is an annual limit on combinedelective deferrals. Elective deferrals are de-fined earlier under Contributions.

Deferrals subject to limit. The limit appliesto the total of all elective deferrals contributedfor the year on your behalf (even if by differentemployers) to:

Cash or deferred arrangements (knownas section 401(k) plans) to the extentexcluded from your gross income,

Section 501(c)(18) plans created beforeJune 25, 1959, and only to the extentexcluded from your gross income,

SIMPLE plans,

Simplified employee pension (SEP)plans, and

Tax-sheltered annuity (TSAs).

Dollar limit. Generally, you cannot defermore than an allowable amount each year forall plans covering you, including TSAs. For1998, the allowable amount (limit) is $10,000.

This limit applies without regard to communityproperty laws. If you defer more than the al-lowable amount for a tax year, you must in-clude the excess in your gross income for thatyear. See Excess Deferrals, later.

Increase for 15-year employees. If youhave a TSA and you have completed at least15 years of service with an educational or-ganization, hospital, home health serviceagency, health and welfare service agency,church, or convention or association ofchurches (or associated organization), the$10,000 limit for the TSA is increased eachtax year. The limit is increased by the small-estof the following:

1) $3,000,

2) $15,000, reduced by increases to the$10,000 limit you were allowed in earlieryears because of this rule, or

3) $5,000 times the number of your yearsof service for the organization, minus thetotal elective deferrals made by the or-ganization for you for earlier years.

For example, if you qualify, you may in-crease your elective deferrals to $13,000. Forthe computation, see Step 2 of Worksheet 3.

Cost-of-living adjustment. Under cur-

rent law, the $10,000 limit is to be increasedto reflect any increases in the ConsumerPrice Index in future years.

WORKSHEET 3at the end of thispublication will help you figure the Limiton Elective Deferrals.

Excess DeferralsExcess deferrals are total elective deferralsfor the year minus the limit on elective defer-rals.

Tax Treatment

General rule. If the total you defer for a taxyear is more than the limit for the year, youmust include the excess in your gross incomefor that year on line 7 of Form 1040.

Distribution of excess. If the plan allowsyou to receive the excess amount and that iswhat you choose to do, you must notify theplan as explained next.

One plan. If only one plan is involved,you must notify the plan by March 1 after theend of the tax year that an excess amountwas deferred. The plan must then pay you theexcess, along with any income on thatamount, by April 15.

CAUTION

!Because you are responsible for no-tifying the plan, you must monitorcontributions to the plan.

More than one plan. If more than oneplan is involved, you must notify each planby March 1 of the amount to be paid from thatparticular plan, and the plan must then payyou that amount, along with any income onthat amount, by April 15.

Distribution of excess by the requireddate. If you receive the excess amount byApril 15, do not include it again in your grossincome and do not subject it to the additional10% tax for premature distributions. However,any income earned on the excess deferralthat is distributed to you is taxable to you inthe tax year paid.

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If you receive part of the excess deferraland the income earned on it, you must treatthe distribution as if ratably received from theexcess deferral and the income earned on it.For example, assume that your excessdeferral is $1,800 and the income earned onit is $200. If your distribution is $1,000, $900is from the excess deferral and $100 is fromthe income earned that must be separatelyreported.

Excess left in the plan. If you leave theexcess deferral in the plan, you must includethe excess amount in your gross income forthe tax year in which the amount was de-ferred. You cannot treat the excess amountas an investment in the contract (tax-free re-turn of cost) when you figure the taxableamount of any future benefits or distributions.Thus, an excess deferral left in the plan wouldbe taxed twice, once when contributed andagain when distributed.

Limit on EmployerContributionsLimits are placed on the contributions that canbe made by an employer to tax-shelteredannuity (TSA) plans for each limitation year(defined later). Every TSA is treated as a de-fined contribution plan for purposes of thislimit (which is also called the general rule).Under the general rule, an employer's contri-butions (including elective deferrals) to anemployee's account under a defined contri-bution plan should not be more than thelesser of:

1) $30,000, or

2) 25% of the employee's compensation(defined later) for the year.

This limit is in addition to the exclusion al-lowance (discussed later) and the limit onelective deferrals (discussed earlier). Also,

see Catch-up Election Alternative Limits forCertain Employees, later.

WORKSHEET 2at the end of thispublication will help you figure the Limiton Employer Contributions and theamount you can exclude from grossincome.

Limitation year. Generally, your limitationyear is the calendar year. However, you canelect to change to a different limitation yearconsisting of any period of 12 consecutivemonths by attaching a statement to your in-dividual income tax return for the tax year youmake the change.

Contributions in excess of employer limit.An excess employer contribution must be in-cluded in your gross income in the tax yearwhen it is made.

For future tax years, the exclusion allow-ance (see The Exclusion Allowance, later)must be reduced by this excess contributioneven though it was not excludable from yourgross income in the tax year when it wasmade.

TSA and qualified plan. If because youmust combine a TSA with a qualified plan, thelimit is exceeded, the same rule applies. Youmust include the excess in your gross incomefor the tax year the excess contribution is

made and reduce your exclusion allowancefor any future years in which you are a par-ticipant in a TSA plan.

If you are a participant in both a TSA planand a qualified plan, see Limit for Contribu-tions to More Than One Plan, later.

Excess contribution in earlier years. Ifin earlier years your employer made annualcontributions to a TSA for you that were morethan the annual maximum permitted underthis limit on employer contributions, your ex-clusion allowance is reduced by the excess.

Reduction procedure. The exclusion al-lowance is reduced by including the excesscontributions from prior years in amountspreviously excludable (discussed later underThe Exclusion Allowance). Include prioryears' excess contributions in amounts previ-ously excludable only if the limit was ex-ceeded for a tax year beginning after January24, 1980.

Compensation. Generally, for purposes ofthe 25% of compensation limit (item (2) at thebeginning of this discussion), compensationincludes:

Wages, salaries, and fees for personalservices with the employer maintainingthe plan, even if excludable as foreign

earned income, Certain taxable accident and health in-

surance payments,

Moving expense payments or reimburse-ments paid by employer if such paymentsare not deductible by you, and

The value of nonqualified stock optionsgranted to you that are includible in yourgross income in the year granted.

Generally, compensation does not include:

Contributions toward a TSA contract(other than elective deferrals),

Contributions toward a deferred com-pensation plan if, before applying the limit

on employer contributions, the contribu-tions are not taxable,

Distributions from a deferred compen-sation plan,

Proceeds from the disposition of stockacquired under a qualified stock option,and

Certain other amounts that areexcludable from your income, such asgroup term life insurance premiums thatare not taxable.

