Pension Provisions in the 1996 Tax Acts
Turville, Mary A., The National Public Accountant
Congress passed two tax bills in 1996 with significant changes in pension tax law that will greatly effect individuals and small businesses. The Small Business Job Protection Act of 1996 (H.R. 3448) introduces a new retirement plan and changes some rules relating to qualified plans. The Health Insurance Portability and Accountability Act (H.R. 3103) makes some changes in the penalty provisions for IRA withdrawals. Both bills offer changes that increase access to pensions for most individuals employed in small businesses which until now were discouraged from offering these benefits because of complicated compliance rules.
Information provided in this article summarizes the basic provisions in the tax bills in order for practitioners to help their clients with tax planning for 1997, when most of the new laws will take effect. More detailed explanations will be available as the Internal Revenue Service publishes Tax Regulations and Revenue Procedures, interpreting the new laws.
Changes in Pension Participation Rules
Beginning January 1, 1997, a new simplified retirement plan will be available for small businesses called the Savings Incentive Match Plan for Employees (SIMPLE). SIMPLE plans allow eligible employers to create retirement plan opportunities for employees without the complicated requirements and reporting procedures of qualified plans.
SIMPLE plans may be adopted by employers who have 100 or fewer employees and do not offer any other employer-sponsored retirement plan. Employees who have received at least $5,000 in compensation in any two prior years and the current year are eligible to participate. Self-employed individuals are also allowed to set up a SIMPLE. The new retirement arrangements may be established as SIMPLE accounts - which are similar to IRAs - for each eligible employee, or as a qualified SIMPLE plan, which is similar to a cash deferred 401(k) arrangement. Both types of SIMPLEs are subject to the same participation, vesting, contribution and distribution rules.
Contributions to SIMPLE plans will consist of two components. Employees can elect to make contributions up to a certain percentage of wages to the plan, and the employer will also make a contribution, under either a matching formula or a "non-elective" formula. Employee elective contributions to the SIMPLE will be based on a percentage of compensation not to exceed a maximum annual contribution amount of $6,000. If the contributions are made to the employee's account under a salary reduction arrangement, they are excludable from the employee's income. Employers must deposit employees' elective deferrals to their individual accounts within 30 days after the end of the month to which the contributions relate.
The employer can choose one of two options to make the employer contributions: (1) make an employer-elective contribution by matching employee-elective contributions dollar for dollar up to 3% of compensation (up to a $6,000 maximum contribution), or (2) in lieu of making matching contributions, make a nonelective contribution of 2% of compensation (up to a $3,000 maximum contribution) for each eligible employee. Under a special rule, the employer may elect a reduced matching contribution of as little as 1% of compensation in no more than two out of five years. This special rule is available only to SIMPLE accounts and not to the SIMPLE 401(k) plan. The employer contributions for the year must be made by the date for filing the tax return plus extensions, if extensions are filed.
Elective employer contributions are included in the total amount of elective deferrals allowed to each employee that can be excluded from income, subject to an annual limit of $9,500 (for 1996). Employer contributions are not wages subject to withholding and employment (FICA and FUTA) taxes. Employee-elective contributions under a salary reduction arrangement are subject to FICA and FUTA. …