Why do partners sometimes report more income on tax returns than they receive in cash?
If you’re a partner in a business, you may have come across a
situation that gave you pause. In a given year, you may be taxed on more
partnership income than was distributed to you from the partnership in which
you’re a partner.
Why is this? The answer lies in the way partnerships and
partners are taxed. Unlike regular corporations, partnerships aren’t subject to
income tax. Instead, each partner is taxed on the partnership’s earnings —
whether or not they’re distributed. Similarly, if a partnership has a loss, the
loss is passed through to the partners. (However, various rules may prevent a
partner from currently using his share of a partnership’s loss to offset other
income.)
Separate entity
While a partnership isn’t subject to income tax, it’s treated as
a separate entity for purposes of determining its income, gains, losses,
deductions and credits. This makes it possible to pass through to partners
their share of these items.
A partnership must file an information return, which is IRS Form
1065. On Schedule K of Form 1065, the partnership separately identifies
income, deductions, credits and other items. This is so that each partner can
properly treat items that are subject to limits or other rules that could
affect their correct treatment at the partner’s level. Examples of such items
include capital gains and losses, interest expense on investment debts and
charitable contributions. Each partner gets a Schedule K-1 showing his or her
share of partnership items.
Basis and distribution rules ensure that partners aren’t taxed
twice. A partner’s initial basis in his partnership interest (the determination
of which varies depending on how the interest was acquired) is increased by his
share of partnership taxable income. When that income is paid out to partners
in cash, they aren’t taxed on the cash if they have sufficient basis. Instead,
partners just reduce their basis by the amount of the distribution. If a cash
distribution exceeds a partner’s basis, then the excess is taxed to the partner
as a gain, which often is a capital gain.
Here’s an example
Two individuals each contribute $10,000 to form a partnership.
The partnership has $80,000 of taxable income in the first year, during which
it makes no cash distributions to the two partners. Each of them reports
$40,000 of taxable income from the partnership as shown on their K-1s. Each has
a starting basis of $10,000, which is increased by $40,000 to $50,000. In the
second year, the partnership breaks even (has zero taxable income) and
distributes $40,000 to each of the two partners. The cash distributed to them
is received tax-free. Each of them, however, must reduce the basis in his
partnership interest from $50,000 to $10,000.
Other rules and limitations
The example and details above are an overview and, therefore,
don’t cover all the rules. For example, many other events require basis
adjustments and there are a host of special rules covering noncash
distributions, distributions of securities, liquidating distributions and other
matters.
© 2020
If you’re selling your home, don’t forget about taxes
Traditionally, spring and summer are popular times for selling a
home. Unfortunately, the COVID-19 crisis has resulted in a slowdown in sales.
The National Association of Realtors (NAR) reports that existing home sales in
April decreased year-over-year, 17.2% from a year ago. One bit of good news is
that home prices are up. The median existing-home price in April was $286,800,
up 7.4% from April 2019, according to the NAR.
If you’re planning to sell your home this year, it’s a good time
to review the tax considerations.
Some gain is excluded
If you’re selling your principal
residence, and you meet certain requirements, you can exclude up to
$250,000 ($500,000 for joint filers) of gain. Gain that qualifies for the
exclusion is also excluded from the 3.8% net investment income tax.
To be eligible for the exclusion, you must meet these tests:
- The ownership test. You must have owned the property for at least two years
during the five-year period ending on the sale date. - The use test. You
must have used the property as a principal residence for at least two
years during the same five-year period. (Periods of ownership and use
don’t need to overlap.)
In addition, you can’t use the exclusion more than once every
two years.
Larger gains
What if you have more than $250,000/$500,000 of profit when
selling your home? Any gain that doesn’t qualify for the exclusion generally
will be taxed at your long-term capital gains rate, provided you owned the home
for at least a year. If you didn’t, the gain will be considered short term and
subject to your ordinary-income rate, which could be more than double your
long-term rate.
Here are two other tax considerations when selling a home:
- Keep track of your basis. To support an accurate tax basis, be sure to maintain
complete records, including information on your original cost and
subsequent improvements, reduced by any casualty losses and depreciation
claimed based on business use. - Be aware that you can’t deduct a loss. If you sell your principal residence at a loss, it
generally isn’t deductible. But if a portion of your home is rented out or
used exclusively for your business, the loss attributable to that part may
be deductible.
