Qualified Plans (Keogh Plans) A qualified employer plan set up by a self-employed individual issometimes called a Keogh or HR-10 plan. A sole proprietor or apartnership can set up a qualified plan. A common-law employee or apartner cannot set up a qualified plan. The plans described here canalso be set up and maintained by employers that are corporations. Allthe rules discussed here apply to corporations except wherespecifically limited to the self-employed. The plan must be for the exclusive benefit of employees or theirbeneficiaries. A qualified plan can include coverage for aself-employed individual. A self-employed individual is treatedas both an employer and an employee. As an employer, you can usually deduct, subject to limits,contributions you make to a qualified plan, including those made foryour own retirement. The contributions (and earnings and gains onthem) are generally tax free until distributed by the plan. Kinds of Plans There are two basic kinds of qualified plans --definedcontribution plans and defined benefitplans--and different rules apply to each. You can have morethan one qualified plan, but your contributions to all the plans mustnot total more than the overall limits discussed underContributions and Employer Deduction, later. Defined Contribution Plan A defined contribution plan provides an individual account for eachparticipant in the plan. It provides benefits to a participant largelybased on the amount contributed to that participant's account.Benefits are also affected by any income, expenses, gains, losses, andforfeitures of other accounts that may be allocated to an account. Adefined contribution plan can be either a profit-sharing plan or amoney purchase pension plan. Profit-sharing plan.A profit-sharing plan is a plan for sharing your business profitswith your employees. However, you do not have to make contributionsout of net profits to have a profit-sharing plan. The plan does not need to provide a definite formula for figuringthe profits to be shared. But, if there is no formula, there must besystematic and substantial contributions. The plan must provide a definite formula for allocating thecontribution among the participants and for distributing theaccumulated funds to the employees after they reach a certain age,after a fixed number of years, or upon certain other occurrences. In general, you can be more flexible in making contributions to aprofit-sharing plan than to a money purchase pension plan (discussednext) or a defined benefit plan (discussed later). But the maximumdeductible contribution may be less under a profit-sharing plan (seeLimits on Contributions and Benefits, later). Forfeitures under a profit-sharing plan can be allocated to theaccounts of remaining participants in a nondiscriminatory way or theycan be used to reduce your contributions. Money purchase pension plan.Contributions to a money purchase pension plan are fixed and arenot based on your business profits. For example, if the plan requiresthat contributions be 10% of the participants' compensation withoutregard to whether you have profits (or the self-employed person hasearned income), the plan is a money purchase pension plan. Thisapplies even though the compensation of a self-employed individual asa participant is based on earned income derived from business profits. Defined Benefit Plan A defined benefit plan is any plan that is not a definedcontribution plan. Contributions to a defined benefit plan are basedon what is needed to provide definitely determinable benefits to planparticipants. Actuarial assumptions and computations are required tofigure these contributions. Generally, you will need continuingprofessional help to have a defined benefit plan. Forfeitures under a defined benefit plan cannot be used to increasethe benefits any employee would otherwise receive under the plan.Forfeitures must be used instead to reduce employer contributions. Setting Up a Qualified Plan There are two basic steps in setting up a qualified plan. First youadopt a written plan. Then you invest the plan assets. You, the employer, are responsible for setting up and maintainingthe plan. TaxTip: If you are self-employed, it is not necessary to have employeesbesides yourself to sponsor and set up a qualified plan. If you haveemployees, see Eligible Employees, later. Set-up deadline.To take a deduction for contributions for a tax year, your planmust be set up (adopted) by the last day of that year (December 31 forcalendar-year employers). Adopting a Written Plan You must adopt a written plan. The plan can be an IRS-approvedmaster or prototype plan offered by a sponsoring organization. Or itcan be an individually designed plan. Written plan requirement.To qualify, the plan you set up must be in writing and must becommunicated to your employees. The plan's provisions must be statedin the plan. It is not sufficient for the plan to merely refer to arequirement of the Internal Revenue Code. Master or prototype plans.Most qualified plans follow a standard form of plan (a master orprototype plan) approved by the IRS. Master and prototype plans areplans that are made available by plan providers for adoption byemployers (including self-employed individuals). Under a master plan,a single trust or custodial account is established, as part of theplan, for the joint use of all adopting employers. Under a prototypeplan, a separate trust or custodial account is established for eachemployer. Plan providers.The following organizations generally can provide IRS-approvedmaster or prototype plans. Banks (including some savings and loan associations andfederally insured credit unions). Trade or professional organizations. Insurance companies. Mutual funds. Individually designed plans.If you prefer, you can set up an individually designed plan to meetspecific needs. Although advance IRS approval is not required, you canapply for approval by paying a fee and requesting a determinationletter. You may need professional help for this. Revenue Procedure99-6 may help you decide whether to apply for approval of yourplan. Revenue Procedure 99-6 is in Internal Revenue Bulletin No.1999-1. It is also available at most IRS offices and at somelibraries. Investing Plan Assets In setting up a qualified plan, you arrange how the plan's fundswill be used to build its assets. You can establish a trust or custodial account to invest thefunds. You, the trust, or the custodial account can buy an annuitycontract from an insurance company. Life insurance can be includedonly if it is incidental to the retirement benefits. You, the trust, or the custodial account can buy face-amountcertificates from an insurance company. These certificates are treatedlike annuity contracts. You set up a trust by a legal instrument (written document). Youmay need professional help to do this. You can set up a custodial account with a bank, savings and loanassociation, credit union, or other person who can act as the plantrustee. You do not need a trust or custodial account, although you can haveone, to invest the plan's funds in annuity contracts or face-amountcertificates. If