Establishing and Opening your myRA

You may establish a myRA if you receive Compensation and your AGI is not in excess of the amounts described below and have either a Social Security Number or Individual Tax Identification Number. To establish a myRA, you must complete and sign all applicable documents. An MyRA can be a great tool to save for retirement for many Americans.


What is an Inherited myRA?

In general, an Inherited myRA is established upon the death of an Individual who has already established a myRA, the in favor of each Beneficiary of that myRA. However, if a surviving spouse Beneficiary of a myRA whose owner is now deceased elects to treat the myRA as the spouse’s own, the myRA is established as the surviving spouse’s own myRA. In addition, if such a spouse has already established a myRA, the myRA that the spouse elects to treat as the spouse’s own will be consolidated with the spouse’s already established myRA.


How to open an MyRA?

Your myRA will be considered opened when you have provided Comerica with all of the documentation that Comerica requires, including, but not limited to, as applicable, an executed Acceptance Form, ESIGN Notice and Consent, online acceptance of these Master Terms and taxpayer identification certification, and Comerica has noted the myRA as open on its records. Comerica requires identification and taxpayer information in order to open a myRA. Comerica may also independently verify your identity through the comparison of identifying information you or your 5 representative have provided with information Comerica obtains from a consumer or business reporting agency, public database or other source. Accordingly, you agree to provide true, accurate and complete information on all forms required by Comerica and agree to inform Comerica anytime there is a material change to such information.

Contributions to a myRA?

Contributions to a myRA are not tax deductible. The maximum amount that you may contribute to a myRA for any Tax Year is, subject to the limitations discussed in Section 3.2 below, the lesser of (a) 100% of your taxable Compensation for the year or (b) the Applicable Amount, less any contributions to other IRAs. If you are age fifty (50) or older, your Applicable Amount includes a Catch-Up Contribution. The limit on myRA contributions is reduced by contributions to any other IRA for the same Tax Year.


How to make contribution to a myRA?

Contributions to your myRA may be made through ACH transactions at any time, in any frequency and in any amount, subject to the contribution limits discussed in this Section 3.1 and Section 3.2. Contributions (other than those made by a direct deposit deduction from your wages) can be set up as one-time contributions or recurring contributions. If contributions are made by deduction from your wages, the contributions are made each pay period in the amount specified on the direct deposit form you provide to your employer, or, if available to you, thought your employer’s online direct deposit authorization process. There is no per deposit minimum contribution amount.

How much can you contribute to a myRA?

In general, contributions to your myRA for any Tax Year are limited to the lesser of (a) 100% of your Compensation or (b) the Applicable Amount. However, if your AGI exceeds certain limits (which depend on your income tax filing status), the Applicable Amount may be reduced to as low as zero. The following chart describes these AGI limits and associated reductions to the Applicable Amount.

Rollovers and Transfers to myRA

Rollovers and transfers to myRAs are not permitted, except in the event of (a) the death of a myRA owner whose Beneficiary has a myRA and (b) the divorce of a myRA owner whose former spouse has a myRA and will receive a portion of the myRA owner’s myRA in the divorce. In the event of either exception, only the amount of the myRA to be transferred to the recipient may be rolled over or transferred to the recipient’s myRA.


Terminating a myRA Account

You may request that your myRA be closed or to transfer your myRA to another institution at any time. If you transfer the assets in your myRA to another institution, those assets will help in a private-sector Roth IRA, which may have fees associated with it. Your myRA will be automatically closed by Comerica once it has been open for thirty (30) years or when the balance reaches $15,000, whichever happens first. Prior to closing your myRA, Comerica will contact you so that you can provide Comerica with written instructions to transfer all the assets of your myRA to the trustee or Custodian of another Roth IRA. You agree that, if after Comerica’s reasonable efforts to contact you, you cannot be reached, Comerica will act as your attorney-in-fact to establish a Roth IRA for you at a financial services provider selected through a process established by the U.S. Treasury.


MyRA Account to Roth IRA Account

Except as the U.S. Treasury may otherwise determine, your Roth IRA will be opened at Comerica. You agree that Comerica may transfer to that financial services provider the balance held in your myRA and all of your financial records relating to the myRA, including personal and identifying information sufficient for the financial services provider to comply with customer identification requirements to open a Roth IRA for you. In order for a financial services provider to open a Roth IRA for a customer, IRS rules require that you enter 9 into a trust or custodial agreement with the financial services provider.


Saver’s Tax Credit and MyRA

If you have contributed to your myRA and have an AGI below a certain level, you may be eligible for the saver’s tax credit under Code Section 25B for that year’s contribution. In 2015, to be eligible, you AGI must be below: (a) $61,000 for married couples filing jointly; (b) $45,700 for heads of household; and (c) $30,500 for single or married Individuals who are filing separately. Changes in these amounts may occur annually to reflect cost of living adjustments.

Who is eligible for the Saver’s Credit and myRA?

