This week, Gail answers a SEP IRA-related question — and helps us figure out our tax savings for each income level

Hello Gail;

Are there any increases in the SEP IRAS?

Thanks, Diane

 

Dear Diane,

In a nutshell: yes and no. As regular readers of this column know, the 2001 Tax Act signed into law by President Bush last June substantially increases the amounts both you and your employer can contribute to your company retirement account.

"SEP," which stands for "Simplified Employee Pension," is a type of retirement plan only available to companies with 25 employees or less. It's especially common among self-employed individuals who are both the owner of a business and its sole employee.

As with all retirement plans, the company gets a tax deduction for whatever amount it contributes to employees' accounts. Under current law, the maximum contribution an employer can make to a SEP account is 15% of compensation. For reasons too complex to go into here, a business owner is limited to contributing 13.04% to their own personal account.

The problem is, there's a glitch in the Economic Growth and Tax Relief Reconciliation Act (a.k.a. "EGTRRA"), according to Martha Priddy Patterson, a director in Human Capital Advisory Services at the accounting firm Deloitte & Touche. Next year, the new law allows a company to increase its contribution to a SEP plan to 25% of compensation. However, the writers of this act forgot to increase the other side of the equation. That is, they failed to raise the amount a company could deduct.

That means a SEP contribution in excess of 15% is not only non-deductible at this point, it is also subject to a penalty, making it highly unlikely that any company is going to be stupid enough increase its 2002 contribution.

To be fair, EGTTRA is a huge piece of legislation. As with most major laws, things inadvertently fall through the cracks. This omission was not intentional. In fact, a spokesperson for the House Ways & Means Committee told me they are very aware of this particular issue and fully intend to fix the mistake when an upcoming "technical corrections" bill is passed.

However, as you can imagine, due to the terrorist attacks and subsequent anthrax scares, Washington is operating in anything but a normal fashion these days. The Ways and Means Committee, which writes all of the legislation affecting spending and taxation, is unable to work in its normal quarters and, in fact, is spread out among several different office buildings. So the mechanics of drafting the corrections bill are more complex than usual.

I fully expect this issue to be cleared up, if not by the end of this year, then by early next year. When that is the case, a company will be able to contribute — and fully deduct — up to 25% of salary on behalf of employees and up to 20% on behalf of the owner.

Keep the faith,

Gail

 

Gail,

You should list a chart showing the tax savings for each income rate.

This would bring it down to a more personal level. Though I know that some are going to fuss when they see what the rich are getting back, but logic says the more you pay in the more you will get back when based on a percentage.

This tax cut will help us all and I thought I would pass along this idea.

Keep up the good work at Fox!

Tim

 

Dear Tim —

Great idea! I agree that it's much easier to relate to "dollars" rather than "percentages."

The good folks at CCH, the respected tax and legal research firm, were kind enough to work up some basic examples. Please keep in mind that it's impossible to customize these — every taxpayer is different.

We made some very basic assumptions. For instance, we assumed the taxpayer would only take the "Standard Deduction" and would not itemize. We also left a lot of other potential deductions out. But I think this should give everyone a "ballpark" idea of the taxes they will save in 2002 compared to what they're paying in 2001.

The table below cover four categories of taxpayers: Single Filer, Head of Household with Two Children, Married Filing Jointly with Two Children and Married with No Children.

The year-over-year tax savings are based on three different income levels: $50,000, $100,000 and $150,000. At income levels lower than this — say, $30,000 — you will not see a big drop in your tax bill from 2001 to 2002 because most of your income will continue to fall in the two lowest brackets: 10% and 15%. It is the higher tax rates which will gradually decline further over the next few years.

So, only if your income falls into these higher brackets will you see much difference. In fact, most taxpayers — and especially those in the lowest brackets — will experience the biggest tax reduction this year, thanks to the introduction of the new 10% rate and the increase in the child tax credit.

Don't forget: you already partially received the benefit of these changes in the form of the rebate checks sent out by the federal government a few months ago.

To use the table, first scroll down to the taxpayer category that you fall into. Then check out the tax savings at the different income levels.

Keep in mind that as the higher income tax rates continue to decline, the amount of tax savings will increase, too.

Thanks for the suggestion, Tim!