More than one annuity contract. For eachyear you apply this limit, you must combinethe contributions to all TSAs made on yourbehalf by your employer. This is done

whether or not you elect one of the alternativelimits discussed under Catch-up Election Alternative Limits for Certain Employees,later. You may also have to combine contri-butions to qualified plans of the same em-ployer or an employer that you control (forpurposes of applying this limit). See Limit forContributions to More Than One Plan, later.

The ExclusionAllowanceThe exclusion allowance is the amount ofemployer contributions (including elective

deferrals) to your tax-sheltered annuity (TSA)that you can exclude from income. To figurethe amount of the exclusion allowance, seeHow to Figure, later. You pay tax on the ex-cluded amount when you receive a distribu-tion from the TSA.

More than one TSA. If, during any tax year,you have two or more TSA contracts, custo-dial accounts, or retirement income accountsmaintained by your employer, figure only oneexclusion allowance for the TSAs because

you must consider them as one TSA.

More than one employer. If more than onequalified employer contributes to a TSA foryou, you must figure a separate exclusion al-lowance for each qualified employer. Do notinclude amounts contributed, compensation,or years of service for one qualified employerin the computation for another qualified em-ployer. Special rules apply to church employ-ees, as discussed under Years of Service,later.

Employer must remain qualified. The ex-clusion allowance applies only to those con-tributions made while your employer was aqualified employer. If, for example, your em-ployer loses tax-exempt status and is nolonger qualified, your exclusion allowance willnot apply to the employer's contributionsmade after losing the exemption.

How to FigureYou determine the exclusion allowance at theend of your tax year as follows:

Reduction of the exclusion allowance.You must reduce your exclusion allowanceby the amount that your employer's contribu-tions (for tax years beginning after January24, 1980) were more than the limit on em-ployer contributions for those years. (SeeContributions in excess of employer limit un-der Limit on Employer Contributions, earlier.)

For future years, treat the excess asthough it were an amount previouslyexcludable.

Example. At the end of 1998, you hadcompleted 3 years of service with your em-ployer. Your salary for 1998 was $32,000 af-ter being reduced under a revocable salaryreduction agreement by $3,600 to financeyour employer's contributions toward thepurchase of a TSA for you. Your employer'scontributions for the year totaled $3,600, $100of which was for current term life insuranceprotection.

In previous years, your employer's contri-butions to the regular retirement plan totaled$7,200, all of which you properly excludedfrom gross income. You figure your exclusionallowance (the amount excludable from grossincome) and the amount of any employercontributions includible in your gross incomefor 1998 as follows:

1) Includible compensation (discussedlater) ...................................................... $

2) Percentage limit .................................... 20%

3) Years of service (discussed later) ......

4) Multiply (1) (2) (3) ........................... $

5) Minus: Amounts previouslyexcludable (discussed later) ................

6) Exclusion allowance (before reductionfor any excess contributions) ................ $

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WORKSHEETS 1 through 6at the endof this publication will help you figurethe amount of employer contributionsthat you can exclude from gross incomeand the amount you must include.

Catch-up election for certain employees.Certain employees can elect to substitute thelimit on employer contributions for the exclu-sion allowance under an alternate rule calledthe overall limit (explained under Catch-upElection Alternative Limits for Certain Em-ployees, later). Only employees of educa-tional organizations, hospitals, home healthservice agencies, health and welfare serviceagencies, churches, and certain church-related organizations can make the election.

Minimum exclusion allowance for churchemployees. If you are a church employee(defined later under Years of Service) and

your adjusted gross income (figured withoutregard to community property laws) is notmore than $17,000, you are entitled to ex-clude from your gross income a certain mini-mum amount called a minimum exclusion al-lowance. The minimum is your exclusionallowance figured as explained earlier, but notless than the smaller of:

1) $3,000, or

2) Your includible compensation (definednext).

Step 1Limit on Employer Contributions Includible CompensationFor purposes of figuring your exclusion al-lowance, includible compensation generallyis the amount of pay that you received fromthe employer who made contributions to yourTSA and that you must include in income forthe most recent period (ending no later thanthe end of your tax year) which you can countas one year of service. It does not includeyour employer's contributions to your TSA.You determine the amount that must be in-cluded in income without taking into account

the foreign earned income exclusion. SeeMost Recent One-Year Period of Servicelater.

For purposes of figuring your exclusionallowance, the following amounts (which yougenerally do not have to include in income)are includible compensation.

Elective deferrals (employer's contribu-tions made on your behalf under a salaryreduction agreement).

Amounts contributed or deferred by youremployer under a Section 125 cafeteriaplan, and

Amounts contributed or deferred under aSection 457 nonqualified deferred com-pensation plan (state or local governmentor tax-exempt organization plan).

Self-employed ministers. Compensation ofa self-employed minister, who is treated asemployed by a tax-exempt organization, is theminister's earnings from self-employment re-duced by contributions to retirement plansand the deduction for one-half of the self-employment tax.

Special RulesWhen figuring your includible compensation,you should examine the following exceptionsand definitions.

Employer not qualified. Only the compen-sation earned from the employer purchasingyour TSA contract is includible compensation.Do not include compensation earned whileyour employer was not a qualified employer.However, your employer's status when youactually receive the compensation does notmatter.

Other employers. Compensation fromemployers who are not purchasing your TSAcontract and compensation from othersources generally is not includible compen-sation. However, see Service with one em-ployerunder Years of Servicelater.

Contributions for a TSA. Contributions byyour employer for a TSA are not part ofincludible compensation.

Foreign missionary. However, if you area foreign missionary during the tax year, yourincludible compensation includes contribu-tions by the church during the year towardyour TSA.

You are a foreign missionary if you are aduly ordained, commissioned, or licensedminister of a church, or a lay person, you arean employee of a church or a convention orassociation of churches, and your principalduties are spreading religious doctrine orperforming sacerdotal functions orhumanitarian good works for the church out-side the United States.

TIP

Beginning in 1998, contributionsmade to a church plan on behalf of aduly ordained, commissioned, or li-

censed minister employed by an employerother than the church that has the plan, areexcluded from the minister's gross income ifthey would have been excluded had theminister been an employee of the church.

For purposes of this rule, a minister of achurch also includes:

1) A self-employed minister, and

2) A minister employed by an organizationother than a tax-exempt organizationthat shares a common religious bondwith the minister.