If you’re selling a second
home (for example, a beach house), it won’t be eligible for the gain exclusion.
But if it qualifies as a rental property, it can be considered a business
asset, and you may be able to defer tax on any gains through an installment
sale or a Section 1031 like-kind exchange. In addition, you may be able to
deduct a loss.
For many people, their homes are their most valuable asset. So
before selling yours, make sure you understand the tax implications. We can
help you plan ahead to minimize taxes and answer any questions you have about
your home sale.
© 2020
Seniors: Can you deduct Medicare premiums?
If you’re age 65 and older, and you have basic Medicare
insurance, you may need to pay additional premiums to get the level of coverage
you want. The premiums can be costly, especially if you’re married and both you
and your spouse are paying them. But there may be a silver lining: You may
qualify for a tax break for paying the premiums.
Tax deductions for Medicare premiums
You can combine premiums for Medicare health insurance with
other qualifying health care expenses for purposes of claiming an itemized
deduction for medical expenses on your tax return. This includes amounts for
“Medigap” insurance and Medicare Advantage plans. Some people buy Medigap
policies because Medicare Parts A and B don’t cover all their health care
expenses. Coverage gaps include co-payments, co-insurance, deductibles and
other costs. Medigap is private supplemental insurance that’s intended to cover
some or all gaps.
Many people no longer itemize
Qualifying for a medical expense deduction may be difficult for
a couple of reasons. For 2020 (and 2019), you can deduct medical expenses only
if you itemize deductions and only to the extent that total qualifying expenses
exceeded 7.5% of AGI.
The Tax Cuts and Jobs Act nearly doubled the standard deduction
amounts for 2018 through 2025. As a result, fewer individuals are claiming
itemized deductions. For 2020, the standard deduction amounts are $12,400 for
single filers, $24,800 for married couples filing jointly and $18,650 for heads
of household. (For 2019, these amounts were $12,200, $24,400 and $18,350,
respectively.)
However, if you have significant medical expenses, including
Medicare health insurance premiums, you may itemize and collect some tax
savings.
Note: Self-employed people and shareholder-employees of S
corporations can generally claim an above-the-line
deduction for their health insurance premiums, including Medicare premiums. So,
they don’t need to itemize to get the tax savings from their premiums.
Medical expense deduction basics
In addition to Medicare premiums, you can deduct various medical
expenses, including those for dental treatment, ambulance services, dentures,
eyeglasses and contacts, hospital services, lab tests, qualified long-term care
services, prescription medicines and others.
There are also many items that Medicare doesn’t cover that can
be written off for tax purposes, if you qualify. In addition, you can deduct
transportation expenses to get to medical appointments. If you go by car, you
can deduct a flat 17-cents-per-mile rate for 2020 (down from 20 cents for
2019), or you can keep track of your actual out-of-pocket expenses for gas, oil
and repairs.
We can help
Contact us if you have additional questions about Medicare
coverage options or claiming medical expense deductions on your personal tax
return. We can help determine the optimal overall tax-planning strategy based
on your situation.
© 2020
A nonworking spouse can still have an IRA
It’s often difficult for married couples to save as much as they
need for retirement when one spouse doesn’t work outside the home — perhaps so
that spouse can take care of children or elderly parents. In general, an IRA
contribution is allowed only if a taxpayer has compensation. However, an exception
involves a “spousal” IRA. It allows a contribution to be made for a nonworking
spouse.
Under the spousal IRA rules, the amount that a married couple
can contribute to an IRA for a nonworking spouse in 2020 is $6,000, which is
the same limit that applies for the working spouse.
Two main benefits
As you may be aware, IRAs offer two types of benefits for
taxpayers who make contributions to them.
- Contributions of up to $6,000 a year to an IRA may be
tax deductible. - The earnings on funds within the IRA are not taxed
until withdrawn. (Alternatively, you may make contributions to a Roth IRA.
There’s no deduction for Roth IRA contributions, but, if certain requirements
are met, distributions are tax-free.)