Gail

1. Single — No Kids

2001 2002
Adjusted Gross Income 50,000 50,000
Std. Deduction 4,550 4,700
Personal Exemptions 2,900 3,000
--- ---
Taxable Income $42,550 $42,300
Tax 8,320 7,767
Rate Reduction Credit/Rebate (300)
--- ---
Tax 8,020 7,767

 

2001 2002
Adjusted Gross Income 100,000 100,000
Std. Deduction 4,550 4,700
Personal Exemptions 2,900 3,000
--- ---
Taxable Income $92,550 $92,300
Tax 22,880 22,005
Rate Reduction Credit/Rebate (300)
--- ---
Tax 22,580 22,005

 

2001 2002
Adjusted Gross Income 150,000 150,000
Std. Deduction 4,550 4,700
Personal Exemptions 2,494 2,640
--- ---
Taxable Income $142,956 $142,660
Tax 38,564 37,184
Rate Reduction Credit/Rebate (300)
--- ---
Tax 38,264 37,184

 

2. Head of Household — 2 Children Qualifying for the Child Credit

2001 2002
Adjusted Gross Income 50,000 50,000
Std. Deduction 6,650 6,900
Personal Exemptions 8,700 9,000
--- ---
Taxable Income $34,650 $34,100
Tax 5,198 4,615
Rate Reduction Credit/Rebate (500)
Child Tax Credit (1,200) (1,200)
--- ---
Tax 3,498 3,415

 

2001 2002
Adjusted Gross Income 100,000 100,000
Std. Deduction 6,650 6,900
Personal Exemptions 8,700 9,000
--- ---
Taxable Income $84,650 $84,100
Tax 18,748 17,713
Rate Reduction Credit/Rebate (500)
Child Tax Credit (0) (0)
--- ---
Tax 18,248 17,713

 

2001 2002
Adjusted Gross Income 150,000 150,000
Std. Deduction 6,650 6,900
Personal Exemptions 8,700 9,000
--- ---
Taxable Income $134,650 $134,100
Tax 33,728 32,335
Rate Reduction Credit/Rebate (500)
Child Tax Credit (0) (0)
--- ---
Tax 33,228 32,335

 

3. Married Filing Jointly — 2 children qualifying for the child credit

2001 2002
Adjusted Gross Income 50,000 50,000
Std. Deduction 7,600 7,850
Personal Exemptions 11,600 12,000
--- ---
Taxable Income $30,800 $30,150
Tax 4,620 3,923
Rate Reduction Credit/Rebate (600)
Child Tax Credit (1,200) (1,200)
--- ---
Tax 2,820 2,723

 

2001 2002
Adjusted Gross Income 100,000 100,000
Std. Deduction 7,600 7,850
Personal Exemptions 11,600 12,000
--- ---
Taxable Income $80,800 $80,150
Tax 16,570 15,437
Rate Reduction Credit/Rebate (600)
Child Tax Credit (1,200) (1,200)
--- ---
Tax 14,770 14,237

 

2001 2002
Adjusted Gross Income 150,000 150,000
Std. Deduction 7,600 7,850
Personal Exemptions 11,600 12,000
--- ---
Taxable Income $130,800 $130,150
Tax 30,967 29,456
Rate Reduction Credit/Rebate (600)
Child Tax Credit (0) (0)
--- ---
Tax 30,367 29,456

 

4. Married Filing Jointly — No Children

2001 2002
Adjusted Gross Income 50,000 50,000
Std. Deduction 7,600 7,850
Personal Exemptions 5,800 6,000
--- ---
Taxable Income $36,600 $36,150
Tax 5,490 4,823
Rate Reduction Credit/Rebate (600)
  --- ---
Tax 4,890 4,823

 

2001 2002
Adjusted Gross Income 100,000 100,000
Std. Deduction 7,600 7,850
Personal Exemptions 5,800 6,000
--- ---
Taxable Income $86,600 $86,150
Tax 18,165 17,057
Rate Reduction Credit/Rebate (600)
--- ---
Tax 17,565 17,057

 

2001 2002
Adjusted Gross Income 150,000 150,000
Std. Deduction 7,600 7,850
Personal Exemptions 5,800 6,000
--- ---
Taxable Income $136,600 $136,150
Tax 32,736 31,256
Rate Reduction Credit/Rebate (600)
--- ---
Tax 32,138 31,256

 

If you have a question for Gail Buckner and the Your $ Matters column, send them to moneymatters@foxnews.com along with your name and phone number.

The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.