Contributions to a TSA and a qualified re-tirement plan. If your employer makes con-tributions for you toward both a TSA contractand a qualified retirement plan, your employ-er's contributions to the qualified retirementplan that you can exclude from income arenot part of includible compensation for figur-ing your exclusion allowance.

Contributions that are more than your ex-clusion allowance. Contributions that aremore than your exclusion allowance are not

part of compensation for figuring your exclu-sion allowance, but they must be included inyour gross income.

Example. After taking a reduction in sal-ary to pay for your employer's contribution foran annuity during your first year of employ-ment, you received a salary of $12,000. Ac-cording to your agreement, $2,800 ($400more than your exclusion allowance) is con-tributed for your annuity. Use $12,000 asincludible compensation in figuring the exclu-sion allowance, even though you must include$12,400 in gross income.

The cost of incidental life insurance. Thecost of incidental life insurance provided un-der a TSA contract is not includible compen-

sation even though this cost is taxable to you.This part of the cost of your TSA contract istreated as contributed by you, rather thanyour employer, and is part of your cost (basis)in the contract.

Foreign earned income exclusion.Excludable foreign earned income is part ofincludible compensation.

Most Recent One-Year Periodof ServiceWhen determining your includible compen-sation for purposes of figuring the exclusionallowance, first take into account the servicesyou performed during the tax year for which

you are figuring the exclusion allowance.Keep in mind that your most recent one-yearperiod of service may not be the same asyour employer's most recent annual workperiod. This can happen if your tax year isnot the same as that of your employer.

Tax year different than that of employer.If your tax year is not the same as that of youremployer, your most recent one-year periodof service is made up of parts of at least twoof your employer's annual work periods.

Example. A professor who reports herincome on a calendar year basis is employedon a full-time basis by a university that oper-ates on an academic year (October through

1) a) Maximum ......................... $30,000b) 25% of employee's com-pensation (25% $35,600 =$8,900) ................................. $8,900c) Limit (Lesser of (a) or (b)). ... ... ... .. ... ... ... ... ... ... ... ... ... ... ... . $8,900

Step 2Contributions in Excess of EmployerLimit2) 1998 contribution for

purchase of TSA .................. $3,6003) Minus: Portion of line 2,

if any, representing cost ofterm life insurance (treated

as paid by employee) .......... 1004) Employer contribution ......................... $3,5005) Minus: Limit on employer contributions

[line 1(c)] ............................................. 8,9006) Excess contribution (if any) ............. $ 0

Step 3Exclusion Allowance7) Includible compensation ..................... $32,0008) Percentage limit .................................. 20%9) Years of service ... .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. 3

10) Multiply (7) (8) (9) ........................ $19,20011) Minus: Amounts previously

excludable .......................................... 7,20012) Exclusion allowance ........................ $12,000

Step 4Amount Excludable From Gross Income13) a) Employer contribution

[line 4] .................................. $3,500b) Limit on employer contri-butions [line 1(c)] ................. $8,900c) Exclusion allowance

[line 12] ................................ $12,000d) Limit on electivedeferrals ............................... $10,000

14) Amount excludable[least of 13(a), (b), (c), or (d)] ............ $3,500

Step 5Amount Includible in Gross Income15) Employer contribution [line 4] ............. $3,50016) Minus: Amount excludable [line 14] .. 3,50017) Amount includible ........................... $ 0

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May). For purposes of computing her exclu-sion allowance for 1998, the professor's mostrecent one-year period of service consists ofher service performed during January throughMay of 1998 and her service performed dur-ing October through December of 1998.

Part-time or employed only part of year.If you are a part-time employee, or a full-timeemployee who is employed for only part of theyear, your most recent one-year period ofservice consists of your service this year and

your service for as many previous years asis necessary to total one full year of service.(See Full year of servicelater under Rules forFiguring.) You add up your most recent peri-ods of service to determine your most recentone-year period of service. First take into ac-count your service during your tax year forwhich the exclusion allowance is being de-termined. Then add your service during yournext preceding tax year and so forth until yourservice totals one year of service.

Example. You were employed on a full-time basis during the months July throughDecember 1996 (1/2 year of service), Julythrough December 1997 (1/2 year of service),and October through December 1998 (1/4year of service), your most recent one-yearperiod of service for purposes of computingyour exclusion allowance for 1998 is the totalof your service during 1998 (1/4 year of ser-vice), your service during 1997 (1/2 year ofservice), and your service during the monthsOctober through December 1996 (1/4 yearof service).

Not yet employed for one year. If at theclose of your tax year, you have not yetworked for your employer for one year (in-cluding time you worked for the same em-ployer in earlier tax years) use the period oftime you have worked for the employer asyour most recent one-year period of service.

Years of ServiceFor purposes of figuring your exclusion al-lowance, your years of service depend onyour employment status with the employerwho maintains the plan for this tax year andearlier tax years. How you figure your yearsof service depends on whether you were afull-time or a part-time employee, whether youworked for the full year or only part of theyear, and whether you have worked for youremployer for one year.

DefinitionYour years of service are the total number ofyears you worked for your employer figured

as of the end of the tax year for which youare figuring an exclusion allowance. Theservice need not be continuous.

Rules for FiguringTake the following rules into account whenfiguring your years of service.

Less than one year of total service. Youryears of service cannot be less than one year.If at the end of your tax year, you have lessthan one year of service (including service inany previous years), figure your exclusion al-lowance as if your years of service is oneyear.

Status of employer. Your years of servicewill only include periods that your employerwas a qualified employer, (defined earlier).

Service with one employer. Generally, youcannot count service for any other employer.

Church employee. If you are a churchemployee, treat all of your years of servicewith related church organizations as years ofservice with one employer. If during yourchurch career you transfer from one organ-ization to another within that church or to an

associated organization, treat all this serviceas service with a single employer. Whenthese organizations make contributions toyour annuity contracts, treat them as madeby the same employer.

A church employee is anyone who is anemployee of a church or a convention or as-sociation of churches. This includes an em-ployee of a tax-exempt organization con-trolled by or associated with a church or aconvention or association of churches.

Self-employed ministers. If you are a self-employed minister, your years of service in-clude full and part years in which you havebeen treated as employed by a qualified tax-exempt organization.

Full-time employee for full year. Counteach full year during which you were em-ployed full-time as one year of service. Indetermining whether you were employed full-time, compare the amount of work you wererequired to perform with the amount of worknormally required of others who held thesame position with the same employer andwho generally received most of their pay fromthe position.