As long as the couple together has at least $12,000 of earned
income, $6,000 can be contributed to an IRA for each, for a total of $12,000.
(The contributions for both spouses can be made to either a regular IRA or a
Roth IRA, or split between them, as long as the combined contributions don’t
exceed the $12,000 limit.)
Catching up
In addition, individuals who are age 50 or older can make
“catch-up” contributions to an IRA or Roth IRA in the amount of $1,000. Therefore,
in 2020, for a taxpayer and his or her spouse, both of whom will have reached
age 50 by the end of the year, the combined limit of the deductible
contributions to an IRA for each spouse is $7,000, for a combined deductible
limit of $14,000.
There’s one catch, however. If, in 2020, the working spouse is
an active participant in either of several types of retirement plans, a
deductible contribution of up to $6,000 (or $7,000 for a spouse who will be 50
by the end of the year) can be made to the IRA of the non-participant spouse
only if the couple’s AGI doesn’t exceed $104,000. This limit is phased out for
AGI between $196,000 and $206,000.
Contact us if you’d like more information about IRAs or you’d
like to discuss retirement planning.
© 2020
Student loan interest: Can you deduct it on your tax return?
The economic impact of the novel coronavirus (COVID-19) is
unprecedented and many taxpayers with student loans have been hard hit.
The Coronavirus Aid, Relief and Economic Security (CARES) Act
contains some assistance to borrowers with federal student loans. Notably,
federal loans were automatically placed in an administrative forbearance, which
allows borrowers to temporarily stop making monthly payments. This payment
suspension is scheduled to last until September 30, 2020.
Tax deduction rules
Despite the suspension, borrowers can still make payments if
they choose. And borrowers in good standing made payments earlier in the year
and will likely make them later in 2020. So can you deduct the student loan
interest on your tax return?
The answer is yes, depending on your income and subject to
certain limits. The maximum amount of student loan interest you can deduct each
year is $2,500. The deduction is phased out if your adjusted gross income (AGI)
exceeds certain levels.
For 2020, the deduction is phased out for taxpayers who are
married filing jointly with AGI between $140,000 and $170,000 ($70,000 and
$85,000 for single filers). The deduction is unavailable for taxpayers with AGI
of $170,000 ($85,000 for single filers) or more. Married taxpayers must file
jointly to claim the deduction.
Other requirements
The interest must be for a “qualified education loan,” which
means debt incurred to pay tuition, room and board, and related expenses to
attend a post-high school educational institution. Certain vocational schools
and post-graduate programs also may qualify.
The interest must be on funds borrowed to cover qualified
education costs of the taxpayer, his or her spouse or a dependent. The student
must be a degree candidate carrying at least half the normal full-time
workload. Also, the education expenses must be paid or incurred within a
reasonable time before or after the loan is taken out.
It doesn’t matter when the loan was taken out or whether
interest payments made in earlier years on the loan were deductible or not. And
no deduction is allowed to a taxpayer who can be claimed as a dependent on
another taxpayer’s return.
The deduction is taken “above the line.” In other words, it’s
subtracted from gross income to determine AGI. Thus, it’s available even to
taxpayers who don’t itemize deductions.
Document expenses
Taxpayers should keep records to verify eligible expenses.
Documenting tuition isn’t likely to pose a problem. However, take care to
document other qualifying expenditures for items such as books, equipment,
fees, and transportation. Documenting room and board expenses should be simple
if a student lives in a dormitory. Student who live off campus should maintain
records of room and board expenses, especially when there are complicating factors
such as roommates.
Contact us if you have questions about deducting student loan
interest or for information on other tax breaks related to paying for college.
© 2020
Help protect your personal information by filing your 2019 tax return early
The IRS announced it is opening the 2019 individual income tax
return filing season on January 27. Even if you typically don’t file until much
closer to the April 15 deadline (or you file for an extension), consider filing
as soon as you can this year. The reason: You can potentially protect yourself
from tax identity theft — and you may obtain other benefits, too.
Tax identity theft explained
In a tax identity theft scam, a thief uses another individual’s
personal information to file a fraudulent tax return early in the filing season
and claim a bogus refund.
