Tax Breaks on the Way

This week, Gail explains how the new Tax Act will help small businesses and clarifies the rules on income limits for Roth IRAs.

Gail,

I'm wondering what — if anything — in the new tax law will help small business owners? Is there anything I should be aware of when the new year starts in a couple of weeks?

Linda

Dear Linda,

Congress understands that small businesses are the engine that drives job creation. The folks in Washington have also finally heard what business owners such as yourself have been complaining about for years: that the costs and red tape involved in setting up retirement plans is one of the main reasons small employers tend to not offer them.

Starting in January, here are a few of the ways these problems are addressed, thanks to the 2001 Tax Act:

- Companies with 100 or fewer employees that establish a new retirement plan can get a tax credit (much more beneficial than a tax "deduction") of up to $500/year for three years to offset the costs of setting up and administering the plan.

- The IRS will review your plan for free — instead of assessing its usual fees — to see if it meets federal guidelines for a "qualified" retirement plan. The cost of getting a so-called "determination letter" can run into hundreds of thousands of dollars, so the savings could be substantial.

- The amount you can contribute to a "SIMPLE" plan increases from $6,500 to $7,000 in 2002 and continues rising through 2005 when it hits $10,000. In addition, participants who are over age 50 can contribute an extra $500 next year and an additional $1,000 starting in 2003. These "Savings Incentive Match Plans" were introduced a few years ago and were specifically designed for small businesses; they involve a lot less record-keeping than a full-blown retirement plan such as a 401(k) and are inexpensive to start and maintain.

- For complex reasons, many small business owners who wanted to sock away as much as possible in a retirement plan during prosperous years, but didn't want to be forced to contribute the same percentage in leaner years had no choice but to adopt two plans. Thanks to the new law, you can achieve maximum flexibility with a profit-sharing plan alone, reducing the cost of maintaining two plans.

- Typically, the owner of a small business is the highest paid employee. But the amount the company was allowed to contribute to the boss's account was limited. That amount is going up, meaning company owners will be able to set aside more on their own behalf.

- Of course, the main incentive for a company to contribute to a retirement plan for its employees is the fact that this is tax deductible. Next year, the amount of the deduction is increasing.

- Small and medium-size companies will also get a bigger deduction for providing day-care for employees' children. Whether you are your company's sole employee or the boss of up to 100, now would be a good time to talk with a tax professional about how you can take advantage of these and other tax breaks coming in 2002.

Hope this helps,

Gail

Gail,

What should people do when their income during the year might be anywhere from $145,000 to 165,000? We already contributed to Roth IRAs this year, but with retroactive raises, interest rates going down, etc. we have no idea whether we'll still be eligible. How late can we wait if we need to "re-characterize" them as regular IRAs?

Ray

Dear Ray,

Relax! Believe it or not, the writers of the tax code anticipated just such a dilemma. As you are aware, in order to contribute the full amount to a Roth IRA*, your "modified adjusted gross income" cannot exceed $95,000 if you're single or $150,000 if you're married.

You're allowed to make a partial contribution until your income hits $110,000 (single) or $160,000 (married). Above these levels, you're simply out of luck. No Roth contribution is allowed at all.

But if you're close to these dollar amounts, it's tough to know where you're going to stand until the year is over and you've had a chance to tally up all your income.

The good news is, if you end up exceeding the income limits for a Roth IRA, you can undo your contribution so you don't run afoul of the law. In IRS-speak, you would "re-characterize" your Roth contribution as a non-deductible, traditional IRA contribution. Every IRA sponsor has a form to handle this.

The deadline line for setting the record straight is up until you file your 2001 tax return, including extensions. Theoretically, that gives you until October 15, 2002 to correct the situation.

So, take a deeeeep breath and enjoy the holidays,

Gail

*$2,000 in 2001; $3,000 in 2002.

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.