anyone other than a trustee holds them, however, thecontracts or certificates must state that they are not transferable. Eligible Employees An employee must be allowed to participate in your plan if he orshe meets both the following requirements. Has reached age 21. Has at least 1 year of service (2 years if the plan is not a401(k) plan and provides that after not more than 2 years of servicethe employee has a nonforfeitable right to all of his or her accruedbenefit). Caution: A plan cannot exclude an employee because he or she has reached aspecified age. Other plan requirements.For information on other important plan requirements, seeQualification Rules, later. Minimum Funding Requirements In general, if your plan is a money purchase pension plan or adefined benefit plan, you must actually pay enough into the plan tosatisfy the minimum funding standard for each year. Determining theamount needed to satisfy the minimum funding standard is complicated.The amount is based on what should be contributed under the planformula using actuarial assumptions and formulas. For information onthis funding requirement, see section 412 and its regulations. Quarterly installments of required contributions.If your plan is a defined benefit plan subject to the minimumfunding requirements, you must make quarterly installment payments ofthe required contributions. If you do not pay the full installmentstimely, you may have to pay interest on any underpayment for theperiod of the underpayment. Due dates.The due dates for the installments are 15 days after the end ofeach quarter. For a calendar-year plan, the installments are due April15, July 15, October 15, and January 15 (of the following year). Installment percentage.Each quarterly installment must be 25% of the required annualpayment. Extended period for making contributions.Additional contributions required to satisfy the minimum fundingrequirement for a plan year will be considered timely if made by 8 1/2 months after the end of that year. Contributions A qualified plan is generally funded by your contributions.However, employees participating in the plan may be permitted to makecontributions. Contribution deadline.You can make deductible contributions for a tax year up to the duedate of your return (plus extensions) for that year. Self-employed individual.You can make contributions on behalf of yourself only if you havenet earnings (compensation) from self-employment in the trade orbusiness for which the plan was set up. Your net earnings must be fromyour personal services, not from your investments. If you have a netloss from self-employment, you cannot make contributions for yourselffor the year, even if you can contribute for common-law employeesbased on their compensation. When ContributionsAre Considered Made You generally apply your plan contributions to the year in whichyou make them. But you can apply them to the previous year if all thefollowing requirements are met. You make them by the due date of your tax return for theprevious year (plus extensions). The plan was established by the end of the previousyear. The plan treats the contributions as though it had receivedthem on the last day of the previous year. You do either of the following. You specify in writing to the plan administrator or trusteethat the contributions apply to the previous year. You deduct the contributions on your tax return for theprevious year. (A partnership shows contributions for partners onSchedule K (Form 1065).) Employer's promissory note.Your promissory note made out to the plan is not a payment thatqualifies for the deduction. Also, issuing this note is a prohibitedtransaction subject to tax. See Prohibited Transactions,later. Employer Contributions There are certain limits on the contributions and other annualadditions you can make each year for plan participants. There are alsolimits on the amount you can deduct. See Deduction Limits,later. Limits onContributions and Benefits Your plan must provide that contributions or benefits cannot exceedcertain limits. The limits differ depending on whether your plan is adefined contribution plan or a defined benefit plan. Defined benefit plan.For 1999, the annual benefit for a participant under a definedbenefit plan cannot be more than the lesser of thefollowing amounts. $130,000. 100% of the participant's average compensation for his orher highest 3 consecutive calendar years. Defined contribution plan.For 1999, a defined contribution plan's annual contributions andother additions (excluding earnings) to the account of a participantcannot be more than the lesser of the following amounts. $30,000. 25% of the compensation actually paid to theparticipant. The maximum compensation that can be taken into account forthis limit is $160,000. Excess annual additions.Excess annual additions are the amounts contributed that are morethan the limits discussed previously. A plan can correct excess annualadditions caused by any of the following actions. A reasonable error in estimating a participant'scompensation. A reasonable error in determining the amount of electivedeferrals permitted (discussed later). Forfeitures allocated to participants' accounts. Correcting excess annual additions.A plan can provide for the correction of excess annual additions inthe following ways. Allocate and reallocate the excess to other participants inthe plan to the extent of their unused limits for the year. If these limits are exceeded, do one of the following. Hold the excess in a separate account and allocate (andreallocate) it to participants' accounts in the following year (oryears) before making any contributions for that year (see alsoCarryover of Excess Contributions, later). Return employee after-tax contributions or electivedeferrals (see Employee Contributions and ElectiveDeferrals (401(k) Plans), later). Tax treatment of returned contributions or distributedelective deferrals.The return of employee after-tax contributions or the distributionof elective deferrals to correct excess annual additions is considereda corrective payment rather than a distribution of accrued benefits.The penalties for early distributions and excess distributions do notapply. These disbursements are not wages reportable on FormW-2. You must report them on a separate Form 1099-R asfollows. Report the total amount of the distribution, includingemployee contributions, in box 1. If the distribution includes anygain from the contribution, report the gain in box 2a. Report thereturn of employee contributions in box 5. Enter Code E in box7. Report a distribution of an elective deferral in boxes 1 and2a. Include any gain from the contribution. Leave box 5 blank andenter Code E in box 7. Participants must report these amounts on the line for Totalpensions and annuities on Form 1040 or Form 1040A. Employee Contributions Participants may be permitted to make nondeductible contributionsto a plan in addition to your contributions. Even though theseemployee contributions are not deductible, the earnings on them aretax free until distributed in later years. Also, these contributionsmust