The legitimate taxpayer discovers the fraud when he or she files
a return and is informed by the IRS that the return has been rejected because
one with the same Social Security number has already been filed for the tax
year. While the taxpayer should ultimately be able to prove that his or her
return is the valid one, tax identity theft can cause major headaches to
straighten out and significantly delay a refund.
Filing early may be your best defense: If you file first, it
will be the tax return filed by a would-be thief that will be rejected, rather
than yours.
Note: You can get your individual tax return prepared by us before January
27 if you have all the required documents. It’s just that processing of the
return will begin after IRS systems open on that date.
Your W-2s and 1099s
To file your tax return, you must have received all of your W-2s
and 1099s. January 31 is the deadline for employers to issue 2019 Form W-2 to
employees and, generally, for businesses to issue Form 1099 to recipients of
any 2019 interest, dividend or reportable miscellaneous income payments
(including those made to independent contractors).
If you haven’t received a W-2 or 1099 by February 1, first
contact the entity that should have issued it. If that doesn’t work, you can
contact the IRS for help.
Other advantages of filing early
Besides protecting yourself from tax identity theft, another
benefit of early filing is that, if you’re getting a refund, you’ll get it
faster. The IRS expects most refunds to be issued within 21 days. The time is
typically shorter if you file electronically and receive a refund by direct
deposit into a bank account.
Direct deposit also avoids the possibility that a refund check
could be lost or stolen or returned to the IRS as undeliverable. And by using
direct deposit, you can split your refund into up to three financial accounts,
including a bank account or IRA. Part of the refund can also be used to buy up
to $5,000 in U.S. Series I Savings Bonds.
What if you owe tax? Filing early may still be beneficial. You
won’t need to pay your tax bill until April 15, but you’ll know sooner how much
you owe and can plan accordingly.
Be an early-bird filer
If you have questions about tax identity theft or would like
help filing your 2019 return early, please contact us. We can help you ensure
you file an accurate return that takes advantage of all of the breaks available
to you.
© 2020
New rules will soon require employers to annually disclose retirement income to employees
As you’ve probably heard, a new law was recently passed with a
wide range of retirement plan changes for employers and individuals. One of the
provisions of the SECURE Act involves a new requirement for employers that sponsor
tax-favored defined contribution retirement plans that are subject to ERISA.
Specifically, the law will require that the benefit statements
sent to plan participants include a lifetime income disclosure at least once
during any 12-month period. The disclosure will need to illustrate the monthly
payments that an employee would receive if the total account balance were used
to provide lifetime income streams, including a single life annuity and a
qualified joint and survivor annuity for the participant and the participant’s
surviving spouse.
Background Information
Under ERISA, a defined contribution plan administrator is required to provide benefit statements to participants. Depending on the situation, these statements must be provided quarterly, annually or upon written request. In 2013, the U.S. Department of Labor (DOL) issued an advance notice of proposed rule making providing rules that would have required benefit statements provided to defined contribution plan participants to include an estimated lifetime income stream of payments based on the participant’s account balance.
Some employers began providing this information in these
statements — even though it wasn’t required.
But in the near future, employers will have to begin providing
information to their employees about lifetime income streams.
Effective Date
Fortunately, the effective date of the requirement has been
delayed until after the DOL issues guidance. It won’t go into effect until 12
months after the DOL issues a final rule. The law also directs the DOL to
develop a model disclosure.
Plan fiduciaries, plan sponsors, or others won’t have liability
under ERISA solely because they provided the lifetime income stream
equivalents, so long as the equivalents are derived in accordance with the
assumptions and guidance and that they include the explanations contained in
the model disclosure.
Stay Tuned
Critics of the new rules argue the required disclosures will
lead to confusion among participants and they question how employers will
arrive at the income projections. For now, employers have to wait for the DOL
to act. We’ll update you when that happens. Contact us if you have questions
about this requirement or other provisions in the SECURE Act.
© 2019
Tax Developments: Summary of the 2019 SECURE Act provisions affecting business and individual taxpayers
On December 20, 2019, the SECURE Act, a new tax law included
as part of the Further Consolidated Appropriations Act of 2020, was enacted.
The “Setting Every Community Up for Retirement Enhancement” (SECURE) Act
expands the ability for individuals to maximize their savings and makes
simplifications to the qualified retirement system. This article outlines
specific provisions of the act in summary form and explains the mechanics of
the rules under old and new law.
