You can usually deduct, subject to limits, contributions you make to a qualified plan, including those made for your own retirement. The contributions (and earnings and gains on them) are generally tax free until distributed by the plan. taxmap/pubs/p560-016.htm#en_us_publink10008978
The deduction limit for your contributions to a qualified plan depends on the kind of plan you have.taxmap/pubs/p560-016.htm#en_us_publink10008979
The deduction for contributions to a defined contribution plan (profit-sharing plan or money purchase pension plan) cannot be more than 25% of the compensation paid (or accrued) during the year to your eligible employees participating in the plan. If you are self-employed, you must reduce this limit in figuring the deduction for contributions you make for your own account. See Deduction Limit for Self-Employed Individuals, later.
When figuring the deduction limit, the following rules apply.
- Elective deferrals (discussed later) are not subject to the limit.
- Compensation includes elective deferrals.
- The maximum compensation that can be taken into account for each employee is $230,000.
The deduction for contributions to a defined benefit plan is based on actuarial assumptions and computations. Consequently, an actuary must figure your deduction limit.
In figuring the deduction for contributions, you cannot take into account any contributions or benefits that are more than the limits discussed earlier under Limits on Contributions and Benefits. However, your deduction for contributions to a defined benefit plan can be as much as the plan's unfunded current liability.
If you make contributions for yourself, you need to make a special computation to figure your maximum deduction for these contributions. Compensation is your net earnings from self-employment, defined in chapter 1. This definition takes into account both the following items.
- The deduction for one-half of your self-employment tax.
- The deduction for contributions on your behalf to the plan.
The deduction for your own contributions and your net earnings depend on each other. For this reason, you determine the deduction for your own contributions indirectly by reducing the contribution rate called for in your plan. To do this, use either the Rate Table for Self-Employed or the Rate Worksheet for Self-Employed in chapter 5. Then figure your maximum deduction by using the Deduction Worksheet for Self-Employed in chapter 5.taxmap/pubs/p560-016.htm#en_us_publink10008983
Deduct the contributions you make for your common-law employees on your tax return. For example, sole proprietors deduct them on Schedule C (Form 1040), Profit or Loss From Business, or Schedule F (Form 1040), Profit or Loss From Farming; partnerships deduct them on Form 1065, U.S. Return of Partnership Income; and corporations deduct them on Form 1120, U.S. Corporation Income Tax Return, or Form 1120S, U.S. Income Tax Return for an S Corporation.
Sole proprietors and partners deduct contributions for themselves on line 28 of Form 1040, U.S. Individual Income Tax Return. (If you are a partner, contributions for yourself are shown on the Schedule K-1 (Form 1065), Partner's Share of Income, Deduction, Credits, etc., you get from the partnership.)taxmap/pubs/p560-016.htm#en_us_publink10008984
If you contribute more to the plans than you can deduct for the year, you can carry over and deduct the difference in later years, combined with your contributions for those years. Your combined deduction in a later year is limited to 25% of the participating employees' compensation for that year. For purposes of this limit, a SEP is treated as a profit-sharing (defined contribution) plan. However, this percentage limit must be reduced to figure your maximum deduction for contributions you make for yourself. See Deduction Limit for Self-Employed Individuals, earlier. The amount you carry over and deduct may be subject to the excise tax discussed next.
Table 4–1 taxmap/pubs/p560-016.htm#en_us_publink10008985
illustrates the carryover of excess contributions to a profit-sharing plan.
Table 4–1. Carryover of Excess Contributions Illustrated—Profit-Sharing Plan (000's omitted)
|Year||Participants' compensation||Participants' share of required contribution (10% of annual profit)||Deductible|
limit for current
year (25% of compensation)
|Contribution||Excess contribution carryover|
deduction including carryovers
|Excess contribution carryover available at|
end of year
|2005||$1,000||$100||$250||$100||$ 0||$100||$ 0|
1There were no carryovers from years before 2005.
If you contribute more than your deduction limit to a retirement plan, you have made nondeductible contributions and you may be liable for an excise tax. In general, a 10% excise tax applies to nondeductible contributions made to qualified pension and profit-sharing plans and to SEPs.taxmap/pubs/p560-016.htm#en_us_publink10008986
The 10% excise tax does not apply to any contribution made to meet the minimum funding requirements in a money purchase pension plan or a defined benefit plan. Even if that contribution is more than your earned income from the trade or business for which the plan is set up, the difference is not subject to this excise tax. See Minimum Funding Requirement, earlier.taxmap/pubs/p560-016.htm#en_us_publink10008987
You must report the tax on your nondeductible contributions on Form 5330. Form 5330 includes a computation of the tax. See the separate instructions for completing the form.