satisfy the nondiscrimination test of section 401(m). See Notice98-1 for further guidance and transition relief relating torecent statutory amendments to the nondiscrimination rules undersections 401(k) and 401(m). Notice 98-1 is in Internal RevenueBulletin No. 1998-3. Employer Deduction You can usually deduct, subject to limits, contributions you maketo a qualified plan, including those made for your own retirement. Thecontributions (and earnings and gains on them) are generally tax freeuntil distributed by the plan. Deduction Limits The deduction limit for your contributions to a qualified plandepends on the kind of plan you have. Defined contribution plans.The deduction limit for a defined contribution plan depends onwhether it is a profit-sharing plan or a money purchase pension plan. Profit-sharing plan.Your deduction for contributions to a profit-sharing plan cannot bemore than 15% of the compensation paid (or accrued) duringthe year to your eligible employees participating in the plan. Youmust reduce this 15% limit in figuring the deduction for contributionsyou make for your own account. See Deduction Limit forSelf-Employed Individuals, later. Money purchase pension plan.Your deduction for contributions to a money purchase pension planis generally limited to 25% of the compensation paid (oraccrued) during the year to your eligible employees. You must reducethis 25% limit in figuring the deduction for contributions you makefor yourself, as discussed later. Defined benefit plans.The deduction for contributions to a defined benefit plan is basedon actuarial assumptions and computations. Consequently, an actuarymust figure your deduction limit. Caution: In figuring the deduction for contributions, you cannot take intoaccount any contributions or benefits that are more than the limitsdiscussed earlier under Limits on Contributions and Benefits. Deduction limit for multiple plans.If you contribute to both a defined contribution plan and a definedbenefit plan and at least one employee is covered by both plans, yourdeduction for those contributions is limited. Your deduction cannot bemore than the greater of the following amounts. 25% of the compensation paid (or accrued) during the year toyour eligible employees participating in the plan. You must reducethis 25% limit in figuring the deduction for contributions you makefor your own account. Your contributions to the defined benefit plans, but notmore than the amount needed to meet the year's minimum fundingstandard for any of these plans. Caution: For this rule, a simplified employee pension (SEP) plan is treatedas a separate profit-sharing (defined contribution) plan. Deduction Limit for Self-Employed Individuals If you make contributions for yourself, you need to make a specialcomputation to figure your maximum deduction for these contributions.Compensation is your net earnings from self-employment, definedearlier under Definitions You Need To Know. This definitiontakes into account both the following items. The deduction for one-half of your self-employmenttax. The deduction for contributions on behalf of yourself to theplan. The deduction for your own contributions and your net earningsdepend on each other. For this reason, you determine the deduction foryour own contributions indirectly by reducing the contribution ratecalled for in your plan. To do this, use either the Rate Tablefor Self-Employed or the Rate Worksheet for Self-Employedin the Appendix. Then figure your maximum deductionby using the Deduction Worksheet for Self-Employed in theAppendix. Multiple plans.The deduction limit for multiple plans (discussed earlier) alsoapplies to contributions you make as an employer on your own behalf. Where To Deduct Contributions Deduct the contributions you make for your common-law employees onSchedule C (Form 1040), on Schedule F (Form 1040), or on Form 1065,whichever applies. You take the deduction for contributions for yourself on line 29 ofForm 1040. If you are a partner, the partnership passes its deduction to youfor the contributions it made for you. The partnership will reportthese contributions on Schedule K-1 (Form 1065). You deduct themon line 29 of Form 1040. Carryover ofExcess Contributions If you contribute more to the plans than you can deduct for theyear, you can carry over and deduct the excess in later years,combined with your contributions for those years. Your combineddeduction in a later year is limited to 25% of the participatingemployees' compensation for that year. The limit is 15% if you haveonly profit-sharing plans (including SEPs). Remember that thesepercentage limits must be reduced to figure your maximum deduction forcontributions you make for yourself. See Deduction Limit forSelf-Employed Individuals, earlier. The amount you carry overand deduct may be subject to the excise tax discussed next. Table 2. Carryover of Excess Contributions Illustrated Table 2 illustrates the carryover of excesscontributions to a profit-sharing plan. Excise Tax for Nondeductible (Excess) Contributions If you contribute more than your deduction limit to a retirementplan, you have made nondeductible contributions and you may be liablefor an excise tax. In general, a 10% excise tax applies tonondeductible contributions made to qualified pension, profit-sharing,stock bonus, or annuity plans and to simplified employee pension plans(SEPs). Special rule for self-employed individuals.The 10% excise tax does not apply to any contribution made to meetthe minimum funding requirements in a money purchase pension plan or adefined benefit plan. Even if that contribution is more than yourearned income from the trade or business for which the plan is set up,the difference is not subject to this excise tax. See MinimumFunding Requirements earlier. Exception.The 10% excise tax does not apply to contributions to one or moredefined contribution plans that are not deductible only because theyare more than the combined plan deduction limit, and then only to theextent the excess is not more than the greater of the followingamounts. 