Economic Growth and Tax Reconciliation Act of 2001 (EGTRA)

 

Issue	Current Law	EGTRA
Tax Credits for New Small Employer Plans	An employer's costs related to the establishment and maintenance of a retirement plan generally are deductible as business expenses. However, there is no tax credit for such expenses.	Beginning in 2002, small businesses with 100 employees or less will be eligible for an annual tax credit of 50 percent on up to $1000 of administrative costs for the first three years of a new plan. The credit is available only if at least one non-highly compensated employee is participating..
Participant Loans for Small Business Owners	Generally, plans may make loans to participants. But, prohibited transaction rules prevent sole proprietors, partners, and Subchapter S corporation shareholders from taking participant loans.	The prohibited transaction rules are modified to allow for participant loans to sole proprietors, partners, and Subchapter S corporation shareholders. The provision also applies prospectively to pre-existing loans.
Repeal of the Multiple Use Test	In addition to two nondiscrimination tests (the ADP and ACP tests), some 401(k) plans must also satisfy the complicated multiple use test.	The multiple test is repealed.
Tax Credits for Lower Income Savers	Currently there is no tax credit for low and moderate income savers.	Eligible persons will receive a non-refundable tax credit of up to 50 percent on up to $2000 in contributions to an IRA, 401(k), 403(b), SIMPLE, SEP or 457 plan. This credit is in addition to the tax deduction already associated with these contributions. In the case of joint filers, individuals whose adjustable gross income is less than $30,000 are eligible for a 50 percent credit. Joint filers with adjusted gross income between $30,000 and 32,500 are eligible for a 20 percent credit. Joint filers with income between $32,500 and $50,000 are eligible for a 10 percent credit. The income threshold for single filers is one-half the threshold for joint filers.
Catch-up contributions for Older Workers	The Code limits the amount that can be contributed to a defined contribution plan on behalf of an employee for any year. In the case of elective deferrals, the limit is $10,500 per year. There are no separate limits for older workers.	Beginning in 2002, individuals who are age 50 or older will be allowed to make an additional contribution to a 401(k), 403(b), 457 plan equal to $1,000 in 2002, then increased by $1,000 each year until $5,000 in 2006, and then indexed in $500 increments. The catch-up amount for SIMPLE plans will be one-half of these amounts. The amount of the catch-up contribution will not be subject to nondiscrimination testing, provided all participating employees over age 50 are eligible to make a catch-up contribution. Also the catch-up contribution will not count against the employers deduction limit under section 404, or against the individual's overall 415(c) dollar limit.
Modifications of Top Heavy Rules	A plan is generally considered "top heavy" if more than 60 percent of plan assets are held on behalf of "key employees." Due to the design of this test, top heavy rules essentially affect only small business. Key employees generally include officers earning over half the Section 415 defined benefit plan dollar limit ($70,000 in 2001), 5 percent owners, 1 percent owners earning over $150,000, and the 10 employees with the larges ownership interest in the business (as long as they earn more than $30,000). Further, family members of 5 percent owners are deemed to be key employees under family attribution rules. Top heavy plans must meet a special vesting schedule and make minimum contributions to all non-key employees to the extent contributions are made on behalf of key employees.	A number of changes have been made here: The definition of "key employee" is modified to delete the "top 10 owner" rule, provided that an employee will not be treated as a key employee based on his/her officer status unless the employee earns more that $130,000, and to eliminate the 4-year look-back rule for identifying "key employees." Matching contributions will now count toward satisfying the top heavy minimums. The matching contributions 401(k) plan safe harbor will be deemed to satisfy the top heavy rules. This does not mean that an accompanying profit sharing contribution automatically satisfies the top heavy rules, although the matching contributions will count toward otherwise satisfying the minimum. The 5-year look-back rule applicable to distributions will be shortened to one year. However, the 5-year look-back rule will continue to apply to in-service distributions. A frozen top heavy defined benefit plan will no longer be required to make minimum accruals on behalf of non-key employees.
