The passage of the Tax Cuts & Jobs Act at the end of 2017 brought with it changes that will affect all Americans, from individual taxpayers to corporations and retirement plan sponsors. Here are the key changes that you need to be familiar with if your company sponsors a retirement plan:
Plan Loans
Starting January 1, 2018, things have gotten easier for employees who are terminated with outstanding loan balances. Plan participants now have until the due date of their tax return (including extensions) for the year during which the loan was deemed a distribution to pay it back and avoid a penalty. A former employee may choose to deposit an amount equal to the loan balance into an IRA in order to avoid a taxable event.
Reclassification of Roth Conversions
Effective January 1, 2018, you can no longer reclassify a Roth conversion. If you convert a pre-tax account to a Roth, you cannot change your mind and undo it.
Relief for Disaster Areas
Plan participants in 2016 federally declared disaster areas get relief under the new laws. They will owe no excise tax and are allowed to repay distributions made in 2017.
People affected by the recent California wildfires can take up to a $100,000 distribution from their retirement account without facing early withdrawal penalties. Some affected participants may also qualify to take a $100,000 loan from a qualified plan with an extended repayment period.
Hardship Withdrawals
Beginning January 1, 2019, employees who take hardship withdrawals are no longer required to stop 401(k) deferrals for 6 months. The withdrawals can also include earnings on their 401(k) and 403(b) deferrals. Participants are also no longer required to take all available loans prior to taking a hardship withdrawal.
Tax Cuts & Jobs Act: What Hasn’t Changed
Deferrals for 401(k) plans were unaffected by the new legislation. Also, employer contributions for C corporations were also unaffected. Generally, smaller C-corps can continue to use their profit sharing contribution to zero out taxable profits and avoid double taxation on dividends.
20% Deduction: Do Employer Contributions Still Make Sense With The Deduction?
The new 20% deduction for non-service-based pass-through entities reduces the tax incentive to make employer contributions. This is because, with the deduction, the marginal rate can be as low as 29.6% on K-1 income as opposed to the 37% marginal rate on ordinary income. However, not all of these companies will get the full deduction. The deduction is limited to the lesser of:
- 20% of the qualified business income from the taxpayer’s trade or business or the greater of:
- 50% of the total W-2 wages of the business paid to all employees; or
- 25% of the W-2 wages plus 2.5% of the original acquisition cost of the business’s real property.
Even with the full deduction, employer contributions do still make sense. Here is a comparison of how a $50,000 contribution earning 7% a year would perform in a qualified retirement plan and out of one, including the tax consequences:
Even with the 20% deduction, there is still a $23,057 benefit for contributing to a retirement plan.
20% Deduction: How Employer Contributions Can Help With Eligibility
The new 20% deduction gives S corporations and other pass-through professional service entities (not including architects and engineers) an even greater incentive to contribute to a retirement plan. Making plan contributions can help bring their taxable income below the $315,000 threshold to be eligible for the deduction.
Contributions to retirement plans do count in reducing income in order to get the deduction. Here is a comparison of the tax li ability for a business owner making $415,000 both with and without a $100,000 contribution to a retirement plan:
For this business owner, making the retirement plan contribution resulted in saving $42,769 on taxes.
Even with all the changes in the law, it still makes sense for businesses to offer a retirement plan and incredible tax savings can be reaped by contributing to one. If you have any questions about the new laws or sponsoring a retirement plan, please contact our office today.
The Farmer & Betts team offers the highest level of expertise and service, as well as an ERISA attorney on staff and an experienced compliance department. We are happy to support you with specialized plan design and competitive fees. Contact us by phone at 1.888.565.9887 to learn more.