The changes to the Internal Revenue Code made by this act
apply to individuals who are participants in qualified retirement plans and to
sponsors (i.e. employers) that administer such plans.
The additional flexibility offered by these rules should
help certain individuals, especially those working longer, those working while
obtaining advanced degrees, and families looking to save for college obtain
flexibility in the accumulation and utilization of retirement funds. For
changes to stretch IRAs, many individuals are recommended to review their
estate planning to ensure that the distribution of any retirement accounts is
handled according to their wishes and in accord with new law.
The changes in the Kiddie Tax rules may be a planning
opportunity for families with children who have unearned (usually investment)
income. The ability to elect to apply these rules retroactively may be a place
to find tax savings if the changes under the TCJA had increased the family’s
tax liability in 2018 and 2019.
For employers, the flexibility in setting up a plan and the
expansion of credits available for new plans should make offering qualified
retirement benefits to employees much more attractive. The ability to combine
multiple plans for more efficient growth and investment results should benefit
retirees with increased returns over the life of the plan. At the same time,
increases in penalties means that employers who do administer plans should be
taking extra care that they are meeting all compliance and fiduciary
requirements.
Individuals
Repeal of the maximum age for traditional IRA contributions.
Before 2020, traditional IRA contributions were not allowed
once the individual attained age 70½. Starting in 2020, the new rules allow an
individual of any age to make contributions to a traditional IRA, as long as
the individual has compensation, which generally means earned income from wages
or self-employment.
Required minimum distribution age raised from 70½ to 72.
Before 2020, retirement plan participants and IRA owners
were generally required to begin taking required minimum distributions, or
RMDs, from their plan by April 1 of the year following the year they reached
age 70½. The age 70½ requirement was first applied in the retirement plan
context in the early 1960s and, until recently, had not been adjusted to account
for increases in life expectancy.
For distributions required to be made after Dec. 31, 2019,
for individuals who attain age 70½ after that date, the age at which
individuals must begin taking distributions from their retirement plan or IRA
is increased from 70½ to 72.
Partial elimination of stretch IRAs.
For deaths of plan participants or IRA owners occurring
before 2020, beneficiaries (both spousal and nonspousal) were generally allowed
to stretch out the tax-deferral advantages of the plan or IRA by taking
distributions over the beneficiary s life or life expectancy (in the IRA
context, this is sometimes referred to as a “stretch IRA”).
However, for deaths of plan participants or IRA owners
beginning in 2020 (later for some participants in collectively bargained plans
and governmental plans), distributions to most nonspouse beneficiaries are
generally required to be distributed within ten years following the plan
participant s or IRA owner s death. So, for those beneficiaries, the
“stretching” strategy is no longer allowed.
Exceptions to the 10-year rule are allowed for distributions
to (1) the surviving spouse of the plan participant or IRA owner; (2) a child
of the plan participant or IRA owner who has not reached majority; (3) a
chronically ill individual; and (4) any other individual who is not more than
ten years younger than the plan participant or IRA owner. Those beneficiaries
who qualify under this exception may generally still take their distributions
over their life expectancy (as allowed under the rules in effect for deaths
occurring before 2020).
Expansion of Section 529 education savings plans to cover registered apprenticeships and distributions to repay certain student loans.
A Section 529 education savings plan (a 529 plan, also known
as a qualified tuition program) is a tax-exempt program established and
maintained by a state, or one or more eligible educational institutions (public
or private). Any person can make nondeductible cash contributions to a 529 plan
on behalf of a designated beneficiary. The earnings on the contributions
accumulate tax-free. Distributions from a 529 plan are excludable up to the
amount of the designated beneficiary's qualified higher education expenses.
Before 2019, qualified higher education expenses didn't include
the expenses of registered apprenticeships or student loan repayments.
But for distributions made after Dec. 31, 2018 (the
effective date is retroactive), tax-free distributions from 529 plans can be
used to pay for fees, books, supplies, and equipment required for the
designated beneficiary s participation in an apprenticeship program. In
addition, tax-free distributions (up to $10,000) are allowed to pay the
principal or interest on a qualified education loan of the designated
beneficiary, or a sibling of the designated beneficiary.
