You Asked Us - Establishing and Maintaining a SIMPLE IRA or a SEP IRA

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Q. What definition of compensation should we use when making either the 3% employer matching contribution or the 2% nonelective contribution to our SIMPLE IRA plan?

A. When an employer makes either the 3% matching contribution or the 2% nonelective contribution on behalf of a SIMPLE IRA plan participant, it is based on the participant’s wages subject to income tax withholding plus the amount of salary reduction contributions, if any, made by the participant. Wages subject to income tax withholding are defined in Code §3401(a) and this is the amount shown in box 1 of an employee’s Form W-2. Salary deferrals are reported on box 12, Code S. In addition, to permit SIMPLE IRA plans to be established for domestic help, compensation includes amounts paid for domestic service in a private home, local college club, or local chapter of a college fraternity or sorority, even though such amounts are not wages under §3401(a).

The cap on the amount of compensation that can be considered for contribution purposes ($230,000 for 2008), which applies to most employer retirement plans, applies only to the 2% nonelective contribution.

In the case of a self-employed individual participating in a SIMPLE IRA plan, the 3% matching contribution or the 2% nonelective contribution is based on net earnings from self-employment determined under §1402(a) (Form 1040, Schedule SE, Section A, line 4 or Section B, line 6) prior to subtracting any contributions made under the SIMPLE IRA plan on the individual’s behalf. Compensation for a self-employed individual also includes amounts paid for services performed by members of certain religious faiths that have received exemptions from the self-employment tax.

For additional information, see:

Pub 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans)
Pub 590, Individual Retirement Arrangements (IRAs)
Retirement Plans FAQs regarding SIMPLE IRA Plans

*******This Q&A was taken from the IRS's Summer 2008 Employee Plan Newsletter ******

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