How to compare. You can use anymethod that reasonable and accurately re-flects the amount of work required. You canuse the number of hours of classroom in-struction as a measure of the amount of workrequired.

In determining whether positions with thesame employer are the same, consider all ofthe facts and circumstances concerning thepositions, including the work performed, themethods by which pay is determined, and thedescriptions (or titles) of the positions. Forexample, an assistant professor employed inthe English department of a university will beconsidered a full-time employee if the amountof work that he is required to perform is thesame as the amount of work normally re-quired of assistant professors of English atthat university who get most of their pay fromthat position.

If no one else works for your employer inthe same position, compare your work withthe work normally required of others who held

the same position with similar employers orsimilar positions with your employer.Full year of service. A full year of service

for a particular position means the usual an-nual work period of anyone employed full-timein that general type of work at that place ofemployment.

Example. If a doctor works for a hospital12 months of a year except for a one-monthvacation, the doctor will be considered asemployed for a full year if the other doctorsat that hospital also work 11 months of theyear with a one-month vacation. Similarly, ifthe usual annual work period at a universityconsists of the fall and spring semesters, aninstructor at that university who teaches these

semesters will be considered as working a fullyear.

Part-time or employed only part of year.You include a fraction of a year of service foreach year during which you were a full-timeemployee for part of the year or a part-timeemployee for the entire year or for a part ofthe year.

Full-time for part of year. If you workedfull time for part of the year, you figure thefraction of a year of service to include by di-

viding the number of weeks (or months) dur-ing which you were a full-time employee bythe number of weeks (or months) consideredthe usual annual work period for the positionyou held.

Example. If you were employed full timeas an instructor by a university for the 1998spring semester (which lasts from February1998 through May 1998) and the academicyear of the university is 8 months long, (fromOctober 1997 through May 1998), you com-pleted 4/8 of a year of service.

Part-time for full year. If you worked parttime for a full year, you figure the fraction ofa year of service to include by dividing theamount of work required of you by the amountof work normally required of someone holdingthe same position on a full-time basis. Youcan use any method that reasonably and ac-curately reflects the amount of work required.You can use the number of hours of class-room instruction as a measure of the amountof work required.

Example. A practicing physician teachesone course at a local medical school 3 hoursper week for two semesters and other facultymembers at the same school teach 9 hoursper week for two semesters. The practicingphysician is considered as having completed3/9 of a year of service.

Part- time for part of year. If you worked

part time for part of the year, you figure thefraction of a year of service to include bymultiplying two fractions. Figure one fractionas if you worked full time for part of the yearand figure the other fraction as if you workedpart time for the full year.

Example. An attorney who is a specialistin a subject teaches a course in that subjectfor 3 hours per week for one semester at alaw school. The full-time instructors at thatlaw school teach 12 hours per week for twosemesters. The fractional part of a year ofservice for the part-time instructor is com-puted as follows: The fractional year of ser-vice if the instructor were a part-time em-ployee for a full year is 3/12 (number of hoursemployed divided by the usual number ofhours of work required for that position); thefractional year of service if the instructionwere a full-time employee for part of a yearis 1/2 (period worked or one semester, di-vided by usual work period, or 2 semesters).These fractions are multiplied to obtain thefractional year of service: 3/12 times 1/2, or3/24 (1/8).

Amounts PreviouslyExcludableTo figure your exclusion allowance, you mustknow the amounts previously excludable fromyour income.

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DefinitionAmounts previously excludable is the total ofall contributions for retirement benefits madefor you by your employer that you could ex-clude from your gross income. It does not in-clude amounts for the tax year for which thecurrent exclusion allowance is being figured.

Amounts previously excludable includecontributions in earlier years by your em-ployer to:

A tax-sheltered annuity (TSA),

A qualified annuity plan or a qualifiedpension, profit-sharing, or stock bonustrust,

A qualified bond-purchase plan,

A retirement plan under which the contri-butions originally were excludable by youonly because your rights to the contribu-tions were forfeitable when made, andwhich also were excludable by you whenyour rights became nonforfeitable (Thisdoes not apply to contributions made af-ter 1957 to purchase an annuity contractif your employer was an exempt organ-ization when the contributions weremade.), or

An eligible deferred compensation plan(under Code section 457) of a state orlocal government or tax-exempt organ-ization, even if maintained by a separateemployer.

You must treat contributions to a stateteachers retirement system made for you inearlier tax years, up to the amount that wasexcludable, as amounts previouslyexcludable.

You must treat employer contributions andother additions in earlier years (beginning af-ter January 24, 1980) that were more than thelimit as if they were amounts previouslyexcludable. See Limit on Employer Contribu-tions, earlier.

How To Figure

If you do not know the amount thatan employer contributed to a plan onyour behalf, you can figure your part

of your employer's contributions by anymethod using recognized actuarial principlesthat are consistent with your employer's planand the method used by your employer forfunding the plan. You can also use the fol-lowing formula.

Formula. Determine the contributions youremployer made for you as of the end of anytax year by multiplying the following four

items.

1) The projected annual amountof yourpension (as of the end of the tax year)to be provided at normal retirement agefrom employer contributions, based onthe plan provisions in effect at that timeand assuming your continued employ-ment with that employer at your thencurrent salary rate,

2) The value from Table Ibased on thenormal retirement age as defined in theplan.

3) The amount from Table II for the sumof the following two items:

a) The number of years remainingfrom the end of the tax year tonormal retirement age, and

b) The lesser of the number of yearsof service credited through the endof the tax year or the number ofyears that the plan has been in ex-istence at that time.

4) Thelesser ofthe number of years ofservice credited through the end of thetax year or the number of years that theplan has been in existence at that time.

An example of the use of this formula followsTable Iand Table II.

Note: If the normal form of retirementbenefit under the plan is other than astraight-life annuity, divide the value from

Table I by the appropriate figure as follows:

The term cash refund refers to a refundof accumulated employer contributions, not toa refund of employee contributions only, oftenreferred to as modified cash refund.

Example. Joe Blue, who was 29 at theend of 1998, has been employed by the OakCounty school system since 1995. In 1995,Joe's employer contributed to a TSA plan.Since 1995, Joe's employer has contributedto both the TSA plan and a statewide retire-ment system that provides a straight-life an-nuity upon retirement. Joe is covered by bothplans.

