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The IRS recently issued a fact sheet for self-employed small business owners to provide guidance on deductions for retirement plans. If you are self-employed small business owner, you can set up a qualified retirement plan for yourself and your employees.

If you are a sole proprietor, you can deduct contributions you make to the plan for yourself. You can also deduct trustee fees if contributions to the plan do not cover them.

The Internal Revenue Code provides significant tax incentives for employers that establish and maintain retirement plans that comply with the requirements of the Code. Such plans include Simplified Employee Pension (SEP) plans and Savings Incentive Match Plan for Employees Individual Retirement Account (SIMPLE IRA) plans.

Generally, contributions under these plans that are set aside for retirement may be currently deductible by the employer, but are not taxable to the employee until distributed from the plan.

You must set up and fund a qualified retirement plan, such as a SEP or SIMPLE-IRA. No matter what type of plan for the self-employed you are considering, you must actually make contributions to a qualified, properly maintained retirement plan account.

Qualifications to Claim Deductions

If you are self-employed, you may qualify for a tax deduction for contributions you make to a qualified retirement plan. You must have self-employment income to qualify. Self-employment income consists of net profits from Schedule C or Schedule F.

The deduction is the total plan contribution you can subtract from gross income on your federal income tax return. Limits apply to the amount deductible. You can potentially avoid examinations and additional assessments by making sure you qualify for the deduction.

Deduction Limits for the Self-Employed

Use the rate table or worksheets in chapter 5 of IRS Publication 560, Retirement Plans for Small Business for figuring your allowable contribution rate and tax deduction for your SEP-IRA plan contributions.

Deducting Contributions

When to deduct contributions for a year depends on the tax year on which the SEP is maintained. If the SEP is maintained on a calendar year basis, you deduct the yearly contributions on your tax return for the year within which the calendar year ends. If you file your tax return and maintain the SEP using a fiscal year or short tax year, you deduct contributions made for a year on your tax return for that year. For example, you are a fiscal year taxpayer whose tax year ends June 30. You maintain a SEP on a calendar year basis. You deduct SEP contributions made for calendar year 2008 on your tax return for your tax year ending June 30, 2009. The allowable deduction for yourself is reported on your Form 1040 Line 28.

There are many other factors to consider when choosing a retirement plan that is right for you and for your business. A retirement plan has many benefits, including investing in the future now for financial security when you retire. As a bonus, you may qualify for significant tax advantages and other incentives. IRS Publication 560, Retirement Plans for Small Business, is a valuable resource for computing self-employment income and determining limitations on SEP and other retirement contributions and deductions.

Special thanks to Small Business Taxes & Management and the Internal Revenue Service for their help in compiling this article.

NOTE: New IRS Pilot Programs
For two years that began on December 1, 2008, the IRS will offer post-Appeals mediation and arbitration for Offers in Compromise (settling tax liability for less than 100% on the dollar) and Trust Fund Recovery Penalty (for owners personally liable for income tax withholding and employees’ FICA). The programs are available to those who file appeals in the IRS offices in Phoenix, Arizona; San Francisco, California; Atlanta, Georgia; Chicago, Illinois; Indianapolis, Indiana; Louisville, Kentucky; Cincinnati, Ohio; and Houston, Texas. The mediation process applies to both legal and factual issues; the arbitration process is limited to factual issues. To learn more, read Internal Revenue Bulletin Announcement 2008-111.