WHAT THE NEW PENSION LAW MEANS TO SMALL BUSINESS
Just before Congress recessed for summer vacation, it passed a massive law to strengthen pension plans and provide other retirement-savings breaks. The Pension Protection Act of 2006, which runs over 900 pages, also creates a number of breaks on charitable contributions for businesses as well as some miscellaneous provisions and technical corrections to prior laws. Here is a roundup of some new rules that can impact your tax bill--for better or worse--this year and in future years.
Permanency of current tax breaks The higher contributions limits to qualified retirement plans and IRAs that had been set to expire after 2010 have become permanent, making it easier to plan ahead. For example, the current high elective deferral limits to 401(k) plans will continue to be indexed annually for inflation, as will catch-up contributions for those age 50 and older.
Also made permanent are Roth 401(k)s, which could have expired after 2010. Because this plan feature has become permanent in the law, businesses should take a serious look at incorporating this savings option into existing retirement plans. While employee contributions do not enjoy tax breaks going into the plan, earnings can be transformed into tax-free income. This is an opportunity for owners to create their own tax-free retirement savings, something they may be barred from doing through a Roth IRA because of their income.
The small employer pension plan start-up credit, which is 50% of administrative costs and employee education expenses of $1,000 (top credit $500) each year for the first three years of the plan, has been made permanent. To qualify for the credit, which is limited to companies with no more than 100 employees, the plan must cover at least one employee who is not a highly-compensated employee. Thus, a self-employed professional with no employees who sets up a solo-401(k) plan cannot claim the credit for start-up costs.
Idea: In view of these and other pension law changes, it is highly advisable that you review your existing plan with a knowledgeable benefits expert to determine where changes should be made as soon as possible.
Defined benefit (pension) plans About 44 million individuals are covered by a traditional pension plan, most of whom work for large corporations. However, some professionals and other small-business owners have defined benefit (pension) plans in place to optimize their annual contributions and owners' retirement savings.
Note: The key provisions of the new law are aimed at the approximately 30,000 pension plans that are underfunded (there is not enough money in the plan to pay the promised pensions) in order to prevent them from resorting to bankruptcy, which would leave U.S. taxpayers holding the bag. The new law allows these plans to take larger current deductions for contributions and gives troubled plans more years in which to become fully funded. Since few small-business plans are underfunded, these new rules are not discussed here.
But if you are a small-business owner with a plan that is not fully funded, the premiums paid to the Pension Benefit Guaranty Corporation (PBGC) will change in 2007. For plans with 25 or fewer employees on the first day of the plan year, the per participant variable-rate premium is capped at no more than $5 multiplied by the number of participants in the plan at the end of the preceding year (which replaces the old variable-rate premium of $9 per $1,000 of unfunded benefits).
The flat-rate premium of $19 per participant, which is paid by all single-employer pension plans, remains unchanged. The variable rate premium, which is paid in addition to the flat-rate premium, applies only if the plan is underfunded.
Looking ahead: Starting in 2010, small employers (those with 500 or fewer employees) can create a combined defined benefit and 401(k) plan, called a DB/K. The plan must provide certain minimum benefits to participants, have automatic enrollment and meet certain other requirements. This new plan can combine the best of both worlds--a guaranteed pension for employees and funding of higher benefits by employees themselves--with lower administrative costs. Which type of company would want to use this new plan remains to be seen.
Here is a checklist of other changes effective in 2007:
Charitable donations
Many breaks for contributions apply for individuals. Here are some business breaks:
Note: If you are age 70-1/2 or older, you can give tax-free distributions from IRAs to charity in 2006 and 2007; the limit is $100,000 a year. While no charitable contribution deduction can be claimed, keeping the distribution from being treated as income keeps adjusted gross income down, which in turn, may entitle you to other tax breaks. For example, you may be able to take the $25,000 rental loss allowance with respect to rental real estate or claim a larger itemized medical deduction.