Modification of Safe Harbor Relief for 401(k) Plan Hardship Withdrawals	401(k) plans generally must restrict distributions of amounts attributable to elective contributions. An exception to this restriction applies in the case of certain hardship distributions. Treasury regulations provide a safe harbor for determining whether a distribution qualifies as a hardship distribution. To qualify for this safe harbor, a participant receiving a hardship distribution must be prohibited from making elective contributions to the plan for the 12 months following the date of distribution.	Treasury is directed to revise its safe harbor hardship distribution rules to reduce to 6 months the period of time participants must be prohibited from making additional elective contributions. Also, hardship withdrawals under the terms of the pan will not be treated as eligible rollover distributions.
Modifications to Limits on Retirement Plan Contributions and Benefits	Current law limits: 401(a)(17): annual compensation taken into account limited to $170,000. 402(g): elective deferrals limited to $10,500 per year. 415(b): maximum annual benefits are the lesser of 100 percent of three-year high salary or $140,000 (or less for pre-65 retirees). 415(c): maximum defined contribution plan contribution is the lesser of $35,000 or 25 percent of compensation. 457(b): contribution limit is generally $8,500 per year. SIMPLE: maximum elective deferral is $6,500 per year.	Beginning in 2002, the Act raises all of the significant dollar limits as follows: 401(a)(17) compensation limit to $200,000; and then indexed in $5,000 increments. 402(g) elective deferral limit to $11,000 in 2002; then increased $1,000 each year until $15,000 in 2006; and then indexed in $500 increments. 415(b) annual benefit limit to $160,000; and then indexed in $5,000 increments. Note that this provision applies to years ending after December 31, 2001. 415(b) annual benefit limit will no longer have to be reduced for retirements ages 62 through 65. Note that this provision applies to years ending after December 31, 2001. 415(c) contribution limit to $40,000, and then indexed in $1,000 increments. 457 elective deferral limit to $11,000 in 2000, then increased $1,000 each year until $15,000 in 2006; and then indexed in $500 increments. SIMPLE elective deferral limit to $7,000 in 2002, then increased $1,000 each year until $10,000 in 2005; and then indexed in $500 increments.
Deduction Limits	A sponsor of a profit sharing plan cannot deduct contributions to the plan in excess of 15 percent of aggregate employees' compensation. In the case of a stand-alone money purchase plan, the deduction limit is the minimum funding requirement for the plan.	The deduction limit for profit sharing plans is increased to 25 percent of aggregate employees' compensation. Money purchase plans will be treated as profit sharing plans for purpose of the 404 deduction limit and thus will be subject to the 25 percent limit.
Increase in 25 Percent of Compensation Limitation	Under Section 415(c), total annual contributions to a defined contribution plan may not exceed the lesser of 25 percent of compensation or $35,000.	The 25 percent of compensation limitation has been increased to 100 percent of compensation. The dollar limitation will still apply. The provision also repeals the maximum exclusion allowance applicable to 403(b) plans.
Repeal of "Same Desk Rule"	Under the "same desk rule," a distribution to a terminated employee is not allowed if the employee continues performing the same functions for a successor employer. The same desk rule applies to 401(k), 403(b) or 457 plans.	The same desk rule is eliminated by replacing "separation from service" under Section 401(k)(2)(B) with "severance from employment." Conforming changes are also made for 403(b) and 457 plans. The provision applies to distributions are after December 31, 2001, regardless of when the severance from employment occurred.
Employers May Disregard Rollovers for purposes of Cash-Out Amounts	Terminated participants' benefits may be cashed out if the non-forfeitable present value of such benefits does not exceed $5,000.	A plan is permitted to ignore amounts attributable to rollover contributions when determining the cash-out amount.