Those eligible for the saver’s tax credit may take the tax credit by filing Form 8880 with their income tax returns. The following chart shows the amount of the saver’s tax credit for different kinds of filers for 2015. Amount of Saver’s tax credit AGI of Individual Married filing jointly Head of Household Single and Others 50% of first $2,000 deferred $0 – $36,500 $0 – $27,325 $0 – $18,250 20% of first $2,000 deferred $36,501 – $39,500 $27,326 – $29,625 $18,251 – $19,750 10% of first $2,000 deferred $39,501 – $61,000 $29,626 – $45,750 $19751 – $30,500 6


Split-dollar life insurance arrangements

Split-dollar life insurance has become a common executive benefit. Beginning in 2001, in a series of notices and regs, IRS significantly changed its position on how split-dollar life insurance should be taxed. The tax advantages of so-called “equity” arrangements have been significantly curtailed. The impact of these rules is less significant if you have a non-equity arrangement-i.e., all you get under the arrangement is term life insurance coverage, including paid-up additions.

What are split-dollar life insurance arrangements?

The final regs, which are effective for split-dollar arrangements entered into or “materially modified” after September 17, 2003, provide two mutually exclusive regimes for taxing these arrangements: the economic benefit regime and the loan regime. Under the economic benefit regime, the premium-paying owner of the life insurance contract is treated as providing economic benefits to the non-owner with an interest in the contract. Under the loan regime, the premium-paying non-owner of the life insurance contract is treated as loaning premium payments to the owner.


Split-dollar life insurance arrangements

More favorable rules govern split-dollar arrangements entered into before, and not materially modified on or after, September 18, 2003. If you have a pre-September 18, 2003 arrangement, it is very important that you avoid inadvertently subjecting the arrangement to the final regs by materially modifying it. The final regs do not define what a “material modification” is; they simply provide a list of some examples of non-material modifications.

If you have a pre-September 18, 2003 arrangement, then IRS will not impose additional taxes if you continue to treat and report the value of the life insurance protection provided to you as an economic benefit included in your income, and you do not access the cash value of the policy. And if you have an equity arrangement that was entered into before January 28, 2002, then you will not be taxed on the net equity increases in the policy upon termination of the arrangement, provided you treat the arrangement as a series of loans from your employer to you. However, there’s a potential problem in relying on this safe harbor if your employer is a public corporation.


Sarbanes-Oxley Act and Split-dollar life insurance arrangements

The Sarbanes-Oxley Act of 2002 bans public corporations from making most kinds of loans to their executive officers and directors. It is unclear whether this Act applies to public corporations making premium payments under split-dollar arrangements. IRS says, in the introduction to the final regs, that the answer to this question is up to the Securities and Exchange Commission (SEC). A further complication arises because some split-dollar arrangements may be subject to the Code Sec. 409A rules, under which deferred compensation is included in current income unless the plan meets detailed requirements. Code Sec. 409A may apply to policies structured under the endorsement method, in which the employer owns the policy but the employee can name the beneficiary. If the employer irrevocably promises to pay premiums in future years, the arrangement may be considered a nonqualified deferred compensation plan. Amending the plan to comply with Code Sec. 409A may present its own problems, because this may be a “material modification” that will make the split-dollar arrangement subject to the less favorable post-September 17, 2003, split-dollar regs discussed above.

Buying and selling mutual fund shares tax consequences

Mutual funds can end up being tax inefficient investments for many reasons. Investors may be making taxable transactions when they do not know it.


Writing check against mutual fund investments.

One way this could happen is if your mutual fund allows you to write checks against your investment in the fund. Every time you write a check against your mutual fund account, you have made a partial sale of your interest in the fund. Thus, except for funds for which share value remains constant, you may have taxable gain (or a deductible loss) whenever you write a check. Moreover, each such sale is a separate transaction that you have to report on your income tax return.


Changing mutual fund allocation

Here’s another way you can unexpectedly make a taxable sale. If your mutual fund sponsor allows you to make changes in the way your money is invested-for instance, lets you switch part of your investment from one fund to another fund-making that switch is treated as a taxable sale of your shares in the first fund.


Mutual Fund Recordkeeping

Recordkeeping is important. Be very careful about saving all the statements that the fund sends you-not only official tax statements, such as Forms 1099-DIV (or the fund’s version of the 1099-DIV), but the confirmations that the fund sends you when you buy or sell shares, or when your dividends are reinvested in new shares in the fund. Unless you keep these records, it may be difficult for you to prove how much you paid for the shares, and thus, you won’t be able to establish the amount of gain that is subject to tax (or the amount of loss you can deduct) when you sell them.

Tracking Basis in Mutual Funds

You will also need to keep these records to prove how long you’ve held your shares, e.g., more than 12 months if you want to take advantage of favorable long-term capital gain tax rates. (If you get a year-end statement that lists all your transactions for the year, then you can just keep that and discard quarterly or other interim statements or confirmations. But save anything that specifically says it contains tax information.)


Keeping Track of Mutual Fund Cost Basis

For mutual fund shares acquired after 2011, recordkeeping is simplified by new rules that require funds to report the customer’s basis in shares sold and whether any gain or loss is short-term or long-term. Time your purchases and sales. If you’re planning to invest in a mutual fund, there are some important tax consequences that you should take into account in timing the investment. For instance, an investment shortly before payment of a dividend is something you should generally try to avoid.