Kiddie tax changes for gold star children and others.
In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA,
P.L. 115-97), which made changes to the so-called “kiddie tax,” which is a tax
on the unearned income of certain children. Before enactment of the TCJA, the
net unearned income of a child was taxed at the parents' tax rates if the
parents' tax rates were higher than the tax rates of the child.
Under the TCJA, for tax years beginning after Dec. 31, 2017,
the taxable income of a child attributable to net unearned income is taxed
according to the brackets applicable to trusts and estates. Children to whom
the kiddie tax rules apply and who have net unearned income also have a reduced
exemption amount under the alternative minimum tax (AMT) rules.
There had been concern that the TCJA changes unfairly
increased the tax on certain children, including those who were receiving
government payments (i.e., unearned income) because they were survivors of
deceased military personnel (“gold star children”), first responders, and
emergency medical workers.
The new rules enacted on Dec. 20, 2019, repeal the kiddie
tax measures that were added by the TCJA. So, starting in 2020 (with the option
to start retroactively in 2018 and/or 2019), the unearned income of children is
taxed under the pre-TCJA rules, and not at trust/estate rates. And starting
retroactively in 2018, the new rules also eliminate the reduced AMT exemption
amount for children to whom the kiddie tax rules apply and who have net
unearned income.
Penalty-free retirement plan withdrawals for expenses related to the birth or adoption of a child.
Generally, a distribution from a retirement plan must be
included in income. And, unless an exception applies (for example, distributions
in case of financial hardship), a distribution before the age of 59-1/2 is
subject to a 10% early withdrawal penalty on the amount includible in income.
Starting in 2020, plan distributions (up to $5,000) that are
used to pay for expenses related to the birth or adoption of a child are
penalty-free. That $5,000 amount applies on an individual basis, so for a
married couple, each spouse may receive a penalty-free distribution up to
$5,000 for a qualified birth or adoption.
Taxable non-tuition fellowship and stipend payments are treated as compensation for IRA purposes.
Before 2020, stipends and non-tuition fellowship payments
received by graduate and postdoctoral students were not treated as compensation
for IRA contribution purposes, and so could not be used as the basis for making
IRA contributions.
Starting in 2020, the new rules remove that obstacle by
permitting taxable non-tuition fellowship and stipend payments to be treated as
compensation for IRA contribution purposes. This change will enable these
students to begin saving for retirement without delay.
Tax-exempt difficulty-of-care payments are treated as compensation for determining retirement contribution limits.
Many home healthcare workers do not have taxable income
because their only compensation comes from “difficulty-of-care” payments that
are exempt from taxation. Because those workers do not have taxable income,
they were not able to save for retirement in a qualified retirement plan or
IRA.
For IRA contributions made after Dec. 20, 2019 (and
retroactively starting in 2016 for contributions made to certain qualified
retirement plans), the new rules allow home healthcare workers to contribute to
a retirement plan or IRA by providing that tax-exempt difficulty-of-care
payments are treated as compensation for purposes of calculating the
contribution limits to certain qualified plans and IRAs.
Businesses
Unrelated employers are more easily allowed to band together to create a single retirement plan.
A multiple employer plan (MEP) is a single plan maintained
by two or more unrelated employers. Starting in 2021, the new rules reduce the
barriers to creating and maintaining MEPs, which will help increase
opportunities for small employers to band together to obtain more favorable
investment results, while allowing for more efficient and less expensive
management services.
New small employer automatic plan enrollment credit.
Automatic enrollment is shown to increase employee
participation and higher retirement savings. Starting in 2020, the new rules
create a new tax credit of up to $500 per year to employers to defray start-up
costs for new 401(k) plans and SIMPLE IRA plans that include automatic
enrollment. The credit is in addition to an existing plan start-up credit, and
is available for three years. The new credit is also available to employers who
convert an existing plan to a plan with an automatic enrollment design.
Increase credit for small employer pension plan start-up costs.
The new rules increase the credit for plan start-up costs to
make it more affordable for small businesses to set up retirement plans.