401k-Type Plans for One-Person Businesses: Introducing 401(k) Easy-For-One for only $495 per year complete plus a one-time only set-up charge of $795--complete!

The Individual (k) Plan is an affordable and complete retirement plan that allows sole owners of one-person companies to shelter a significant portion of their income - in some cases, more than twice as much - than they can shelter with other qualified retirement plans, such as money purchase pension plans, simplified employee pension (SEP) plans and savings incentive match plans for employees (SIMPLEs). It is estimated that nearly 18 million one-person business owners are eligible to participate in an Individual (k). Eligible businesses include corporations, sole proprietorships, and non-profits. Participants include accountants, lawyers, consultants, doctors, software programmers, etc.

The Individual (k) plan is made to fit owner-only businesses and businesses with employees that can be excluded under federal laws governing plan coverage requirements.

Prior to the passage of pension reform, there was no practical reason to use a 401(k) plan for an owner-only business. However, as of January 1, 2002, there are some very compelling reasons for certain small business owners to consider Individual (k) plans, chief among them, to maximize retirement savings and simultaneously reduce income taxes.

Effective January 1, 2002, the employer's maximum deductible contribution for profit sharing plans (including 401(k) plans) is increased to 25 percent of aggregate compensation paid to all eligible plan participants. With a Individual (k) plan, an employer is eligible to make a deductible contribution up to 25 percent of payroll in addition to whatever 401(k) deduction the employer made to his or her Individual (K) during the course of the year, up to a maximum amount of $40,000. To restate, the $40,000 maximum annual contribution is the aggregate of employee pre-tax deferrals AND employer matching and/or other contributions.

For example, A one-person company with a Individual (K) allows the one-person owner to make an annual pre-tax employee contribution to his or her Individual (K) of up to a maximum of $11,000 for 2002. In addition, the same one-person company can make an employer contribution to the one-person company's Individual (K). This employer contribution cannot exceed 25% of the one-person payroll. By year-end the business owner can have an annual amount that when combining the employee contribution with the employer contribution can add up to an aggregated maximum of $40,000 for the year. Additionally, the Individual (K) includes a "catch-up" provision that allows owners who are 50 or older to make additional contributions.

The process of calculating the maximum contribution that a self-employed business owner may make to his or her Individual (k) is relatively straightforward. However, the calculations vary slightly depending on whether the business is a sole proprietorship, a partnership, or a corporation. 401(k) Easy will supply the proper mathematical formula for your one-person business organization type upon request.

Benefits of Individual (k)

* Affordable and complete, at only $495 per year.

* Employer/owners may contribute up to $40,000 per year, depending on their income.

* Individual (k) contributions are made with "pre-tax" dollars, and earnings grow tax-deferred until withdrawn.

*Employer/owners can make salary deferrals equal to 100% of compensation, up to a maximum of $11,000. This maximum will increase by $1,000 per year until 2006, when it reaches $15,000.

* Employer/owners may also make company profit-sharing contributions up to 25% of salary.

* Employer/owners who are age 50 and above may contribute an additional "catch-up" contribution of $1,000 annually, in addition to the $40,000 maximum. This catch-up contribution maximum will increase by $1,000 per year until 2006, when it reached $5,000.

*If new employees are hired the 401(k) Easy system will immediately accommodate them (but some of the advantages of the Individual (k) will vanish).

*Rollovers into the Individual (k) are permitted from SEP, SARSEP, SIMPLE IRA, traditional IRA, rollover IRA, Keogh, 401(k), 403(b) and 457 plans.

*Loans are available to the employer/business owner via the Individual (k).

*Employer/owners have complete control over their Individual (k) investments, as do all 401(k) Easy users.

* 401(k) Retirement Plans are Excluded from the Bankruptcy Estate 

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 excludes from the bankruptcy estate retirement funds that are exempt from taxation under the Internal Revenue Code (the "Code")--such as one-person 401(k) plans, profit sharing plans, traditional 401(k) plans, defined benefit plans and IRAs. In addition, the Act protects tax-exempt retirement funds that are transferred to another tax-exempt retirement fund (i.e. a rollover to an IRA).

The Act provides a limited exemption of $1,000,000 to traditional and Roth IRAs. The debtor may petition the bankruptcy court for protection beyond that limit, and the court may grant the relief "if the interest of justice so requires." The benefits in IRA-based retirement plans, such as simplified employee pension plans (SEPs) or simple retirement accounts (SIMPLEs), are fully protected (the dollar limit does not apply to those plans). 

As a practical matter, IRA holders often commingle rollover and traditional contributions in a single IRA. Under the Act, rollover contributions have unlimited protection, if they came from tax-exempt funds. For this reason, IRA holders should account separately for those funds. The most prudent approach may be to put them in a separate IRA. 

Finally, it should be noted that the Act clarifies that participant loans are not discharged in bankruptcy if they are owed to a pension, profit-sharing, stock bonus or other tax-exempt deferred compensation arrangement. And, it is permissible to ensure repayment of such loans through payroll withholding. 

The Act is significant because it excludes from the bankruptcy estate a much broader range of tax-exempt retirement arrangements than prior law. And, the Act provides specific federal authority for exempting IRAs from bankruptcy estates. Historically, IRAs were thought to be subject to the claims of bankruptcy creditors--at least under federal law. (Note that many states gave full or partial protection to IRAs.) More recently, the U.S. Supreme Court held that there was limited protection for IRA benefits. 

Overall, the new law affords greater asset protection, which should be particularly beneficial to corporate officers, directors and other higher-compensated individuals. The Act becomes effective October 17, 2005. The Act will not apply to any bankruptcy cases filed prior to its effective date. And, it is important to note that its protections apply only if a participant has filed for bankruptcy.