Receiving and Reinvesting Mutual Fund Dividend

Your receipt of the dividend (even if reinvested in additional shares) will be treated as income and increase your tax liability. If you’re planning a sale of any of your mutual fund shares near year-end, you should weigh the tax and the non-tax consequences of a sale in the current year versus a sale in the next year. Identify the shares you sell. Where you sell fewer than all of the shares that you hold in the same mutual fund, there are complicated rules for identifying which shares you have sold. The proper application of these rules can reduce the amount of your taxable gain or qualify the gain for favorable long-term capital gain treatment.


“Tax-managed” mutual funds

There is a relatively new breed of fund, so-called “tax-managed” mutual funds, whose managers are required to employ a series of strategies designed to keep the investors’ tax consequences to a minimum. Most of the large, well-known mutual fund organizations have established tax-managed funds. The techniques employed by these funds are also used by many sophisticated investors in managing their own personal portfolios.


What are Tax Managed Mutual Funds?

• Taking a long-term view of investing, or, in other words, trying to avoid short-term capital gains that would be taxed to the investor at his regular tax rate.
• Reducing investment income by investing in lower-yielding equity securities that are expected to show capital appreciation.
• When selling a portion of a holding, minimizing the gain by selling those shares with the highest cost basis first.
• Selling securities that have gone down in value to generate capital losses that can be offset against realized capital gains.


Index Funds (ETFs) versus Mutual Funds Tax

In addition to tax-managed funds, you might want to also consider index funds. These are funds which invest in the stocks making up a particular market index, for example, the Standard & Poor’s index of 500 large companies. Because these funds stay invested only in the stocks making up the particular index, there are relatively few sales of stock from the portfolio and hence only a small amount of capital gain. (Sales are generally made only when there are changes in the component stocks in the index or to generate cash to satisfy redemption requests from fund shareholders.)

Accruing Interest on U.S. Savings Bonds

Series E and EE U.S. savings bonds are zero coupon investments issued at a discount. The interest is paid at maturity when the coupons are redeemed for their full face value. For each year prior to maturity, the bond’s redemption value increases. This annual increase in value represents the interest accrual for each year. Series E bonds were last issued in 1979. Since then, U.S. savings bonds have been designated as Series EE.


Series H and HH U.S. savings bonds

Series H and HH U.S. savings bonds were issued at face value and pay interest in cash twice a year (taxable on receipt by cash-basis taxpayers). Series H bonds were issued until 1979. Since then, these coupon payment bonds have been designated as Series HH. HH bonds were no longer offered to the public starting September 1, 2004. Series HH bonds were acquired only by exchanging Series E or EE bonds. Exchanging a Series E or EE bond for a Series HH bond did not cause a cash-basis taxpayer to recognize the deferred interest income associated with the Series E or EE bond. Instead, that income is recognized when the Series HH bond matures, which can be up to 20 years later. This exception to income recognition does not apply, however, to corporations or to taxpayers who have elected to accrue the income on the Series E or EE bond.


Series I U.S. savings bonds

Series I U.S. savings bonds combine the features of deferring taxes on the interest until maturity with inflation protected growth. Series I bonds are 30-year instruments. They were first issued in September 1998 and contain a fixed interest rate and an inflation-adjusted rate. The bonds are issued at face value. Interest is added to the bond monthly, compounded semi-annually, and paid when the bond is redeemed. Series EE bonds cannot be exchanged for Series I bonds.

The government has extended the maturity date for some Series EE bonds. Interest continues to accrue on these bonds past the original maturity date. This post-maturity date interest is reported using the same method as applied before maturity.


Election to convert to the accrual method for Series EE and I U.S. savings bond interest

The election to convert to the accrual method for Series EE and I U.S. savings bond interest should be considered when it is likely that the income will be taxed at a higher rate in the year the bond matures or is redeemed. For example, a child (or other low-income taxpayer) who elects to accrue the income will likely be subject to little or no tax each year, while bunching all the income into the year of maturity could push that taxpayer into a higher tax bracket or, if a child, cause a portion of the income to be subject to the parent’s tax rate under the kiddie tax rules.


Accrue Income on Government Bonds

Likewise, it may make sense to elect to accrue the income on the return of a deceased taxpayer if the tax rate on that taxpayer’s final return will be lower than that of the estate or beneficiaries. The election could also be useful for taxpayers with otherwise unusable deductions, such as NOL carryforwards or investment interest expense limited to net investment income.

How stock traders can prepare their tax returns

Although a trader’s security gains and losses are excluded from SE earnings, there is no guidance as to how the trading expenses reported on Schedule C impact SE earnings. Presumably, a trader who has SE earnings from other sources can reduce those earnings by the SE loss generated from the trading expenses.