Joe wishes to figure the amounts previ-ously excludable under both plans so that hecan figure the exclusion allowance for 1998.His employer's contributions to the statewideretirement system were not allocated amongthe individual employees.

Joe's employer gives him the followinginformation:

Employer contributions to the TSA thatwere excludable from gross income in prioryears:

The projected annual amount of Joe'sretirement system pension (as of the end of1997 when Joe was 28) is $12,000. Thepension begins at age 65 from his employer'scontributions. This is based on 1997 planprovisions and assumes that Joe works forthe same employer until age 65 at his 1997salary. Normal retirement age is 65.

Joe figures the amounts previouslyexcludable under the pension plan as follows:

Table II

[Level annual contribution which will accu-mulate to $1.00 at the end of a number ofyears.]

Numberof years Amount

Numberof years Amount

1 .......... $1.0000 26 ........ $ .01252 .......... .4808 27 ........ .01143 .......... .3080 28 ........ .01054 .......... .2219 29 ........ .00965 .......... .1705 30 ........ .00886 .......... .1363 31 ........ .0081

7 .......... .1121 32 ........ .00758 .......... .0940 33 ........ .00699 .......... .0801 34 ........ .006310 ........ .0690 35 ........ .005811 ........ .0601 36 ........ .005312 ........ .0527 37 ........ .004913 ........ .0465 38 ........ .0045Table I14 ........ .0413 39 ........ .0042

[Value at normal retirement ages of annuity of$1.00 per year payable in equal monthly install-ments during the life of the employee.]

15 ........ .0368 40 ........ .003916 ........ .0330 41 ........ .003617 ........ .0296 42 ........ .0033

Ages Value 18 ........ .0267 43 ........ .003040 ................................................................. 11.49

19 ........ .0241 44 ........ .002841 ................................................................. 11.4020 ........ .0219 45 ........ .002642 ................................................................. 11.3121 ........ .0198 46 ........ .002443 ................................................................. 11.2222 ........ .0180 47 ........ .002244 ................................................................. 11.12

45 ................................................................. 11.01 23 ........ .0164 48 ........ .002046 ................................................................. 10.91 24 ........ .0150 49 ........ .001947 ................................................................. 10.79 25 ........ .0137 50 ........ .001748 ................................................................. 10.6849 ................................................................. 10.5650 ................................................................. 10.4351 ................................................................. 10.3052 ................................................................. 10.1853 ................................................................. 10.0454 ................................................................. 9.8955 ................................................................. 9.7556 ................................................................. 9.6057 ................................................................. 9.4458 ................................................................. 9.2859 ................................................................. 9.1360 ................................................................. 8.9661 ................................................................. 8.7962 ................................................................. 8.6263 ................................................................. 8.4464 ................................................................. 8.2565 ................................................................. 8.0866 ................................................................. 7.8867 ................................................................. 7.7068 ................................................................. 7.5069 ................................................................. 7.2970 ................................................................. 7.1071 ................................................................. 6.8872 ................................................................. 6.6873 ................................................................. 6.46 1995 ............................................................. $2,00074 ................................................................. 6.25 1996 ............................................................. 2,40075 ................................................................. 6.03 1997 ............................................................. 2,80076 ................................................................. 5.8277 ................................................................. 5.6178 ................................................................. 5.4079 ................................................................. 5.2080 ................................................................. 4.99

1. Projected annual amountof pensionat normal retirement age (65) .............. $12,000

Annuity for 5 years certain and life there-after ............................................................ 0.97

2. Table Ivalue at normal retirement age(65) ....................................................... 8.08

Annuity for 10 years certain and life there-after ............................................................ 0.90

3. Table IIamount for the sum of:Annuity for 15 years certain and life there-after ............................................................ 0.80 a) Number of years from

end of the preceding taxyear (1997) to normal re-tirement age (65 minus 28) . 37

Annuity for 20 years certain and life there-after ............................................................ 0.70Life annuity with installment refund ........... 0.80

b) Plus: Lesser of years ofplan existence or years ofservice ................................ 3

Life annuity with cash refund ..................... 0.75

40Table II amount for total of 40 ............. .0039

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Joe multiplies (1) times (2) times (3) times(4).

$12,000 x 8.08 x .0039 x 3 = $1,134.43Joe then adds his employer's contributions

to the pension plan ($1,134.43) to theexcludable contributions to the TSA plan inyears prior to the 1998 tax year ($7,200) todetermine the amounts previously excludableof $8,334.43.

Note: See Contributions in excess ofemployer limit, earlier under Limit on Em-ployer Contributions.

Catch-up Election Alternative LimitsforCertain EmployeesIf you are an employee of an educational or-ganization, a hospital, a home health serviceagency, a health and welfare service agency,or a church or church-related organizationthat contributes to a tax-sheltered annuity(TSA) for you, you can make a catch-upelection to increase the limit on your employ-er's contributions by using one of three alter-native limits. See also Special Election forChurch Employees, later.

An educational organization and a churchemployee have been defined earlier.

Home health service agency. This is atax-exempt organization that has been deter-mined by the Secretary of Health and HumanServices to be a home health agency as de-fined in section 1861(o) of the Social SecurityAct.

Church. For this purpose this includes a

church, convention or association ofchurches, or a tax-exempt organization con-trolled by or associated with a church or aconvention or association of churches.

Alternative limits. There are three alterna-tive limits.

1) The year of separation from servicelimit.

2) The any year limit.

3) The overall limit.

Electing (choosing) a limit. You can electany one of the three limits, but with certainrestrictions, as explained later under Makingthe Election. For example, you cannot makemore than one election and, once one ismade, it is irrevocable and limits elections forfuture years.

Effect of election. Generally, the election touse one of the first two alternative limits listedabove will permit you to exclude from grossincome a larger amount of employer contri-butions than allowed under the part of theoverall limit that limits employer contribu-tions to 25% of your compensation. If youelect to use the overall limit, you may beable to exclude a larger amount because youcan disregard the exclusion allowance (dis-cussed earlier) that would otherwise apply.

4. Lesser ofyears of plan existence oryears of service .................................... 3

Excess contributions. If employer contri-butions are included in your income for a taxyear because they exceed any of these al-ternative limits for that year, the excess re-duces the amount of your exclusion allow-ance for future years, even though the excesshas already been included in your income.