6% of the participants' compensation for the year. The sum of employer matching contributions and the electivedeferrals to a 401(k) plan. Reporting the tax.You must report the tax on your nondeductible contributions onForm 5330. Form 5330 includes a computation of the tax. Seethe separate instructions for completing the form. Elective Deferrals(401(k) Plans) Your qualified plan can include a cash or deferred arrangement(401(k) plan) under which participants can choose to have youcontribute part of their before-tax compensation to the plan ratherthan receive the compensation in cash. (As a participant in the plan,you can contribute part of your before-tax net earnings from thebusiness.) This contribution, called an elective deferral,and any earnings on it remain tax free until distributed by theplan. In general, a qualified plan can include a 401(k) plan only if thequalified plan is one of the following plans. A profit-sharing plan. A money purchase pension plan in existence on June 27, 1974,that included a salary reduction arrangement on that date. Partnership.A partnership can have a 401(k) plan. Restriction on conditions of participation.The plan may not require, as a condition of participation, that anemployee complete more than 1 year of service. Matching contributions.If your plan permits, you can make matching contributions for anemployee who makes an elective deferral to your 401(k) plan. Forexample, the plan might provide that you will contribute 50 cents foreach dollar your participating employees choose to defer under your401(k) plan. Nonelective contributions.You can, under a qualified 401(k) plan, also make contributions(other than matching contributions) for your participating employeeswithout giving them the choice to take cash instead. Employee compensation limit.No more than $160,000 of the employee's compensation can be takeninto account when figuring contributions. Limit on Elective Deferrals There is a limit on the amount that an employee can defer each yearunder these plans. This limit applies without regard to communityproperty laws. Your plan must provide that your employees cannot defermore than the limit that applies for a particular year. For 1999, thebasic limit on elective deferrals is $10,000. This limit issubject to annual increases to reflect inflation (as measured by theConsumer Price Index). If, in conjunction with other plans, thedeferral limit is exceeded, the excess is included in the employee'sgross income. Self-employed individual's matching contributions.Matching contributions to a 401(k) plan on behalf of aself-employed individual are not subject to the limit on electivedeferrals. These matching contributions receive the same treatment asthe matching contributions for other employees. Treatment of contributions.Your contributions to a 401(k) plan are generally deductible by youand tax free to participating employees until distributed from theplan. Participating employees have a nonforfeitable right to theaccrued benefit resulting from these contributions. Deferrals areincluded in wages for social security, Medicare, and federalunemployment (FUTA) tax. Reporting on Form W-2.You must report the total amount deferred in boxes 3, 5, and 13 ofyour employee'sForm W-2. See the FormW-2 instructions. Treatment of Excess Deferrals If the total of an employee's deferrals is more than the limit for1999, the employee can have the difference (called an excess deferral)paid out of any of the plans that permit these distributions. He orshe must notify the plan by March 1, 2000, of the amount to be paidfrom each plan. The plan must then pay the employee that amount byApril 17, 2000. Excess withdrawn by April 17.If the employee takes out the excess deferral by April 17, 2000, itis not reported again by including it in the employee's gross incomefor 2000. However, any income earned on the excess deferral taken outis taxable in the tax year in which it is taken out. The distributionis not subject to the additional 10% tax on early distributions. If the employee takes out part of the excess deferraland the income on it, the distribution is treated as madeproportionately from the excess deferral and the income. Even if the employee takes out the excess deferral by April 17, theamount is considered contributed for satisfying (or not satisfying)the nondiscrimination requirements of the plan. See Contributionsor benefits must not discriminate, later, underQualification Rules. Excess not withdrawn by April 17.If the employee does not take out the excess deferral by April 17,2000, the excess, though taxable in 1999, is not included in theemployee's cost basis in figuring the taxable amount of any eventualbenefits or distributions under the plan. In effect, an excessdeferral left in the plan is taxed twice, once when contributed andagain when distributed. Also, if the entire deferral is allowed tostay in the plan, the plan may not be a qualified plan. Reporting corrective distributions on Form 1099-R.Report corrective distributions of excess deferrals (including anyearnings) on Form 1099-R. For specific information aboutreporting corrective distributions, see the 1999 Instructions forForms 1099, 1098, 5498, and W-2G. Tax on excess contributions of highly compensated employees.The law provides tests to detect discrimination in a plan. Iftests, such as the actual deferral percentage test (ADP test)(see section 401(k)(3)) and the actual contributionpercentage test (ACP test) (see section 401(m)(2)), show thatcontributions for highly compensated employees are more than the testlimits for these contributions, the employer may have to pay a10% excise tax. Report the tax on Form 5330. The tax for the year is 10% of the excess contributions for theplan year ending in your tax year. Excess contributions are electivedeferrals, employee contributions, or employer matching or nonelectivecontributions that are more than the amount permitted under the ADP orACP test. See Notice 98-1 for further guidance and transition reliefrelating to recent statutory amendments to the nondiscrimination rulesunder sections 401(k) and 401(m). Notice 98-1 is in InternalRevenue Bulletin No. 1998-3. Distributions Amounts paid to plan participants from a qualified plan are calleddistributions. Distributions may be nonperiodic, such as lump-sumdistributions, or periodic, such as annuity payments. Also, certainloans may be treated as distributions. See Loans Treated asDistributions in Publication 575. Required Distributions A qualified plan must provide that each participant will either: Receive his or her entire interest (benefits) in the plan bythe required beginning date (defined later), or Begin receiving regular periodic distributions by therequired beginning date in annual amounts calculated to distribute theparticipant's entire interest (benefits) over his or her lifeexpectancy or over the joint life expectancy of the participant andthe designated beneficiary. These distribution rules apply individually to each qualified plan.You cannot satisfy the requirement for one plan by taking adistribution from another. These rules may be incorporated in the planby reference. The plan must provide that these rules override anyinconsistent distribution options previously offered. Minimum distribution.If the account balance of a qualified plan participant is to bedistributed (other than as an annuity), the plan administrator mustfigure the minimum amount required to be distributed each distributioncalendar year. This amount is figured by dividing the account balanceby the applicable life expectancy. For details on figuring the minimumdistribution, see Tax on Excess Accumulation in Publication 575. Minimum distribution incidental benefit requirement.Minimum distributions must also meet the minimum distributionincidental benefit requirement. This requirement ensures thatthe plan is used primarily to provide retirement benefits to theemployee. After the employee's death, only "incidental" benefitsare expected to remain for distribution to the employee's beneficiary(or beneficiaries). For more information about this and otherdistribution requirements, see Publication 575. Required