Trader Tax Returns

Because of the unique tax rules that apply to securities traders, properly reporting trading information on Form 1040 can be a challenge. Practitioners should consider the following reporting issues and recommended solutions:


Stock Trader Schedule C Loss

Traders who do not make a Section 475 election report no income and only expenses on Schedule C, resulting in a loss on that form. This reporting may get the IRS’s attention since Schedule C losses sometimes stem from disallowable hobby losses. To help avoid IRS questions regarding this reporting, a footnote or statement explaining the taxpayer’s trader status and the filing implications should be attached to the return.


Stock Trader Reconciling to Forms 1099-B

Because traders report their security sales on Form 8949, the amounts reported to them on brokers’ Forms 1099-B will normally agree with the reported gross proceeds. However, traders who make the Section 475 election treat their trading gains and losses as ordinary income reported on Form 4797 (Part II). The Form 4797 instructions state that these traders should enter the total gross proceeds from Forms 1099-B on line 1 of Form 4797. To help avoid IRS matching notices for gross proceeds shown on Form 1099-B and ultimately reported on Form 4797, taxpayers should also report the gross proceeds for these transactions on Form 8949 and enter the appropriate code (see the Form 8949 instructions) in column (f) and the appropriate dollar amount in column (g) to reconcile any Forms 1099-B and 8949 differences.


Stock Trader Detailing Trading Activity

In many cases, the taxpayer will have detailed records reporting each trade that can be attached to the return to support the amounts shown on Form 8949. The Form 8949 instructions indicate that, instead of reporting each stock transaction on a separate line, taxpayers can report them on an attached statement containing all the same information as Form 8949 and in a similar format. They can use as many attached statements as they need.

IRS Form 8949

The combined totals from all the attached statements are entered on a Form 8949 with the appropriate box checked. The Form 4797 instructions state that traders who make the Section 475 mark-to-market election should attach a statement to the return detailing each trading transaction and carry the totals to line 10 of Form 4797.

Taxation of traders and how do day traders pay tax

Unlike investors, securities traders are deemed to be conducting a trade or business, so their trading expenses are deductible as ordinary and necessary business expenses under IRC Sec.î 162. Thus, the difference brings along many differences of how a day trader will pay tax on their trading gains and be able to deduct trading losses.


What are a trader’s business expenses?

A trader’s business expenses include interest paid on margin accounts used in connection with the trading activity. This is much different than ordinary investors.  However, if the taxpayer does not materially participate in the trading activity (e.g., a limited partner in a trader partnership), interest incurred in the activity is subject to the investment interest expense limitation. In addition, a trader’s business status makes him or her eligible for claiming a home office deduction, provided that the other home office deduction criteria are met. Individuals report their trading expenses (including interest on margin accounts) on Schedule C of their annual tax returns.


Special Assets Held by Day Traders

Traders may acquire assets that qualify for Section 179 expensing. Traders will generally show a loss on their Schedule C (since the gains from trading are reported on either Form 8949 and Schedule D, or if a mark-to-market election is made, on Form 4797). Although the annual Section 179 deduction is limited to taxable income from a trade or business, practitioners should not confuse taxable income with income shown on Schedule C.


What are Day Trading Gains?

The authors believe that the trading gains and losses are included in taxable income for the Section 179 limitation. Reg.î1.179-2(c) defines taxable income as the aggregate net income (or loss) from all of the trades or businesses actively conducted by the individual. Furthermore, business income for this purpose includes Section 1231 gains (or losses) from the trade or business and interest from working capital of the trade or business. Thus, income clearly can include items other than those reported on Schedule C.


What happens when a trade disposes of stock?

When a trader disposes of a stock, the general rule is that the sale is treated as a short-term or long-term capital gain or loss, depending on how long the stock was held. This capital asset treatment occurs because traders do not have customers to whom they sell stock; therefore, their stock does not meet any of the exceptions to capital asset treatment under IRC Sec. 1221. Thus, traders generally report their stock gains and losses as capital gains and losses on Form 8949 and Schedule D and, accordingly, are subject to the $3,000 annual limitation that applies to net capital losses under IRC Sec. 1211(b) and the wash sale rules. The Section 1091 wash sale rules can be particularly detrimental to traders because they defer the recognition of a stock loss when the taxpayer acquires the same stock within a period beginning 30 days before and ending 30 days after the date of sale.


Benefits of Mark-to-market Election for Day Traders

As an alternative to capital asset treatment, IRC Sec. 475(f) allows traders to elect to mark their stock holdings to market at the end of the tax year. If the election is made, all security gains and losses are treated as ordinary income and all securities on hand at year-end are deemed to be sold at the year-end market value, thus recognizing unrealized gains and losses. For traders, the primary benefit of making the election is that the $3,000 limitation on net capital losses and the wash sale rules no longer apply. Conversely, the trader is no longer allowed to treat trading activity gains and losses as capital asset transactions, but this should have minimal negative impact since traders by definition should have few, if any, long-term capital gains.


Using Mark-to-market Election for Day Traders

Because capital gains and losses are specifically excluded from the definition of net earnings from self-employment (SE), earnings from a trading activity are not subject to the SE tax. A Sectionî 475 mark-to-market election converting the gains and losses to ordinary income does not change their status for SE tax purposes. However, since a trader’s net earnings are not SE income, he cannot contribute to a retirement plan (e.g., SEP or IRA) based on such income.