Year of Separationfrom Service LimitFor the limitation year (defined under Limiton Employer Contributions, earlier) that endswith or within the tax year you separate fromthe service of an educational organization,hospital, church, or other organization listedabove, you can elect to substitute your ex-clusion allowance (modified as discussedbelow) for the 25% of your compensation limiton employer contributions under the generalrule. See Limit on Employer Contributions,earlier. The $30,000 limit on employer contri-butions still applies. The limit on electivedeferrals also still applies to the extent thecontributions consist of elective deferrals. SeeLimit on Elective Deferrals, earlier.

Figuring the limit.

Figure your exclusion allowance asexplained earlier, except, for youryears of service, count only the ser-

vice you performed during the 10-year periodending on the date of separation. Do not usea period longer than 10 years even if the10-year period is less than your actual num-ber of years of service. Your amounts previ-ously excludable are the amounts excludableduring your years of service (limited to 10years). All service for your employer per-formed within the 10-year period must betaken into account.

Limit. Compare this modified exclusion al-

lowance to the $30,000 limit on employercontributions and the limit on elective defer-rals, if it applies. Your year of separation fromservice limit is the smallest of these.

If your employer's contributions for theyear are more than the smallest of:

1) Your modified exclusion allowance,

2) $30,000, or

3) The limit on elective deferrals, if it ap-plies,

you must include the excess in gross income.

Example. Frank Green, who is presidentof a university, plans to retire on December31, 1998, after 20 years of service. Hiscompensation for 1998, which was not re-duced by any elective deferrals, is $100,000.During the 10-year period before the date ofseparation from service, Frank's employercontributed $40,000 to Frank's TSA. Thecontributions, which were non-elective, wereexcludable from Frank's gross income. Dur-ing all his years of service, his employercontributed a total of $60,000 that wasexcludable from Frank's gross income. For1998, Frank elects to have his employercontribute the maximum amount permitted fornon-elective employer contributions to hisTSA. He figures that amount using the yearof separation from service limit as follows:

Because Frank elected this alternativelimit, and because there are no electivedeferrals, his employer can contribute$30,000 to Frank's TSA during the year of hisseparation from service without making anexcess contribution. In Step 1, Frank's unad-

justed exclusion allowance is $340,000. InStep 2, employer contributions to Frank's TSAare limited to $25,000. If it were not for thiselection, the limit on employer contributionsfor Frank would be $25,000 (Step 2). Instead,

the limit is $30,000.

WORKSHEET 4at the end of thispublication will help you figure the Yearof Separation from Service Limit andthe amount you can exclude from grossincome.

Any Year LimitFor any limitation year (defined under Limiton Employer Contributions, earlier), you cansubstitute for the 25% of employee's com-pensation limit the smallestof the following:

1) $4,000, plus 25% of your includible

compensation for the tax year in whichthe limitation year ends;

2) The exclusion allowance for the tax yearin which the limitation year ends; or

3) $15,000.

If you elect this limit, the maximum per-mitted contribution to your TSA is $15,000,not the $30,000 that may apply under otherlimits.

If your employer's annual contributions aremore than the smallest of:

1) Your any year limit,

2) The exclusion allowance, or

Step 1Exclusion Allowance (before modifica-tion)

1) Includible compensation ................ $100,0002) Percentage limit ............................. 20%3) Years of serv ice .. .. .. .. .. .. .. .. .. .. .. .. .. .. . 204) Multiply (1) (2) (3) .................... $400,0005) Minus: Amounts previously

excludable ...................................... 60,0006) Exclusion allowance ....................... $340,000

Step 2Limit on Employer Contributions1) Maximum ........................................ $30,0002) 25% of compensation limit .............

(a) Compensation ...................... $100,000

(b) Percentage limit ................... 25%(c) Limit ...................................... $25,000

3) Limit on Employer Contributions(lesser of (1) or (2)) ....................... $25,000

Step 3Year of Separation from Service Limit1) Employer Limit on Contributions

Maximum ........................................ $30,0002) Exclusion allowance (modified)

(a) Includible com-pensation .................. $100,000(b) Percentage limit . . 20%(c) Years of service(Limited to 10 years) . 10(d) Multiply (a) (b) (c) .............................. $200,000(e) Minus: Amountspreviously excludableduring 10-year period

................................... 40,000(f) Exclusion allowance (modi-fied) ............................................ $160,000

3) Alternative Limit Year of Sepa-ration from Service Limit [lesser of(1) or (2)(f)] .................................... $30,000

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3) The limit on elective deferrals (to theextent the contributions are electivedeferrals),

you must include the excess in your grossincome.

Example. Bill Black is a principal with theMaple County school system. In 1998, his17th year of service, Bill's salary is $39,000without reduction for an amount under a sal-ary reduction agreement. Bill's employer hadcontributed $34,400 to the TSA plan in earlieryears and all the contributions were excludedfrom Bill's income. Under a salary reductionagreement, Bill and his employer agree toelective deferral contributions of $9,000 thatmay be excluded from Bill's gross income.To find the maximum employer contributionallowed, Bill figured the any year limit asfollows:

Under this alternative limit, Bill's employercan contribute $11,500 to the annuity plan.

In Step 1, the exclusion allowance is$67,600; in Step 2, the maximum amount theemployer can contribute on Bill's behalf is$11,500. Since the $9,000 contribution isless than the limit in Step 1, the limit in Step2, and the limit on elective deferrals, $9,000can be excluded from gross income.

If it were not for the alternative limit (theany year limit), the maximum amount Bill'semployer could contribute under the generalrule would be $7,500 (the lesser of $30,000or $7,500 (25% $30,000)). See also Exam-ples of Catch-up Elections, later.

WORKSHEET 5at the end of thispublication will help you figure the AnyYear Limit and the amount you canexclude from gross income.

Overall LimitYou can elect to have the limit on your em-ployer's contributions and your exclusion al-lowance be equal to the lesser of $30,000 or25% of compensation (as defined under Limiton Employer Contributions, earlier) for thelimitation year ending in the tax year. Underthis election, you disregard the computationof the exclusion allowance.

Include in your gross income any contri-bution to your TSA that is more than thelesser of the limit on employer contributions($30,000 or 25% of compensation) or theelective deferral limit ($10,000), if it applies.

If you elect the overall limit as your al-ternative limit, you must combine employercontributions to your TSA with your employ-er's contributions to a qualified plan to deter-

mine whether the limits on employer contri-butions have been exceeded. See Limit forContributions to More Than One Plan, later.

Example. Mary White is employed as anurse with Apple City General Hospital. In her11th year of service, she agrees to have heremployer contribute additional amounts to herTSA plan for catch-up contributions.