Starting in 2020, the credit is increased by changing the calculation of the
flat dollar amount limit on the credit to the greater of (1) $500, or (2) the
lesser of: (a) $250 multiplied by the number of nonhighly compensated employees
of the eligible employer who are eligible to participate in the plan, or (b)
$5,000. The credit applies for up to three years.
Expand retirement savings by increasing the auto enrollment safe harbor cap.
An annual nondiscrimination test called the actual deferral
percentage (ADP) test applies to elective deferrals under a 401(k) plan. The
ADP test is deemed to be satisfied if a 401(k) plan includes certain minimum
matching or non-elective contributions under either of two safe harbor plan
designs and meets certain other requirements. One of the safe harbor plans is
an automatic enrollment safe harbor plan.
Starting in 2020, the new rules increase the cap on the
default rate under an automatic enrollment safe harbor plan from 10% to 15%,
but only for years after the participant's first deemed election year. For the
participant's first deemed election year, the cap on the default rate is 10%.
Allow long-term part-time employees to participate in 401(k) plans.
Currently, employers are generally allowed to exclude
part-time employees (i.e., employees who work less than 1,000 hours per year)
when providing certain types of retirement plans—like a 401(k) plan—to their
employees. As women are more likely than men to work part-time, these rules can
be especially harmful for women in preparing for retirement.
However, starting in 2021, the new rules will require most
employers maintaining a 401(k) plan to have a dual eligibility requirement
under which an employee must complete either a one-year-of-service requirement
(with the 1,000-hour rule), or three consecutive years of service where the
employee completes at least 500 hours of service per year. For employees who
are eligible solely by reason of the new 500-hour rule, the employer will be
allowed to exclude those employees from testing under the nondiscrimination and
coverage rules, and from the application of the top-heavy rules.
Loosen notice requirements and amendment timing rules to facilitate adoption of nonelective contribution 401(k) safe harbor plans.
The actual deferral percentage nondiscrimination test is
deemed to be satisfied if a 401(k) plan includes certain minimum matching or
nonelective contributions under either of two plan designs (referred to as a
“401(k) safe harbor plan”), as well as certain required rights and features,
and satisfies a notice requirement. Under one type of 401(k) safe harbor plan,
the plan either (1) satisfies a matching contribution requirement, or (2)
provides for a nonelective contribution to a defined contribution plan of at
least 3% of an employee's compensation on behalf of each nonhighly compensated
employee who is eligible to participate in the plan.
Starting in 2020, the new rules change the nonelective
contribution 401(k) safe harbor to provide greater flexibility, improve
employee protection, and facilitate plan adoption. The new rules eliminate the
safe harbor notice requirement, but maintain the requirement to allow employees
to make or change an election at least once per year. The rules also permit
amendments to nonelective status at any time before the 30th day before the
close of the plan year. Amendments after that time are allowed if the amendment
provides (1) a nonelective contribution of at least 4% of compensation (rather
than at least 3%) for all eligible employees for that plan year, and (2) the
plan is amended no later than the last day for distributing excess
contributions for the plan year (i.e., by the close of following plan year).
Expansion of portability of lifetime income options.
Starting in 2020, the new rules permit certain retirement
plans to make a direct trustee-to-trustee transfer to another
employer-sponsored retirement plan, or IRA, of a lifetime income investment or
distributions of a lifetime income investment in the form of a qualified plan
distribution annuity, if a lifetime income investment is no longer authorized
to be held as an investment option under the plan. This change permits
participants to preserve their lifetime income investments and avoid surrender
charges and fees.
Qualified employer plans barred from making loans through credit cards and similar arrangements.
After Dec. 20, 2019, plan loans may no longer be distributed
through credit cards or similar arrangements. This change is intended to ensure
that plan loans are not used for routine or small purchases, thereby helping to
preserve retirement savings.
Nondiscrimination rules modified to protect older, longer service participants in closed plans.
Starting in 2020, the nondiscrimination rules as they
pertain to closed pension plans (i.e., plans closed to new entrants) are being
changed to permit existing participants to continue to accrue benefits. The
modification will protect the benefits for older, longer-service employees as
they near retirement.
Plans adopted by filing due date for year may be treated as in effect as of close of year.
