TaxLater.Com - EGTRRA Information

When EGTRRA (The Economic Growth and Tax Relief Reconciliation Act) passed, it enhanced the advantage of the new “Safe Harbor 401(k)” plan for small businesses. This plan is particularly suited for small businesses and/or independent contractors. One of the major goals of EGTRRA was to encourage the establishment of small business retirement plans. Enhancements in the legislation have made the qualified plans much more appealing to the small business owners and to the employees. The tax law creates a multitude of opportunities with more than 60 provisions that encourage small business retirement plans by raising benefits and contribution levels, and even creating a tax credit for the first three years of administration costs. It also initiates an increase in the maximum benefit allowed and at an earlier retirement age, and opens the viability of this type of plan to much younger individuals. The following is an example of one opportunity scenario that EGTRRA has generated:

The tax law now allows a one-person 401(k) plan. In the past, if the business was taking the maximum allowable deduction of 15% then no further contributions could be made. Any 401(k) elective deferral was counted toward the maximum deduction of the business so the owner could make no 401(k) deferral.

That has changed. Now, a deferral on behalf of the participant no longer counts against the maximum business deduction. In addition, beginning this year, the maximum business deduction was increased to 25% of the participant’s salaries for a profit sharing plan. This combination of increased business deferral and a new allowable personal 401(k) deferral creates the scenario below for a one-person corporation with a salary of $50,000 for the owner.

The elective deferral has increased to $15,000. If the owner is over fifty, he/she is allowed an additional $5,000 in “catch-up” contributions in 2006 for a total of $20,000.

THE ONE PERSON 401(k)

EXAMPLE: ONE PERSON CORPORATION

TOTAL PROFIT SHARING DEDUCTIONS AVAILABLE PREVIOUSLY

COMPARED TO 2006 THANKS TO THE TAX LAW (EGTRRA)

______________________________________________________________________________

Salary Maximum Maximum

Before Profit Sharing Elective Total Taxable

Age Deferral Contribution Deferral Deductions Salary

Before EGTRRA 50 $50,000 $ 7,500 -0- $ 7,500 $50,000

After EGTRRA 50 $50,000 $ 12,500 $20,000 $32,500 $30,000

Would you believe a deduction of 204% of taxable income? It is a possibility under the new tax law. The keys to large deductions are: 1. Increased deferral limits. 2. Adding the spouse to payroll. The example below demonstrates a specific situation and the deduction possibilities in a Profit Sharing Plan after EGTRAA. The pension rules are effective in 2006. This demonstrates the deductions allowable in this situation and compares them to what would have been allowed in the past. The total deduction is almost triple what would have been allowed before EGTRRA.

This is but one of the examples of increased deductions and increased flexibility under the tax law.

Historically, doctor’s offices (as one example) have installed combination Money Purchase and Profit Sharing plans so doctors could receive the maximum 25% of the salary contribution into plans. Under the tax law, this combination of plans is no longer necessary. It is now possible to receive the maximum deduction with the Profit Sharing plan alone. The business deduction available is a maximum of 25% of the sum of the salaries of all participants. Any one individual can receive a maximum annual addition of 100% of salary up to a dollar limit of $44,000 (in 2006)!

There is no need for businesses to continue both plans. Two plans create double the administrative fees and government fillings. In addition, the Money Purchase contribution is a “fixed” contribution with no flexibility. If the entire contribution is allocated to the Profit Sharing plan, there is complete flexibility in the total contribution each year. The Profit Sharing plan has no requirement to make a contribution regardless of business earnings. The Money Purchase plan does.

A.) Save fees by having one plan. They can merge the Money Purchase plan into the Profit Sharing plan.

B.) Add flexibility to the contribution level. With all funds going into the Profit Sharing plan, there is complete flexibility each year as to what the level of contribution made by the business is.

C.) Enjoy more investment options. In most cases, many plans may offer 45 investment choices that may allow more options and flexibility than the funding vehicles they are presently in.

D.) Create new allocation formulas benefiting the owners. The ability to redesign the plan (usually introducing the New Comparability approach) and allow for much larger allocations to the owners with the same or less total outlay from the business.