beginning date.Generally, each participant must receive his or her entire benefitsin the plan or begin to receive periodic distributions of benefitsfrom the plan by the required beginning date. A participant must begin to receive distributions from his or herqualified retirement plan by April 1 of the year that follows thelater of the following years. Calendar year in which he or she reaches age 70 1/2. Calendar year in which he or she retires. Before 1997, the law did not take into account whether or not theparticipant had retired. A participant was required to begin receivingdistributions by April 1 of the year following the calendar year inwhich the participant reached age 70 1/2. This rule stillapplies if the participant is a 5% owner or the distribution is from atraditional IRA. For more information, see Tax on ExcessAccumulation in Publication 575. Distributions after the starting year.The distribution required to be made by April 1 is treated as adistribution for the starting year. (The starting year is the year inwhich the participant meets (1) or (2) above, whichever applies.)After the starting year, the participant must receive the requireddistribution for each year by December 31 of that year. If nodistribution is made in the starting year, required distributions for2 years must be made in the next year (one by April 1 and one byDecember 31). Distributions after participant's death.See Publication 575 for the special rules covering distributionsmade after the death of a participant. Distributions From 401(k) Plans Generally, a distribution may not be made until one of thefollowing occurs. The employee retires, dies, becomes disabled, or otherwiseseparates from service. The plan ends and no other defined contribution plan isestablished or continued. In the case of a 401(k) plan that is part of aprofit-sharing plan, the employee reaches age 59 1/2 orsuffers financial hardship. For the rules on hardship distributions,including the limits on them, see section 1.401(k)-1(d)(2) ofthe regulations. Caution: Some of the above distributions may be subject to the tax on earlydistributions discussed later. Qualified domestic relations order (QDRO).These distribution restrictions do not apply if the distribution isto an alternate payee under the terms of a QDRO, which is defined inPublication 575. Tax Treatment of Distributions Distributions from a qualified plan minus a prorated part of anycost basis are subject to income tax in the year they are distributed.Since most recipients have no cost basis, a distribution is generallyfully taxable. An exception is a distribution that is properly rolledover as discussed next under Rollover. The tax treatment of distributions depends on whether they are madeperiodically over several years or life (periodic distributions)or are nonperiodic distributions. See Taxationof Periodic Payments and Taxation of Nonperiodic Paymentsin Publication 575 for a detailed description of howdistributions are taxed, including the 5- or 10-year tax option orcapital gain treatment of a lump-sum distribution. Caution: The 5-year tax option is repealed for tax years beginning after1999.    Rollover.The recipient of an eligible rollover distribution froma qualified plan can defer the tax on it by rolling it over into anIRA or another eligible retirement plan. However, it may be subject towithholding as discussed under Withholding requirements,later. Eligible rollover distribution.This is a distribution of all (such as a lump-sum distribution) orany part of an employee's balance in a qualified retirement plan thatis not any of the following. A required minimum distribution. See RequiredDistributions, earlier. An annual (or more frequent) payment under a long-term (10years or more) annuity contract or as part of a similar long-termseries of substantially equal periodic distributions. A hardship distribution. The portion of a distribution that represents the return ofan employee's nondeductible contributions to the plan. SeeEmployee Contributions, earlier. A corrective distribution of excess contributions ordeferrals under a 401(k) plan and any income allocable to the excess,or of excess annual additions and any allocable gains. SeeCorrecting excess annual additions, earlier, underLimits on Contributions and Benefits. Caution: Hardship distributions from a 401(k) plan that occur after 1998cannot be rolled over into an IRA or other eligible retirement plan.They are subject to the 10% additional tax on early distributions.However, they are not subject to the 20% withholding tax thatgenerally applies to eligible rollover distributions that are nottransferred directly to another retirement plan or IRA. The IRS has made application of this new rule optional for 1999.For more information, see Notice 99-5 in Internal RevenueBulletin No. 1999-3. More information.For more information about rollovers, see Rollovers inPublications 575 and 590. Withholding requirements.If, during a year, a qualified plan pays to a participant one ormore eligible rollover distributions (defined earlier) thatare reasonably expected to total $200 or more, the payor must withhold20% of each distribution for federal income tax. Exceptions.If, instead of having the distribution paid to him or her, theparticipant chooses to have the plan pay it directly to an IRA oranother eligible retirement plan (a direct rollover), nowithholding is required. If the distribution is not an eligible rollover distribution,defined earlier, the 20% withholding requirement does not apply. Otherwithholding rules apply to distributions such as long-term periodicdistributions and required distributions (periodic or nonperiodic).However, the participant can still choose not to have tax withheldfrom these distributions. If the participant does not make thischoice, the following withholding rules apply. For periodic distributions, withholding is based on theirtreatment as wages. For nonperiodic distributions, 10% of the taxable part iswithheld. Estimated tax payments.If no income tax is withheld or not enough tax is withheld, therecipient of a distribution may have to make estimated tax payments.For more information, see Withholding Tax and Estimated Taxin Publication 575. Tax on Early Distributions If a distribution is made to an employee under the plan before heor she reaches age 59 1/2, the employee may have to pay a10% additional tax on the distribution. This tax applies tothe amount received that the employee must include in income. Exceptions.The 10% tax will not apply if distributions before age 59 1/2 are made in any of the following circumstances. Made to a beneficiary (or to the estate of the employee) onor after the death of the employee. Due to the employee having a qualifying disability. Part of a series of substantially equal periodic paymentsbeginning after separation from service and made at least annually forthe life or life expectancy of the employee or the joint lives or lifeexpectancies of the employee and his or her designated beneficiary.