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Deducting Retirement Contributions

One of the best ways to reduce your tax bill, while increasing your net worth and future security, is to invest in a retirement plan. When you own the show, you're in a position to tailor-make a plan that suits your needs precisely. If you set up a plan that meets the IRS requirements, you can make tax-deductible contributions to the plan, which will build up tax-free until you withdraw them.

As a self-employed business owner, your major retirement plan options are:

  • Keogh plans - defined benefit, defined contribution, or hybrid retirement plans set up by a self-employed person or partnership. Common types of Keoghs include money-purchase plans and profit-sharing plans.
  • Simplified Employee Pensions (SEPs) - a very flexible, easy plan to set up that involves making contributions to special Individual Retirement Accounts (IRAs) set up for the business owner and each eligible employee.
  • SIMPLE plans - the Savings Incentive Match Plan for Employees (SIMPLE plan), which allows employees to make elective contributions of up to $11,500 in 2012 ($12,000 in 2013) and requires employers to make matching contributions.
  • Individual Retirement Accounts (IRAs) - the easiest solution to retirement savings, although your contributions are limited to $5,000 in 2012 ($5,500 in 2013).

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Small employers with no more than 100 employees receive a tax credit for some of the costs of establishing new retirement plans. The credit equals 50 percent of the start-up costs incurred to create or maintain a new employee retirement plan. The credit is limited to $500 in any tax year and it may be claimed for qualified costs incurred in each of the three years beginning with the tax year in which the plan becomes effective.

To further encourage low- and middle-income taxpayers to save for retirement, a nonrefundable saver's tax credit is currently available. The maximum credit available is $1,000 for a $2,000 contribution.

Reporting retirement plan contributions. If you are a sole proprietor, contributions made for employees to a Keogh plan, an SEP, or a SIMPLE plan are reported on Line 19 of Schedule C, "Pension and profit-sharing plans."

Contributions made to the plan on your own behalf would be reported on Line 28 of your Form 1040.

There are also some special tax reporting requirements with regard to the Keogh or other retirement plan itself. Generally, an annual report on IRS Form 5500-C/R (for plans with fewer than 100 participants) must be filed with the IRS by the last day of the 7th month after the close of the plan year. Single-participant plans can use Form 5500-EZ. See the instructions for these forms (available from the IRS by calling 1-800-TAX-FORM, or at its website or see your professional tax advisor.

IRA contributions. If your IRA contribution is deductible, you don't need to file any special forms to claim it, nor do you need to itemize your deductions on Schedule A of Form 1040. Simply write the amount of your contribution (and your spouse's contribution, if married filing jointly) on Line 32 of Form 1040, or Line 17 of Form 1040A.

To report any nondeductible IRA contributions, you must file IRS Form 8606, Nondeductible IRAs, with your tax return. To claim a tax credit for your retirement contributions, if you are eligible, you must file IRS Form 8880, Credit for Qualified Retirement Savings Contributions,.

Business Tools

Among the Business Tools are Form 1040, Form 1040A, Form 8880, Schedule A and Schedule C. They are in Adobe Portable Document Format (.pdf), and you will need the free Acrobat Reader to view and print the file.

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