Starting in 2020, employers can elect to treat qualified
retirement plans adopted after the close of a tax year, but before the due date
(including extensions) of the tax return, as having been adopted as of the last
day of the year. The additional time to establish a plan provides flexibility
for employers who are considering adopting a plan, and the opportunity for
employees to receive contributions for that earlier year.
New annual disclosures required for estimated lifetime income streams.
The new rules (starting at a to-be-determined future date)
will require that plan participants' benefit statements include a lifetime
income disclosure at least once during any 12-month period. The disclosure will
have to illustrate the monthly payments the participant would receive if the
total account balance were used to provide lifetime income streams, including a
qualified joint and survivor annuity for the participant and the participant s
surviving spouse and a single life annuity.
Fiduciary safe harbor added for selection of annuity providers.
When a plan sponsor selects an annuity provider for the
plan, the sponsor is considered a plan “fiduciary,” which generally means that
the sponsor must discharge his or her duties with respect to the plan solely in
the interests of plan participants and beneficiaries (this is known as the
“prudence requirement”).
Starting on Dec. 20, 2019 (the date the SECURE Act was
signed into law), fiduciaries have an optional safe harbor to satisfy the
prudence requirement in their selection of an insurer for a guaranteed
retirement income contract, and are protected from liability for any losses
that may result to participants or beneficiaries due to an insurer's future
inability to satisfy its financial obligations under the terms of the contract.
Removing ambiguity about the applicable fiduciary standard eliminates a
roadblock to offering lifetime income benefit options under a plan.
Increased penalties for failure-to-file retirement plan returns.
Starting in 2020, the new rules modify the failure-to-file
penalties for retirement plan returns.
The penalty for failing to file a Form 5500 (for annual plan
reporting) is changed to $250 per day, not to exceed $150,000.
A taxpayer's failure to file a registration statement incurs
a penalty of $10 per participant per day, not to exceed $50,000.
The failure to file a required notification of change
results in a penalty of $10 per day, not to exceed $10,000.
The failure to provide a required withholding notice results in a penalty of $100 for each failure, not to exceed $50,000 for all failures during any calendar year. For planning opportunities or to learn more about these changes, please contact our office at 617-651-0531 or by using our contact us form below.
New law helps businesses make their employees’ retirement secure
A significant law was recently passed that adds tax breaks and
makes changes to employer-provided retirement plans. If your small business has
a current plan for employees or if you’re thinking about adding one, you should
familiarize yourself with the new rules.
The Setting Every Community Up for Retirement Enhancement Act
(SECURE Act) was signed into law on December 20, 2019 as part of a larger
spending bill. Here are three provisions of interest to small businesses.
- Employers that are unrelated will be able to join together to create one retirement plan. Beginning in 2021, new rules will make it easier to create and maintain a multiple employer plan (MEP). A MEP is a single plan operated by two or more unrelated employers. But there were barriers that made it difficult to setting up and running these plans. Soon, there will be increased opportunities for small employers to join together to received better investment results, while allowing for less expensive and more efficient management services.
- There’s an increased tax credit for small employer retirement plan startup costs. If you want to set up a retirement plan, but haven’t gotten around to it yet, new rules increase the tax credit for retirement plan start-up costs to make it more affordable for small businesses to set them up. Starting in 2020, the credit is increased by changing the calculation of the flat dollar amount limit to: The greater of $500, or the lesser of: a) $250 multiplied by the number of non-highly compensated employees of the eligible employer who are eligible to participate in the plan, or b) $5,000.
- There’s a new small employer automatic plan enrollment tax credit. Not surprisingly, when employers automatically enroll employees in retirement plans, there is more participation and higher retirement savings. Beginning in 2020, there’s a new tax credit of up to $500 per year to employers to defray start-up costs for new 401(k) plans and SIMPLE IRA plans that include automatic enrollment. This credit is on top of and existing plan start-up credit described above and is available for three years. It is also available to employers who convert an existing plan to a plan with automatic enrollment.
These are only some of the retirement plan provisions in the
SECURE Act. There have also been changes to the auto enrollment safe harbor
cap, nondiscrimination rules, new rules that allow certain part-timers to
participate in 401(k) plans, increased penalties for failing to file retirement
plan returns and more. Contact us to learn more about your situation.