(The payments under this exception, except in the case of death ordisability, must continue for at least 5 years or until the employeereaches age 59 1/2, whichever is the longerperiod.) Made to an employee after separation from service if theseparation occurred during or after the calendar year in which theemployee reached age 55. Made to an alternate payee under a qualified domesticrelations order (QDRO). Made to an employee for medical care up to the amountallowable as a medical expense deduction (determined without regard towhether the employee itemizes deductions). Timely made to reduce excess contributions under a 401(k)plan. Timely made to reduce excess employee or matching employercontributions (excess aggregate contributions). Timely made to reduce excess elective deferrals. Reporting the tax.To report the tax on early distributions, file Form 5329.See the form instructions for additional information about thistax. Tax on Excess Benefits If you are or have been a 5% owner of the businessmaintaining the plan, amounts you receive at any age that are morethan the benefits provided for you under the plan formula are subjectto an additional tax. This tax also applies to amounts received byyour successor. The tax is 10% of the excess benefit that isincludible in income. 5% owner.You are a 5% owner if you meet either of the following conditions. You own more than 5% of the capital or profits interest inthe employer. You own or are considered to own more than 5% of theoutstanding stock (or more than 5% of the total voting power of allstock) of the employer. You are also a 5% owner if you were a 5% owner at any time duringthe 5 plan years immediately before the plan year that ends within thetax year in which you receive the distribution. Reporting the tax.Include on Form 1040, line 56, any tax you owe for an excessbenefit. On the dotted line next to the total, write "Sec. 72(m)(5)"and write in the amount. Lump-sum distributions.The amount subject to the additional tax is not eligible for theoptional methods of figuring income tax on a lump-sum distribution.The optional methods are discussed under Lump-Sum Distributionsin Publication 575. Excise Tax onReversion of Plan Assets A 20% or 50% excise tax generally is imposed on any direct orindirect reversion of qualified plan assets to an employer. If you owethis tax, report it in Part XIII of Form 5330. See Form5330 instructions for more information. Prohibited Transactions Prohibited transactions are transactions between the plan and adisqualifiedperson that areprohibited by law. (However, see Exemptions, later.) Ifyou are a disqualified person who takes part in a prohibitedtransaction, you must pay a tax (discussed later). Prohibited transactions generally include the followingtransactions. A transfer of plan income or assets to, or use of them by orfor the benefit of, a disqualified person. Any act of a fiduciary by which he or she deals with planincome or assets in his or her own interest. The receipt of consideration by a fiduciary for his or herown account from any party dealing with the plan in a transaction thatinvolves plan income or assets. Any of the following acts between the plan and adisqualified person. Selling, exchanging, or leasing property. Lending money or extending credit. Furnishing goods, services, or facilities. Exemptions.Some transactions are exempt from being treated as prohibitedtransactions. For example, a prohibited transaction does not takeplace if you are a disqualified person and receive any benefit towhich you are entitled as a plan participant or beneficiary. However,the benefit must be figured and paid under the same terms as for allother participants and beneficiaries. For other transactions that areexempt, see section 4975 and its regulations. Disqualified person.You are a disqualified person if you are any of the following. A fiduciary of the plan. A person providing services to the plan. An employer, any of whose employees are covered by theplan. An employee organization, any of whose members are coveredby the plan. Any direct or indirect owner of 50% or more of any of thefollowing. The combined voting power of all classes of stock entitledto vote, or the total value of shares of all classes of stock of acorporation. A capital interest or profits interest of apartnership. The beneficial interest of a trust or unincorporatedenterprise that is an employer or an employee organization describedin (3) or (4). A member of the family of any individual described in (1),(2), (3), or (5). (A member of a family is the spouse, ancestor,lineal descendant, or any spouse of a lineal descendant.) A corporation, partnership, trust, or estate of which (or inwhich) any direct or indirect owner holds 50% or more of the interestdescribed in 5(a), (b), or (c). For (c), the beneficial interest ofthe trust or estate is directly or indirectly owned, or held bypersons described in (1) through (5). An officer, director (or an individual having powers orresponsibilities similar to those of officers or directors), a 10% ormore shareholder, or highly compensated employee (earning 10% or moreof the yearly wages of an employer) of a person described in (3), (4),(5), or (7). A 10% or more (in capital or profits) partner or jointventurer of a person described in (3), (4), (5), or (7). Any disqualified person, as described in (1) through (9)above, who is a disqualified person with respect to any plan to whicha section 501(c)(22) trust is permitted to make payments under section4223 of ERISA. Tax on Prohibited Transactions The initial tax on a prohibited transaction is 15% of the amountinvolved for each year (or part of a year) in the taxable period. Ifthe transaction is not corrected within the taxable period, anadditional tax of 100% of the amount involved is imposed. Forinformation on correcting the transaction, see Correctingprohibited transactions, later. Both taxes are payable by any disqualified person who participatedin the transaction (other than a fiduciary acting only as such). Ifmore than one person takes part in the transaction, each person can bejointly and severally liable for the entire tax. Amount involved.The amount involved in a prohibited transaction is the greater ofthe following amounts. The money and fair market value of any propertygiven. The money and fair market value of any propertyreceived. If services are performed, the amount involved is any excesscompensation given or received. Taxable period.The taxable period starts on the transaction date and ends on theearliest of the following days. The day the IRS mails a notice of deficiency for thetax. The day the IRS assesses the tax. The day the correction of the transaction iscompleted. Payment of the 15% tax.Pay the 15% tax with Form 5330. Correcting prohibited transactions.If you are a disqualified person who participated in a prohibitedtransaction, you can avoid the 100% tax by correcting the transactionas soon as possible. Correcting the transaction means undoing it asmuch as you can without putting the plan in a worse financial positionthan if you had acted under the highest fiduciary standards. Correction period.If the prohibited transaction is not corrected