By Catherine Gordon, Toolkit Staff Writer
For many taxpayers, the 2006 tax season was extended beyond the April 17 filing deadline for a variety of reasons. If you're a calendar year taxpayer that filed IRS Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, for an automatic six-month filing extension, you have until October 15, 2007, to file your required tax forms. While many of the planning opportunities for tax savings for 2006 ended as of the April 17 filing deadline, if you are self-employed and have a Keogh retirement plan in place, you still may be able to take advantage of deductions for contributions to a retirement plan for the 2006 tax year.
Basically, a Keogh plan is a qualified retirement plan for the self-employed. You are eligible to establish a Keogh plan if you own a business or part of a business that is not incorporated. You must be operating as a sole proprietorship, a partnership, or a limited liability company (LLC). You must actually perform personal services for the business; mere passive investment is not enough.
Keogh plans are more flexible than simplified employee pensions (SEPs), and they allow you to save more toward your retirement. As a result, they are more often used by high-income business owners than are SEPs. Also, Keoghs can be set up as defined-benefit plans or as defined-contribution plans, whereas SEPs must be defined-contribution plans.
Both cash-basis and accrual-basis taxpayers may make Keogh contributions after the close of the taxable year if they are made on or before the due date, including extensions, for filing the income tax return for that tax year. However, you must have had the Keogh set up by the end of the tax year in order for your contributions made to it to be deductible for that tax year.
What if you missed the end-of-the-year deadline for establishing a Keogh plan? You can still establish a simplified employee pension (SEP), as long as you do so by the due date, including extensions, of your income tax return. Establishing a SEP in this way does not mean you can't establish a Keogh later.
The amount of the contribution you can make to your Keogh plan is determined by the amount of your earned income for the year. Earned income is defined as your gross income from a trade or business, less any allowable deductions. Remember, income received by a passive partner is considered to be investment income rather than earned income.
The limitations on contributions depend on the type of Keogh plan. A Keogh defined-benefit plan is limited to the amount needed to eventually produce an annual pension payment of the lesser of (1) $175,000 or (2) 100 percent of your average compensation for your three highest years. A Keogh defined-contribution plan contribution is limited to the lesser of $44,000 for 2006, or 100 percent of the participant's earned income for the year.
The rules for deductions by self-employed individuals are as follows:
- If the self-employed person is a sole proprietor, the person can take the entire deduction on the individual income tax return.
- If the self-employed person is a partner, the partner can take the amount of the contribution made by the partnership on the partner's behalf.
- A partner, however, cannot deduct contributions made on behalf of his or her common-law employees (since that deduction is taken by the partnership and is ultimately reflected in the partner's distributable share).
- If an owner-employee is engaged in more than one business, but only one business has a Keogh plan, contributions and deductions to that plan on behalf of the owner-employee can be based only on the earned income from the business that has the plan.
As you can see, the rules regarding the deductibility of contributions to retirement plans can be complex and a tax professional's assistance may be necessary. The final deadline for filing tax returns for 2006 will be here before you know it. Therefore, there's no time like the present to put the plans in motion in order to be able to avail yourself of the opportunity to save money in the form of a tax deduction and save for your retirement as well.
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Added to the news on May 23, 2007.
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