IRS Taxation of Nonqualified Stock Options (NQSOs)

What are Nonqualified Stock Options (NQSOs)?

A Nonqualified Stock Option “NQSO” is any option that is not a qualified stock option. Unlike Incentive Stock Options (ISO) holders who meet the required holding period, the recipient of an NQSO is not allowed either to defer income recognition on the bargain element until the stock is sold or to have all the income associated with the option treated as capital gain. This basically means that they must pay taxes on the amount the is realized.


How are Nonqualified Stock Options (NQSOs) taxed?

Generally, the excess of the stock’s FMV when the option is exercised over the option price is taxable as compensation in the year of exercise. However, if the FMV of the option is readily ascertainable when the option is granted, income will be recognized then rather than when the option is exercised. From an employee’s perspective, this may be the most advantageous time for income recognition if the stock value increases significantly after the option is granted.

Taxation of Option Transfers

Unfortunately, if the option is not traded, it can be difficult to determine whether the option has a readily ascertainable FMV. An option does not have a readily ascertainable FMV unless the following conditions are met:


Taxing NQSOs

1. The option may be transferred freely.

2. The option is exercisable immediately in full.

3. There are no restrictions on the option or stock that have a significant effect on the FMV of either.

4. The FMV of the option privilege can be determined by the value of the property subject to the option, the probability of an increase or decrease in value, and the length of the option period.

The burden is on the taxpayer to prove that an option has a readily ascertainable value. Most NQSOs do not have a readily ascertainable value, and are therefore not taxed at the grant date.


Other Notes About the Exercise of Nonqualified Stock Options (NQSOs)

It is not unusual for an employer that has issued NQSOs to be acquired or merged into another entity. Rev. Rul. 2003-98 provides guidance on the tax consequences of the exercise or disposition of NQSOs after certain corporate transactions.


Transferring Nonqualified Stock Options (NQSOs)

The option may pertain to stock that is nontransferable or subject to a substantial risk of forfeiture (i.e., restricted stock). Here, compensation income generally is not recognized until the restrictions lapse, and it is based on the difference between the FMV of the stock when the restrictions lapse less the exercise price. This can be detrimental to the employee if the stock appreciates after the option is exercised and before the restrictions are lifted. Accordingly, if the stock is expected to appreciate, the employee might want to elect under IRC Sec. 83(b) to recognize the income when the option is exercised rather than when the restrictions lapse based on the appreciated value.


Setting up a 401k Retirement Plan as a Small Business

What is a 401k Plan?

All right, let’s talk about 401(k) plans. I believe that everybody has probably heard of a 401(k) plan. Basically, the way that it works is everybody has a deferral option. And that option is you can keep your cash now as you earn it, or you can defer it into the plan. So, basically, you pay taxes on the money now by keeping it, or you defer taxation to when you actually withdraw monies from the trust. For example, you could put $5,000.00 into the plan in 2015, don’t pay any taxes on it, and you don’t pay until you withdraw the money in 20 or 30 years. Now the employer can also contribute to a 401(k) plan.


How much can you contribute to 401k Plan?

You can put in a match. You can put in a fixed contribution. He can put in a discretionary contribution, like something like a profit- sharing plan that would be determined on a year-by-year basis. 401(k) plans are flexible, and you can change the features in the plan to suit your needs. For example, 401(k) plans can provide for loans, they can provide for hardship distributions, and you can have best used vesting schedules. For example, on the profit-sharing contribution, you could have a six-year graded vesting schedule on it.


Eligibility for 401k Plans

As for eligibility to be in a 401(k) plan, the most stringent you can be is age 21 or you worked 1,000 hours of service in any prior year. Now, of course, you can have the eligibility requirements be, you know, you’re eligible to be in the plan as of your date of hire if you would like. And the plan document, though, is going to dictate who is eligible to be in the plan. So, whatever the plan document says, that is what you have to go by. And any size of employer can offer a 401(k) plan. We see them going all the way down from one person all the way up to millions of people.


Three Different Types of 401k Plan

You have the traditional type of 401(k), which has the most responsibility, and there’s lots of testing involved in it. Something we’ve been seeing a lot now in the last ten years and really picking up is safe harbor 401(k) plans. These are nice because they help you to avoid testing. As long as the employer provides a minimum contribution to the rank and file employees, highly compensated employees can defer large amounts. And there’s also something else that we’ve been seeing more and more of lately. It’s called automatic enrollment, and we’ll explain what this is. And this can help the employer to pass or avoid testing altogether. Now when it comes to 401(k) plans, there is no IRS model form, like you just can’t go to the website and download a 401(k) plan. But, there are a lot of retirement plan providers out there that offer plan documents, and these plan documents are approved by the IRS.