Her compensation for 1998 is $35,000.She figures the overall limit on contributionsto be $8,750, as follows:

WORKSHEET 6at the end of thispublication will help you figure theOverall Limit and the amount you canexclude from gross income.

Examples of Catch-up

ElectionsThe following examples show how you canuse the three alternative limits just discussedto maximize the amount of employer contri-butions to a TSA that you can exclude fromincome.

Example 1. Eli Green was an employeeof Maple Hospital, a tax-exempt charitableorganization, for the entire 1998 calendaryear. His employer's contributions to a TSAfor him are not subject to the elective deferrallimit. Eli has a salary of $30,000 for the year.He has 4 years of service with his employeras of December 31, 1998. During Eli's priorservice with Maple Hospital, his employer hadcontributed $12,000 on Eli's behalf to a TSA,and Eli excluded the amount from gross in-come in earlier years. Thus, for 1998, Eli'sexclusion allowance is $12,000, figured asfollows:

The limit under the general rule is $7,500(the lesser of $30,000 or $7,500 (25% $30,000)).

Without the catch-up elections providedfor certain employees, $7,500 would be themaximum contribution Maple Hospital couldmake for TSAs on behalf of Eli for 1998

without increasing Eli's gross income for thatyear.Since Eli is an employee of a hospital, he

can elect one of the catch-up limits. Eli canelect either the any year limit or the overalllimit. He cannot elect the year of separationfrom service limit since he does not separatefrom service in 1998.

If Eli elects the any year limit, MapleHospital could contribute $11,500 on his be-half for 1998 to a TSA, figured as follows:

If Eli elects the overall limit, Maple Hos-pital could contribute only a maximum of$7,500 without increasing Eli's gross incomefor the year figured as follows:

Example 2. Assume the same facts asin Example 1, except that Maple Hospitalcontributed $18,000 on Eli's behalf in earlieryears to the TSA. The contributions were

excludable from his gross income. Thus, for1998, Eli's exclusion allowance is $6,000 fig-ured as follows:

The limit under the general rule (the limiton employer contributions) for 1998 is thelesser of $30,000 or $7,500 (25% $30,000).

Without the catch-up elections, $6,000(the lesser of the two limits that apply) wouldbe the maximum amount Maple Hospitalcould contribute on Eli's behalf for TSAswithout increasing Eli's gross income. How-ever, if Eli elects the overall limit,MapleHospital could contribute up to $7,500 withoutincreasing Eli's gross income for 1998. Thisis because the election of this limit substitutesthe limit under the general rule for the exclu-sion allowance.

Example 3. Bob White, a teacher, isemployed by Elm School, a tax-exempt edu-cational organization. Bob has a salary, afterreduction for elective deferrals under a TSAplan, of $44,000 for 1998.

Bob has 20 years of service with ElmSchool as of May 30, 1998, the date he sep-arates from the service of Elm School. DuringBob's service with Elm School before tax year1998, Elm School had contributed elective

deferrals of $68,000 toward the purchase ofTSAs on behalf of Bob. The amount wasexcludable from his gross income for the prioryears. Of this amount, $38,000 was contrib-uted and excluded during the 10-year periodending on May 30, 1998. Bob's electivedeferrals limit is increased because he hascompleted at least 15 years of service. Forthe tax year 1998, Bob's limit on electivedeferrals is $13,000 determined as follows:

Bob's limit on employer contributions is$11,000 determined as follows:

Bob's exclusion allowance is $108,000figured as follows:

1) Maximum ............................................... $30,0002) 25% of compensation ........................... $7,5003) Overall limit [lesser of (1) or (2)] ........... $7,500

1) Maximum employer contributions ......... $30,0002) 25% of compensation

(25% $35,000) ................................... $8,7503) Overall limit on employer

contributions(lesser of (1) or (2)) .............................. $8,750

1) Includible compensation ....................... $30,0002) Percentage limit .................................... 20%3) Years of service .................................... 44) (1) (2) (3) ........................................ $24,0005) Minus: Amounts previously excludable . 18,0006) Exclusion allowance .............................. $6,000

Step 1Exclusion Allowance1) Includible compensation ..................... $30,0002) Percentage limit .................................. 20%3) Years of service .................................. 174) Multiply (1) (2) (3) ......................... $102,0005) Minus: Amounts previously excludable

............................................................. 34,4006) Exclusion allowance ............................ $67,600

Step 2Any Year Limit7) a) $4,000 plus 25% of includible com-

pensation ($4,000 + $7,500 (25% $30,000)) ............................................. $11,500b) Exclusion allowance (from Line (6))............................................................. $67,600c) Maximum under this election .......... $15,000d) Alternative limit (Least of (a), (b), or(c)) ....................................................... $11,500

1) Includible compensation ....................... $30,0002) Percentage limit .................................... 20%3) Years of service .................................... 44) (1) (2) (3) ........................................ $24,0005) Minus: Amounts previously excludable . 12,0006) Exclusion allowance .............................. $12,000

1) General limit .......................................... $10,0002) Maximum additional .............................. 3,0003) $15,000 less additional deferrals al-

lowed in prior years .............................. $15,0004) Prior year deferrals limit:

a) Annual amount ................. $5,000b) Years of service .. ... ... ... ... . 20c) Multiply (a) x (b) ............... $100,000

d) Less elective deferralsmade underplan for earlier years ........ 68,000

e)...

Balance .............................................32,000

5) Least of lines 2, 3, or 4(e) .................... 3,0006) Increased elective deferrals limit (line 1

plus line 5) ............................................ $13,000

1) Maximum ............................................... $30,0002) 25% of compensation ($44,000 x 25%)

............................................................... 11,0001) $4,000, plus 25% of includible compen-

sation ..................................................... $11,5003) Lesser of line 1 or 2 .............................. $11,0002) Exclusion allowance .............................. $12,000

3) Maximum under this election ................ $15,0004) Any year limit [least of (1), (2), or (3)] .. $11,500

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Bob's limit under the general rule (limit onemployer contributions) is the lesser of$30,000 or $11,000 (25% of $44,000).

Without the catch-up elections, $11,000would be the maximum excludable contribu-

tion Elm School could make to a TSA onBob's behalf for 1998. This is the least of theexclusion allowance ($108,000), the generalrule ($11,000), or the increased electivedeferral limit ($13,000).