during the taxableperiod, you usually have an additional 90 days after the day the IRSmails a notice of deficiency for the 100% tax to correct thetransaction. This correction period (the taxable period plus the 90days) can be extended if either of the following occurs. The IRS grants a reasonable time needed to correct thetransaction. You petition the Tax Court. If you correct the transaction within this period, the IRS willabate, credit, or refund the 100% tax. Reporting Requirements You may have to file an annual return/report form by the last dayof the 7th month after the plan year ends. See the following list offorms to choose the right form for your plan. Form 5500-EZ.You can use Form 5500-EZ if you meet ALL of thefollowing conditions. The plan is a one-participant plan, definedbelow. discount hotels in BrugesThe plan meets the minimum coverage requirements of section410(b) without being combined with any other plan you may have thatcovers other employees of your business. The plan does not provide benefits for anyone except you,you and your spouse, or one or more partners and their spouses. The plan does not cover a business that is a member of anaffiliated service group, a controlled group of corporations, or agroup of businesses under common control. The plan does not cover a business that leasesemployees. One-participant plan.Your plan is a one-participant plan if, as of the first day of theplan year for which the form is filed, either of the following istrue. The plan covers only you (or you and your spouse) and you(or you and your spouse) own the entire business (whether incorporatedor unincorporated). The plan covers only one or more partners (or partner(s) andspouse(s)) in a business partnership. Example.You are a sole proprietor and your plan meets all the conditionsfor filing Form 5500-EZ. The total plan assets are more than$100,000. You should file Form 5500-EZ. Form 5500-EZ not required.You do not have to file Form 5500-EZ (or Form 5500) if youmeet the conditions mentioned above and either of the followingconditions. You have a one-participant plan that had total plan assetsof $100,000 or less at the end of every plan year beginning on orafter January 1, 1994. You have two or more one-participant plans that together hadtotal plan assets of $100,000 or less at the end of every plan yearbeginning on or after January 1, 1994. Caution: All one-participant plans must file a Form 5500-EZ for theirfinal plan year, even if the total plan assets have always been lessthan $100,000. The final plan year is the year in which distributionof all plan assets is completed. Form 5500.quality hotel LourdesIf you do not meet the requirements for filing Form 5500-EZ,you must file Form 5500, Annual Return/Report of EmployeeBenefit Plan. Schedule A (Form 5500).If any plan benefits are provided by an insurance company,insurance service, or similar organization, complete and attachSchedule A (Form 5500), Insurance Information, to Form5500. Schedule A is not needed for a plan that covers only either ofthe following. An individual or an individual and spouse who wholly own thetrade or business, whether incorporated or unincorporated. Partners in a partnership or the partners and theirspouses. Caution: Do not file a Schedule A (Form 5500) with a Form 5500-EZ.    Schedule B (Form 5500).For most defined benefit plans, complete and attach Schedule B(Form 5500), Actuarial Information, to Form 5500 or Form5500-EZ. Schedule P (Form 5500).This schedule is used by a fiduciary (trustee or custodian) of atrust described in section 401(a) or a custodial account described insection 401(f) to protect it under the statute of limitations providedin section 6501(a). The filing of a completed Schedule P (Form 5500),Annual Return of Fiduciary of Employee Benefit Trust, bythe fiduciary satisfies the annual filing requirement under section6033(a) for the trust or custodial account created as part of aqualified plan. This filing starts the running of the 3-yearlimitation period that applies to the trust or custodial account. Forthis protection, the trust or custodial account must qualify undersection 401(a) and be exempt from tax under section 501(a). Thefiduciary should file, under section 6033(a), a Schedule P as anattachment to Form 5500 or Form 5500-EZ for the plan year inwhich the trust year ends. The fiduciary cannot file Schedule Pseparately. See the Schedule P instructions for more information. Form 5310.If you terminate your plan and are the plan sponsor or planadministrator, you can file Form 5310, Application forDetermination for Terminating Plan. Your application must beaccompanied by the appropriate user fee and Form 8717,User Fee for Employee PlanDetermination Letter Request. More information.For more information about reporting requirements, see the formsand their instructions. Qualification Rules To qualify for the tax benefits available to qualified plans, aplan must meet certain requirements (qualification rules) of the taxlaw. Generally, unless you write your own plan, the financialinstitution that provided your plan will take the continuingresponsibility for meeting qualification rules that are later changed.The following is a brief overview of important qualification rulesthat generally have not yet been discussed. It is not intended to beall-inclusive. See Setting Up a Qualified Plan, earlier. TaxTip: Generally, the following qualification rules also apply to a SIMPLE401(k) retirement plan. A SIMPLE 401(k) plan is, however, not subjectto the top-heavy rules and nondiscrimination rules of qualified plansif the plan satisfies the provisions discussed earlier underSIMPLE 401(k) Plan. Plan assets must not be diverted.Your plan must make it impossible for its assets to be used for, ordiverted to, purposes other than for the benefit of employees andtheir beneficiaries. As a general rule, the assets cannot be divertedto the employer. Minimum coverage requirements must be met.To be a qualified plan, a defined benefit plan must benefit atleast the lesser of the following. 50 employees. The greater of: 40% of all employees, or Two employees. If there is only one employee, the plan must benefit thatemployee. Contributions or benefits must not discriminate.Under the plan, contributions or benefits to be provided must notdiscriminate in favor of highly compensated employees. Contribution and benefit limits must not be more than certainlimits.Your plan must not provide for contributions or benefits that aremore than certain limits. The limits apply to the annual contributionsand other additions to the account of a participant in a definedcontribution plan and to the annual benefit payable to a participantin a defined benefit plan. These limits were discussed earlier underContributions. Minimum vesting standards must be met.Your plan must satisfy certain requirements regarding when benefitsvest. A benefit is vested (you have a fixed right to it)when it becomes nonforfeitable. A benefit is nonforfeitableif it cannot be lost upon the happening, or failure to happen,of any event. Leased employees.A leased employee, defined earlier