Traditional 401k Plans

Okay, so let’s talk a little bit about traditional 401(k) plans. This is going to be one of your most flexible types of plans, and it can allow for very high levels of contributions. For example, in 2015, an employee could defer a salary up to $18,000.00 into a 401(k) plan. If the employee was age 50, he or she could defer an additional $6,000.00 into it, so that’s a lot of money. Now the employer contributions into a 401(k) plan: they can be fixed or they can be discretionary every year. Okay, traditionally the employer is going to offer some kind of a match to go with the plan, and the match, for example, might be like 25 cents on the dollar, up to four percent of pay. But, like whatever kind of a match the employer would offer, that match would have to be stated in the plan and the employer does have to follow the terms of the plan. Employer contributions are not necessarily mandatory in a 401(k) plan. Like if the employer wants to write up the plan documents so that they don’t have to provide a match, then they could do that if they wanted to.


Employer Contributions to 401k Plan

Now the total employee and employer contributions are going to be limited to the lesser of 100% of compensation or $53,000.00. And that $53,000.00 would be between deferrals, matching contributions, and any profit- sharing contributions as well. The employer contributions can be deducted up to 25% of the combined compensation for all the plan participants.


Annual Testing of 401k Plans – ADP and ACP Test

Okay, now there is annual testing for 401(k) plans that we talked about before. You have nondiscrimination tests. They are the ADP test and the ACP test. The ADP stands for Actual Deferral Percentage, and basically all that that is is you’re taking the amount that the individual is deferring each year and you’re dividing it by their compensation. Okay, and you do it for groups. You do it for the entire group of the rank and file employees, and you do it for the entire group of the highly-compensated employees. And the rank and file and the highly-compensated employees are computed separately, and if the highly compensated defer too much, they actually have to return some deferrals at the end of the year.


Highly-compensated employees and 401k Plans

And the ability of the highly-compensated employees to defer is going to be closely tied to how much the rank and file employees defer. And then you have the Actual Contribution Percentage test, ACP, which works the same way as the ADP test. You take the matching contribution provided, divide it by the compensation, it gives you a percentage. It works the same way as the ADP. And it’s like I said before. These tests can limit the amount the highly-compensated employees can defer, and often very significantly. Like you might see a situation where somebody initially deferred like $18,000.00 and come the end of the year they might have to return $15,000.00 of it. And the Form 5500 is going to be required for most 401(k) plans


Safe Harbor 401k Plans

Another type of 401(k) plan is the Safe Harbor 401(k). These plans are a good choice if you’re looking for the benefits of a 401(k), but you don’t want the burden of annual nondiscrimination testing. This plan is like a traditional 401(k), but it does require you to contribute. You can choose either a matching contribution or a fixed percentage of pay. The minimum matching contribution is a full match of the employee’s first three percent of salary deferrals and then 50 cents on the dollar for the next two percent of deferrals for a total match of four percent of pay. The fixed contribution is three percent of compensation for each employee even if they choose not to make any salary deferrals. So, these are the minimum contributions required for a safe harbor. The plan can always be more generous than this. Safe harbor contributions and all employee contributions are immediately 100% owned or vested by the employee. So with these types of plans, you can’t use a gradual vesting schedule like you can in other plans, like a traditional 401(k). Also, before each year, you must provide employees a notice, and you have to explain the essential plan features and how to enroll.


What is a 401k Safe Harbor?

Safe harbor 401(k)s, again, don’t require nondiscrimination testing. And this is significant for a couple of reasons. First, when you have the nondiscrimination testing, it does require time. Sometimes you pay a third party to perform the testing. So with a safe harbor, you would keep your administrative costs lower than a traditional 401(k). Secondly, higher paid employees, including the owner, can defer the maximum salary deferrals allowed under the law without being tied to the lower-paid employee deferral rate. And, like most 401(k)s, safe harbors must file an annual Form 5500.


Automatic enrollment 401(k) plans

Okay, now let’s talk about automatic enrollment 401(k) plans. Whether you have a safe harbor plan or not, it could be an automatic enrollment plan. These types of plans, even though they’ve been around for a while, they have been gaining in popularity recently. Remember that this is an optional feature in plans, it’s not a required feature. And the way that this works is that it will automatically enroll employees in the plan at a certain deferral percentage rate. Traditionally what has happened with 401(k) plans and the reason why it can be difficult to get people to start deferring to them, is an employer will hire an employee, and they’ll sit down with them, and they’ll give them a deferral election form. And they’ll say, we have a 401(k) plan, and what we’d like for you to do is complete this deferral election form and tell us how much you would like to defer into the plan every payroll. And what happens is the employee, for whatever reason, maybe they’re just apathetic, they just never return the form, okay, and so they end up not being in the plan. And then the years go on, and sometimes even entire careers go on, and the employee just never returns the form because they, largely, they’re just apathetic about it, and they largely just really don’t think they have the money. And so, you have situations where people are not saving for their retirement.