However, because Bob was an employeeof an educational organization and has sep-arated from service, he can elect any one ofthe three catch-up elections (alternative lim-its) to increase his allowable 1998 contribu-tion.

Before deciding which catch-up electionto make, Bob considers the following.

If Bob elects the year of separation fromservice limit for 1998, Elm School couldcontribute up to $30,000 for that year withoutincreasing Bob's gross income, figured asfollows:

If Bob elects the any year limit for 1998,Elm School could contribute up to $15,000,which is the least of the following:

If Bob elects the overall limit for 1998,Elm School could contribute up to $11,000,which is the lesser of the following:

Special Electionfor Church EmployeesIf you are a church employee and you electthe Minimum exclusion allowance for churchemployees (described earlier under The Ex-clusion Allowance), your employer can makecontributions for the year up to the minimumexclusion allowance even though the contri-butions would otherwise be more than thelimit on employer contributions to a definedcontribution plan, discussed earlier.

In addition to the any year or overalllimit, you can make a special election thatallows your employer to contribute up to$10,000 for the year, even if this is more than25% of your compensation for the year. Thetotal contributions over your lifetime under thiselection cannot be more than $40,000. In thissituation, the exclusion allowance limit stillapplies, unless you also elect the overall

1) Includible compensation ..................... $44,000 limit described earlier. If the contributions areelective deferrals, they are also subject to thelimit on elective deferrals, discussed earlier.

You cannot make this special election fora tax year in which you use the year of sep-aration from service limit described earlier.

Making the ElectionYou make the election to apply one of thethree alternative limits by figuring your taxusing the limit you choose. However, theelection is treated as made only when neededto support the exclusion from gross incomereflected on the income tax return.

Election is irrevocable. If you elect to usean alternative limit, you cannot change theelection.

One election allowed. If you elect oneof the alternative limits, you cannot elect tohave any of the others apply for any futureyear for any TSA purchased for you by anyemployer.

If you elect the any year limit or theoverall limit, it is the only alternative limit youcan use for later years.

If you elect the year of separation fromservice limit, you cannot elect any alternativelimit in any later year for any TSA. You can

use this limit only once.

Failure to pay estimated income tax. If youamend an earlier year's return to elect an al-ternative limit, and that limit increases yourtax for that year, the difference in tax due tothe use of the alternative limit is not treatedas an underpayment of tax for the penalty forfailure to pay estimated income tax.

Limit forContributions toMore ThanOne PlanSpecial rules may apply in determining thelimit on employer contributions for you to atax-sheltered annuity (TSA) plan if you alsoare covered by a qualified plan.

Combining contributions. Generally, con-tributions to TSA plans must be combinedwith contributions to qualified plans and sim-plified employee pensions of all corporations,partnerships, and sole proprietorships inwhich you have more than 50% control todetermine whether the limits on contributionsand benefits of qualified plans (section 415limits) have been exceeded.

If you elect the overall limit, discussed

earlier, you must combine contributionswhether or not you have this control.

Example 1. You have an HR-10 plan(sometimes called a Keogh plan) for a soleproprietorship business, and you are also aparticipant in a charity's TSA plan. You mustcombine contributions under the two definedcontribution plans to determine whether thelimit on employer contributions is satisfied.

Example 2. You are employed by aneducational organization that provides a TSAplan. You are also a shareholder owningmore than 50% of a professional corporation.You must combine any qualified plan of theprofessional corporation with the TSA to de-

termine if the section 415 limits have beensatisfied.

Excess contributions. If you combinethe TSA contract and a qualified plan, the limiton employer contributions may be exceeded.The excess is includible in your gross incomefor the tax year the excess contribution wasmade, and it reduces your exclusion allow-ance for all future years.

Other RulesThe following additional rules generally relateto contributions to your TSA, and to othertransactions that could affect your TSA beforeyou retire or begin receiving benefits.

Voluntary EmployeeContributionsYou cannot deduct voluntary employee con-tributions you make to your TSA.

However, there may be amounts in yourTSA that are from deductible voluntary em-ployee contributions you made in earlieryears. If these amounts are distributed to you,you must include them in gross income un-

less you roll them over into an IRA or intoanother TSA. For tax years 1982 through1986, employees could make deductible vol-untary employee contributions to a TSA.

Tax on ExcessContributions to aCustodial AccountThere is a 6% excise tax on certain excesscontributions. The tax applies to contributionsthat are more than either the exclusion al-lowance or the limit on employer contributionsin effect when a TSA plan invests in mutualfund shares through a custodial account. Thetax does not apply to excess contributions

made to pay premiums on an annuity con-tract. Also see Taxability of Excess Contribu-tions, later.

You cannot deduct the excise tax. Youmust pay it each year until the excess contri-bution is corrected. Excess contributions canbe corrected by making smaller contributionsin later years. For example, if there is an ex-cess contribution in 1998 and no correctiveaction is taken for that year, you are liable forthe tax for 1998. If after 1998 you do notwithdraw the excess (if not otherwise re-stricted) or reduce it by carrying it over to alater year (or years) in which you contributeless than your allowable contribution for thatlater year (or years), you will continue to beliable for the tax on the excess each year itremains. This tax will be in addition to any tax

due because of additional excess contribu-tions in a later year.

How to figure tax. You figure the excise taxon excess contributions as follows:

2) Percentage limit .................................. 20%3) Years of service .................................. 204) Multiply (1) (2) (3) ......................... $176,0005) Minus: Amounts previously excludable

............................................................. 68,0006) Exclusion allowance ............................ $108,000

1) Includible compensation ....................... $44,0002) Percentage limit .................................... 20%3) Years of serv ice (not to exceed 10) . .. .. 104) Multiply (1) (2) (3) ........................... $88,0005) Minus: Amounts previously excludable . 38,0006) Exclusion allowance (modified) ............ $50,0007) Employer Limit on Contributions

Maximum ............................................... $30,0008) Maximum contribution under year of

separation from service limit (lesser ofline 6 or line 7) ...................................... $30,000

1) $4,000, plus 25% of includible com-pensation ............................................. $15,000

2) Exclusion allowance ............................ $108,000

3) Maximum under this alternative .......... $15,0004) Maximum contribution under any year

limit (least of lines 1, 2, or 3) ............. $15,000

1) Maximum under this alternative ............ $30,0002) 25% of compensation ........................... $11,0003) Maximum contribution under the overall

limit(lesser of line 1 or 2) ..................... $11,000

1) Total amount contributed for currentyear, minus rol

Documents

US Internal Revenue Service: p571--1998