under Definitions You NeedTo Know, who performs services for you (recipient of theservices) is treated as your employee for certain plan qualificationrules. These rules include those in all the following areas. Nondiscrimination in coverage, contributions, andbenefits. Minimum age and service requirements. Vesting. Limits on contributions and benefits. Top-heavy plan requirements. However, contributions or benefits provided by the leasingorganization for services performed for you are treated as provided byyou. Benefit payments must begin when required.Your plan must provide that, unless the participant choosesotherwise, the payment of benefits to the participant must beginwithin 60 days after the close of the latest of thefollowing periods. The plan year in which the participant reaches the earlierof age 65 or the normal retirement age specified in the plan. The plan year in which the 10th anniversary of the year inwhich the participant began participating in the plan. The plan year in which the participant separates fromservice. Early retirement.Your plan can provide for payment of retirement benefits before thenormal retirement age. If your plan offers an early retirementbenefit, a participant who separates from service before satisfyingthe early retirement age requirement becomes entitled to that benefitif he or she meets both the following requirements. Satisfies the service requirement for the earlyretirement benefit. Separates from service with a nonforfeitable right to anaccrued benefit. The benefit, which may be actuarially reduced, ispayable when the early retirement age requirement is met. Survivor benefits.Defined benefit and certain money purchase pension plans mustprovide automatic survivor benefits in both the following forms. A qualified joint and survivor annuity for a vestedparticipant who does not die before the annuity starting date. A qualified pre-retirement survivor annuity for a vestedparticipant who dies before the annuity starting date and who has asurviving spouse. The automatic survivor benefit also applies to any participantunder a profit-sharing plan unless all the following conditions aremet. The participant does not choose benefits in the form of alife annuity. The plan pays the full vested account balance to theparticipant's surviving spouse (or other beneficiary if the survivingspouse consents or if there is no surviving spouse) if the participantdies. The plan is not a direct or indirect transferee of a planthat must provide automatic survivor benefits. Loan secured by benefits.If survivor benefits are required for a spouse under a plan, he orshe must consent to a loan that uses as security the accrued benefitsin the plan. Waiver of survivor benefits.Each plan participant may be permitted to waive the joint andsurvivor annuity or the pre-retirement survivor annuity (or both), butonly if the participant has the written consent of the spouse. Theplan also must allow the participant to withdraw the waiver. Thespouse's consent must be witnessed by a plan representative or notarypublic. Waiver of 30-day waiting period before annuity starting date.A plan may permit a participant to waive (with spousal consent)the 30-day minimum waiting period after a written explanation of theterms and conditions of a joint and survivor annuity is provided toeach participant. The waiver is allowed only if the distribution begins more than 7days after the written explanation is provided. Involuntary cash-out of benefits not more than dollar limit.A plan may provide for the immediate distribution of theparticipant's benefit under the plan if the value of the benefit isnot greater than $5,000. However, the distribution cannot be made after the annuity startingdate unless the participant and the spouse (or surviving spouse of aparticipant who died) consent in writing to the distribution. If thepresent value is greater than $5,000, the plan must have the writtenconsent of the participant and the spouse (or surviving spouse) forany immediate distribution of the benefit. Consolidation, merger, or transfer of assets or liabilities.Your plan must provide that, in the case of any merger orconsolidation with, or transfer of assets or liabilities to, any otherplan, each participant would (if the plan then terminated) receive abenefit equal to or more than the benefit he or she would have beenentitled to just before the merger, etc. (if the plan had thenterminated). Benefits must not be assigned or alienated.Your plan must provide that its benefits cannot be assigned oralienated. Exception for certain loans.A loan from the plan (not from a third party) to a participant orbeneficiary is not treated as an assignment or alienation if the loanis secured by the participant's accrued nonforfeitable benefit and isexempt from the tax on prohibited transactions under section4975(d)(1) or would be exempt if the participant were a disqualifiedperson. A disqualified person is defined earlier under ProhibitedTransactions. Exception for qualified domestic relations order (QDRO).Compliance with a QDRO does not result in a prohibited assignmentor alienation of benefits. QDRO is defined in Publication 575. Payments to an alternate payee under a QDRO before the participantattains age 59 1/2 are not subject to the 10% additionaltax that would otherwise apply under certain circumstances. Theinterest of the alternate payee is not taken into account indetermining whether a distribution to the participant is a lump-sumdistribution. Benefits distributed to an alternate payee under a QDROcan be rolled over tax free to an individual retirement account or toan individual retirement annuity. No benefit reduction for social security increases.Your plan must not permit a benefit reduction for a post-separationincrease in the social security benefit level or wage base for anyparticipant or beneficiary who is receiving benefits under your plan,or who is separated from service and has nonforfeitable rights tobenefits. This rule also applies to plans supplementing the benefitsprovided by other federal or state laws. Elective deferrals must be limited.If your plan provides for elective deferrals, it must limit thosedeferrals to the amount in effect for that particular year. SeeLimit on Elective Deferrals, earlier. Top-heavy plan requirements.A top-heavy plan is one that mainly favors partners, soleproprietors, and other key employees. A plan is top heavy for any plan year for which the total value ofaccrued benefits or account balances of key employees is more than 60%of the total value of accrued benefits or account balances of allemployees. Additional requirements apply to a top-heavy plan primarilyto provide minimum benefits or contributions for non-key employeescovered by the plan. Most qualified plans, whether or not top heavy, must containprovisions that meet the top-heavy requirements and that will takeeffect in plan years in which the plans are top heavy. Thesequalification requirements for top-heavy plans are explained insection 416 and its regulations. SIMPLE exception.The top-heavy plan requirements do not apply to SIMPLE plans.