Automatic enrollment 401(k) plan

So the way you got an automatic enrollment 401(k) plan works, though, is that same employee would come to the employer, and the employer would say, we’d like for you to fill out this deferral election form, but, by the way, we have an automatic enrollment plan, so if you don’t return this deferral election form, we’re automatically going to put you in at three percent, for example. It could be a different amount. And that way, what it does is: if that same employee does not return that deferral election form where they can opt to defer zero, or they can opt to defer ten percent, but if they don’t return it at all, then they will start at a certain percentage of pay, and generally that’s going to be three percent. And, some plans will actually increase this percentage every year, so the next year it’s four percent, the next year it’s five percent. And, something like this can significantly increase plan participation. The theory behind these types of plans is that the employees really don’t notice that their pay is missing, they don’t really miss the money, and then they end up staying in the plan.

This increases participation in these plans. It’s a little bit sneaky, I think, but it’s kind of a good sneaky. And what this does is: it helps the plans to pass nondiscrimination testing and it helps a lot of employees save for their retirement where they otherwise may not have.


Automatic enrollment feature to avoid annual nondiscrimination testing

You can use an automatic enrollment feature to avoid annual nondiscrimination testing. To do this, your automatic enrollment feature has to start with a three percent employee deferral and automatically increase it every year so that the employees contribute at least six percent of their compensation by the fifth year. With this type of automatic enrollment, the company is required to contribute to avoid testing. The required contribution, again, is either a match or a fixed percentage of compensation for all participants. And if you choose the match, it must be a full match on the first one percent of deferrals plus a 50% match for the next five percent of deferrals. If you choose the fixed contribution, it will be three percent of compensation for all eligible employees.


401k Pros and Cons

Okay, so 401(k) pros and cons. The key advantages of traditional 401(k) plans are that employees can contribute more salary deferrals than in other retirement plans. Remember, in the SIMPLE IRA plan, employees make salary deferrals but they have lower maximum annual limits. Also, the types of employer contributions are flexible. You can contribute any combination of matching, fixed and discretionary contributions. But keep in mind, you have to follow what your plan document says. The 401(k) plan’s enrollment terms are flexible. For example, if you have a work force that’s seasonal, or if your workers are under age 21, the 401(k) may be an attractive option to simplify your plan administration. You’re permitted, under the law, to draft the plan so you don’t need to cover employees under 21 and those working less than 1,000 hours during a plan year.


401(k) plans also have flexible plan features

401(k) plans also have flexible plan features, so they can offer loans to participants, hardship distributions, and designated Roth accounts. So if you contrast that to the IRA-based plans like SEPs and SIMPLEs where you aren’t permitted to offer any of those features. The 401(k)s offering optional features is attractive to employees. They might appreciate a loan from the plan, or a hardship distribution, but they do add administrative work for you and your business. And also, for 401(k)s you need a service provider to set up the plan. There’s generally more recordkeeping, we mentioned the testing, and overall maintenance involved than some of the other plan types.


How to Start a Small Business Retirement Plan

Starting a retirement plan. If you want to start a retirement plan, there are a lot of different services that you may need. You may need a record-keeper. This is going to be somebody who keeps track of the participant accounts in the plan. They’re going to process and track enrollment contributions and distributions. And this record-keeper could be somebody who’s at the business or possibly you could go out and employ a specialist to do this. It could even be the person who provided the plan to you. You may need a consultant or an adviser. This is going to be somebody who is going to offer advice about choosing and designing your plan investments. You may need an administrator service provider. This is going to be somebody who provides plan documents, required notices and filings. Generally, they will use an IRS-approved plan that they will provide to you. They may also serve as a record-keeper or consultant for the plan.

Other services that you may want to consider. A third party administrator, we call them TPAs. These people specialize in retirement plans. They will take care of the recordkeeping for you, and they may or they may not provide the plan document for you. You’re going to have plan vendors. They may handle every single aspect of the plan for you. And this could be a mutual fund company. It could be a bank, a broker, or a third-party administrator specializing in retirement plans. You also may need the services of accountants or attorneys. So, you need to understand what your service agreement covers and you need to understand how the fees are earned. So, there are some questions that you would need to ask your service provider, and these are very important.


401k Plan Language

You would need to ask who is responsible for updating the plan document for any law changes. You know, as a Manager of Revenue agents who go out and audit these plans, this is quite easily the largest failure problem that we see. In fact, these plans are not being timely updated for all the law changes. So you definitely want to know who’s responsibility is this. You also want to know who will provide recordkeeping services for the plan, who will give any required plan notices to the participants, that’s important as well. Who is going to be required to file the annual report, the annual return, the Form 5500 with the Department of Labor? Or is it filed with the IRS, if it’s a Form 5500EZ. You want to determine whether any nondiscrimination testing will be required and who is going to conduct the testing. Like, for example, in a 401(k) plan, you might have to do the ADP and the ACP test.

You need this accurate information to track who’s eligible to be in the plan, and their compensation amounts. You need accurate amounts for limits testing and to calculate contributions. You’ll also need to track deferral amounts for testing. Make sure you’re withholding and depositing salary deferrals. Another ongoing job is completing the Form 5500 if it’s required. And then, we mentioned that you have to make sure that your plan document is current for retirement laws, so even after you set up your retirement plan, you may need to amend it for changes in the law. If you have a service provider and they mail you amendments to sign by a due date, make sure you read them, and sign them. Plan amendments are an important legal document.


