Definitions You Need To Know Some of the terms used in this publication are defined below. Thesame term used in another publication may have a slightly differentmeaning. Annual additions.Annual additions are the total amounts of all your contributions ina year, employee contributions (not including rollovers), andforfeitures allocated to a participant's account. Annual benefits.Annual benefits are the benefits to be paid yearly in the form of astraight life annuity (with no extra benefits) under a plan to whichemployees do not contribute and under which no rollover contributionsare made. Business.A business is an activity in which a profit motive is present andsome type of economic activity is involved. Service as a newspapercarrier under age 18 is not a business, but service as a newspaperdealer is. Service as a sharecropper under an owner-tenant arrangementis a business. Service as a public official is not. Common-law employee.A common-law employee is any individual who, under common law,would have the status of an employee. A leased employee can also be acommon-law employee. A common-law employee is a person who performs services for anemployer who has the right to control and direct both the results ofthe work and the way in which it is done. For example, the employer: Provides the employee's tools, materials, and workplace,and Can fire the employee. Common-law employees are not self-employed and cannot set upretirement plans with respect to income from their work, even if thatincome is self-employment income for social security tax purposes. Forexample, common-law employees who are ministers, members of religiousorders, full-time insurance salespeople, and U.S. citizens employed inthe United States by foreign governments cannot set up retirementplans with respect to their earnings from those employments, eventhough their earnings are treated as self-employment income. However, a common-law employee can be self-employed as well. Forexample, an attorney can be a corporate common-law employee duringregular working hours and also practice law in the evening as aself-employed person. In another example, a minister employed by acongregation for a salary is a common-law employee even though thesalary is treated as self-employment income for social security taxpurposes. However, fees reported on Schedule C (Form 1040) forperforming marriages, baptisms, and other personal services areself-employment earnings for qualified plan purposes. Compensation.Compensation for plan allocations is the pay a participant receivedfrom you for personal services for a year. You can generally definecompensation as including all the following payments. Wages and salaries. Fees for professional services. Other amounts received (cash or noncash) for personalservices actually rendered by an employee, including, but not limitedto, the following items. Commissions and tips. Fringe benefits. Bonuses. For a self-employed individual, compensation means the earnedincome, discussed later, of that individual. Compensation also includes amounts deferred in the followingemployee benefit plans, unless you choose not to include any amountcontributed under a salary reduction agreement (that is not includedin the gross income of the employee). Qualified cash or deferred arrangement (section 401(k)plan). Salary reduction agreement to contribute to a tax-shelteredannuity (section 403(b) plan), a SIMPLE IRA plan, or a SARSEP. Section 457 nonqualified deferred compensation plan. Section 125 cafeteria plan. The limit on elective deferrals is discussed later underSalary Reduction Simplified Employee Pension (SARSEP) andQualified Plans (Keogh Plans). Other options. In figuring the compensation of a participant, you can treatany of the following amounts as the employee'scompensation. The employee's wages as defined for income tax withholdingpurposes. The employee's wages that you report in box 1 of FormW-2. The employee's social security wages (including electivedeferrals). Compensation generally cannot include either of the followingitems. Reimbursements or other expense allowances (unless paidunder a nonaccountable plan). Deferred compensation (either amounts going in or amountscoming out), other than certain elective deferrals, unless you choosenot to include those elective deferrals in compensation. Contribution.A contribution is an amount you pay into a plan for all those(including self-employed individuals) participating in the plan.Limits apply to how much, under the contribution formula of the plan,can be contributed each year for a participant. Deduction.A deduction is the amount of plan contributions you can subtractfrom gross income on your federal income tax return. Limits apply tothe amount deductible. Earned income.Earned income is net earnings from self-employment,discussed later, from a business in which your servicesmaterially helped to produce the income. You can also have earned income from property that your personalefforts helped create, such as books or inventions on which you earnroyalties. Earned income includes net earnings from selling orotherwise disposing of the property, but it does not include capitalgains. It includes income from licensing the use of property otherthan goodwill. If you have more than one business, but only one has a retirementplan, only the earned income from that business is considered for thatplan. Employer.An employer is generally any person for whom an individual performsor did perform any service, of whatever nature, as an employee. A soleproprietor is treated as his or her own employer for retirement planpurposes, and a partnership is the employer of each partner. A partneris not an employer for retirement plan purposes. Highly compensated employees.Highly compensated employees are individuals who: Owned more than 5% of the capital or profits in yourbusiness at any time during the year or the preceding year, or For the preceding year, received compensation from you ofmore than $80,000 and, if you so choose, was in the top 20% ofemployees when ranked by compensation. Leased employee.A leased employee who is not your common-law employee mustgenerally be treated as your employee for retirement plan purposes ifhe or she does all the following. Provides services to you under an agreement between you anda leasing organization. Has performed services for you (or for you and relatedpersons) substantially full time for at least 1 year. Performs services under your primary direction orcontrol. Exception.A leased employee is not treated as your employee if the employeeis covered by the leasing organization under its qualified pensionplan and leased employees are not more than 20% of your nonhighlycompensated work force. The leasing organization's plan must be amoney purchase pension plan that has all the following provisions. Immediate participation. Full and immediate vesting. A nonintegrated employer contribution rate of at least 10%of compensation for each participant. However, if the leased employee is your common-law employee,that employee will be your employee for all purposes, regardless ofany pension plan of the leasing organization. Net earnings from self-employment.For SEP and qualified plans, net earnings from self-employment isyour gross income from your trade or business (provided your personalservices are a material income-producing factor) minus allowabledeductions for your business. Allowable deductions includecontributions to SEP and qualified plans for common-law employees andthe deduction allowed for one-half of your self-employment tax. Net earnings from self-employment do not include items that areexcluded from gross income (or their related deductions) other thanforeign earned income and foreign housing cost amounts. For the deduction limits, earned income is net earnings forpersonal services actually rendered to the business. You take intoaccount the income tax deduction for one-half of self-employment taxand the deduction for contributions to the plan made on your behalfwhen figuring net earnings. Net earnings include a partner's distributive share of partnershipincome or loss (other than separately stated items, such as capitalgains and losses). It does not include income passed through toshareholders of S corporations. Guaranteed payments to limitedpartners are net earnings from self-employment if they are paidfor services to or for the partnership. Distributions of other incomeor loss to limited partners are not net earnings from self-employment. For SIMPLE plans, net earnings from self-employment is the amounton line 4 of Short Schedule SE (Form 1040) before subtracting anycontributions made to the SIMPLE IRA plan for yourself. Participant.A participant is an eligible employee who is covered byyour retirement plan. See the discussions of the different types orplans for the definition of an employee eligible to participate in theplan. Partner.A partner is an individual who shares ownership of anunincorporated trade or business with one or more persons. Forretirement plans, a partner is treated as an employee of thepartnership. Self-employed individual.An individual in business for himself or herself is self-employed.Sole proprietors and partners are self-employed. Self-employment caninclude part-time work. Not everyone who has net earnings from self-employment for socialsecurity tax purposes is self-employed for qualified plan purposes.See Common-law employee, earlier. Also see Netearnings from self-employment. In addition, certain fishermen may be considered self-employed forsetting up a qualified plan. See Publication 595, Tax Highlightsfor Commercial Fishermen, for the special rules that are used todetermine whether fishermen are self-employed. Sole proprietor.A sole proprietor is an individual who owns an unincorporatedbusiness by himself or herself. For retirement plans, a soleproprietor is treated as both an employer and an employee.