This is part of fourth section of Anker Reed HSC’s blog series entitled “To Incorporate or Not to Incorporate? That is the Question” regarding the corporate retirement plan.
A corporate retirement plan may include a pension plan, profit-sharing plan or combination of both. A pension plan is “established and maintained by an employer primarily to provide systematically for the payment of definitely determinable benefits to his employees, or their beneficiaries, over a period of years (usually for life) after retirement.” (Blacks Law Dictionary)
A profit-sharing plan is established and maintained by an employer to provide for the participation in the profits of the company by the employees or their beneficiaries. A corporate retirement plan may be qualified or non-qualified in order to take advantage of the tax benefits available. If the corporate retirement plan is qualified according to § 401, special tax status attaches. First, the amount of the contribution will be deductible to the corporation under §404(a)(1) for pension plans and § 404(a)(3) for profit-sharing plans. Second, “Any amount actually distributed to any distributed by any employees’ trust described in section 401(a) which is exempt from tax under section 501(a) shall be taxable to the distributee, in the taxable year of the distributee in which distributed”. (§ 402 Supp., 2000) Therefore, § 402 provides for tax deferral until the corporate retirement plan distributes to the beneficiary. For example, if a corporation makes a $10,000 contribution to a corporate retirement plan in the name of the individual employee, the corporation will be allowed to deduct this amount from taxable income and the individual will not be taxed on this amount in the year of the contribution! The contribution is placed into the corporate retirement account where it appreciates tax-deferred; the individual will be taxed on the amount when the retirement account distributes its corpus to the individual participant.
For the noncorporate taxpayer, usually a member of a union pension plan, the only deductible retirement contribution available would be an Individual Retirement Account (IRA). The deductibility of IRA contributions is limited when the individual is an active participant in a retirement plan maintained by an employer. For such individuals the IRA contribution is phased-out at certain AGI levels ($31,000-$41,000 for 1999).
Therefore, the noncorporate taxpayer may not receive the current tax benefit of the contribution because the contribution will be made with after-tax earnings. The corporate retirement plan has no comparable limitation.
* For specific inquiries regarding a business legal matter that you may have, you are contact our Business Lawyer in Los Angeles.