Common Small Business Retirement Plan Problems

When your plan isn’t well run, some of the most common mistakes are: not including all employees who are eligible for the plan, not using the correct definition of compensation for calculating contributions, and not signing required plan amendments on time. So recognizing that mistakes happen, IRS has a program to get your plan back on track.

And the program is called the Employee Plans Compliance Resolution System, and it’s made up of these three parts. The first two programs, the Self Correction and Voluntary Correction programs, encourage you to find and fix your plan mistakes. The third program, Audit Closing Agreement Program, is when we find a mistake when we audit your plan. You can correct it and pay a negotiated percentage of the tax that would be due if the plan were disqualified. As part of that, you have to fully correct the plan mistake and pay a sanction. So, once you realize you have a mistake in your plan, which program is right for you? Well, self-correction is great because it allows you to correct an error without contacting the IRS and paying a fee. And, if your mistake is insignificant, you can use self-correction at any time. Some problems, though, like late amendments, don’t qualify for self-correction. But, you could still correct this using the voluntary correction program. And this is where you submit an application to the IRS, describe your proposed correction, how you’ll correct it, and you pay a fee. When the IRS approves, they’ll give you a compliance statement. And if the IRS later audits your plan, the auditor will treat the errors you corrected as if they didn’t occur


What is IRS Passive Income?

Two sources of income fall into the “passive” category. The first is income received from rental activities and the second is income originating from a business in which you have ownership but do not “materially” participate. Regardless of whether income is deemed to be passive or non-passive, it must always be reported somewhere on the return, most typically on Schedule E.  The Form 8582 is computational only, figuring the amount of passive loss deductible for the current year.  It not the form used to report income.


Passive Income IRS Definition

Passive income can only be generated by a passive activity.  Just because the taxpayer did not work for the income does not mean it is passive.  There are only two sources for passive income:

  1. A rental activity; or,
  2. A business in which the taxpayer does not materially participate.

Gain on a partial or entire disposition of a passive activity generally is passive income.


What is not Passive Income?

While the following may seem passive, generally none are passive income:

  • Portfolio income, including interest, dividends, royalties, annuities and gains on stocks and bonds;
  • Lottery winnings;
  • Salaries, wages, Form 1099-Misc. commissions and retirement income;
  • Guaranteed payments for services; and,
  • Income from any activity in which the taxpayer materially participates.


Reporting Passive Income on Tax Return

Certain types of income are treated (“recharacterized”) as non-passive.  If a taxpayer rents a property to a business in which he materially participates, net rental income is non-passive and should not be on Form 8582 line 1a as passive income.  See Reg. § 1.469-2(f)(6) and self-rented property checksheet at the end of the chapter.  Net rental losses, however, generally remain passive.


IRS Final Regulations on Employee Stock Options

The IRS has finalized, with modifications, proposed regulations providing guidance on stock options granted under an employee stock purchase plan. The IRS has also issued final regulations relating to corporate employers’ return and notification requirements for employee stock options.


ISO Final Regulations

Under final regulations, an ISO plan must meet certain requirements to qualify as an employee stock purchase plan. These requirements are satisfied either by the terms of the plan or an offering made under the plan. If the terms of an option are inconsistent with the terms of the employee stock purchase plan or an offering under the plan, then an option may not qualify for special tax treatment.

The regulations provide guidance for employee stock purchase plans under which more than one offering is made. One or more offerings may be made under the plan and the offerings may be consecutive or overlapping. Although the terms of each offering need not be identical, the terms of the plan and each offering together must satisfy the requirements. The determination whether the terms of a plan and offering satisfy the requirements related to covered and excluded employees is made on an offering-by-offering basis under the final rules.


Proposed ISO Regulations

Consistent with the proposed regulations, the final regulations also provide that the date of grant is the first day of an offering period if the terms of an employee stock purchase plan or offering designate a maximum number of shares that may be purchased by each employee during the offering. However, if the maximum number of shares that can be purchased under an option is not fixed or determinable until the date the option is exercised, then the date of exercise is the date of grant of the option.

Final regulations have also been released regarding the corporate employers’ return and notification requirements relating to employee stock options. Corporate employers are required to provide information returns to the IRS and an employee where the transfer of stock is made through the exercise of an option through an employee stock purchase plan or an incentive stock option program.


IRS Final Regulations on Employee Stock Options

One of the changes from the proposed regulations relates to when a transfer of legal title to stock occurs. Under the final regulations, the transfer of stock to the employee’s third-party brokerage account upon exercise of an option is treated as the first transfer of legal title, necessitating the corporate filing of the information return. Alternatively, if the employer issues a stock certificate directly to an employee or registers the employee’s name in the employer’s record books and employer holds the certificate in book-entry form, the first transfer of legal title does not occur until the employee sells the stock or transfers the stock to a brokerage account.

Other changes relate to the amount of compensation income recognized where the exercise price is less that the value of the share on the date of the option grant, the return requirements where the transfer of legal title is a qualifying or disqualifying disposition, and the application of the filing requirements to nonresident aliens performing services outside the Untied States.