Can I Claim SIMPLE IRA Contributions on My Taxes?

by Herb Kirchhoff

The Internal Revenue Service (IRS) offers an individual retirement arrangement (IRA) known as the Savings Incentive Match Plan for Employees (SIMPLE IRA). This type of tax-deferred IRA offers small businesses a way to contribute to employees’ retirement savings funds without having to establish a pension plan. Employees also contribute to a SIMPLE IRA. Both the employee and his employer get a tax break on their contributions

Salary Reduction

An employee can’t claim a SIMPLE IRA contribution directly as a deduction on an income tax return. But the employee will get an equivalent tax benefit for IRA contributions by a different route. The employee makes a SIMPLE IRA contribution through a salary reduction rather than an out-of-pocket payment. The salary the employer reports on Form W-2 is reduced by the employee’s SIMPLE IRA contribution amount. For example, if the employee earned $20,000 and contributed $1,000 to his SIMPLE IRA, the W-2 for the year would set wages, tips and other compensation at $19,000.

Contribution Limits

Employees can contribute up to $11,500 to their SIMPLE IRA plan, or $14,000 if they are age 50 or older. Employers must match the employee contribution up to the lesser of 3 percent of the employee’s annual salary or the $11,500 limit. But employers can elect to contribute a fixed amount equal to 2 percent of the employee’s annual salary, instead of making matching contributions. Employers also can elect to match only 1 percent or 2 percent of the employee’s salary. Employers can’t put any restrictions on the amount an employee contributes to a SIMPLE IRA account, other then the limits specified by the IRS.

Employer Deduction

The employer can deduct contributions to employees’ SIMPLE IRA plans. For an employee with a $20,000 salary, the employer must make a matching contribution of $600 to the employee’s plan (3 percent of $20,000). If the employer elected the fixed 2 percent contribution, he would contribute $400 to the plan. If he were matching only 1 percent, he would contribute $200 to the employee’s plan. The employer must decide at the start of each plan year whether to make matching or fixed contributions to employees’ SIMPLE IRA accounts, and whether to match at 3 percent or a lesser rate. The employer must contribute his required share or his SIMPLE IRA plan will lose its special tax status.

DIstributions

Distributions from a SIMPLE IRA are treated the same as distributions from other tax-deferred IRAs. If you are over age 59 1/2, your distribution is subject to income taxes only. If you withdraw before age 59 1/2, you will also have to pay a 10 percent early withdrawal tax penalty unless you qualify for a hardship distribution. If the SIMPLE IRA was open for less than two years, the tax penalty on early withdrawals is 25 percent. Tax-free rollovers of a SIMPLE IRA account can only be to another SIMPLE IRA. Rollovers to any other type of IRA will be treated as a cash distribution to yourself and you will owe tax and a penalty on the amount rolled over.

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