Come tax time, I’m often asked for advice on how to minimize taxes. One of the best ways to minimize taxes is to purchase assets that are needed in your company, such as vehicles or equipment prior to year-end. If you are a cash basis taxpayer, another effective strategy is to pay all your bills by year-end. But what if these ideas aren’t enough? This happened in 2012 — it was a banner year in the pest control industry, and we at PCO Bookkeepers were working overtime right through the end of the year with our clients on tax-reduction strategies.
One effective strategy is to establish and contribute to a retirement plan. Income taxes are expected to rise this year. I have found that many PCOs believe pension plans to be complicated and not worth the effort. Many who have set up 401(k) plans in the past ran into trouble with the “non discrimination” and “top heavy” plan requirements, limiting ownership and management’s ability to derive any significant benefit from participation in the plan (“non discrimination” and “top heavy” are descriptions where the IRS defines highly vs. non-highly compensated employees).
The issue is problematic for many PCOs because most employees don’t participate — or those who do contribute very little to the plan, which disqualifies most contributions made by ownership or management (“highly compensated employees” as defined by the IRS). There are, however, a few options that allow employees and ownership to contribute to a retirement plan, giving the participants tax-deferred compensation, as well as allowing the company a tax deduction without the burdensome income testing that usually hijacks the good intentions of ownership and management, thereby limiting contributions allowed by traditional 401(k) plans.
I will attempt to give a working knowledge of a couple of plans a pest control firm can establish that are not subject to the burdensome and restrictive testing requirements. These plans will allow an employee to contribute to the plan — as well as the employer — while both receive tax benefits. You’ll be armed with enough information to discuss the concepts with a financial professional to determine if the establishment of a plan is for you.
Before we look at the types of plans that fit the above objectives, let’s look at the basic mechanics of a plan. There are many exceptions and rules that complicate things, but following is the basic premise:
- The company establishes the plan.
- An employee may elect to contribute a portion of his salary to the plan, which is held in an account that is separate from company assets and cannot be touched by the company or its creditors. The employee’s contribution is removed from his taxable income for the contribution year, saving the employee current-year taxes. He is not taxed on that money until distribution of the contribution plus any investment earnings that are made while in the account. Distribution is usually made at retirement age or after. If funds are distributed before retirement age, there is a penalty to the employee unless he meets certain hardship exceptions.
- The company can contribute funds to the account on behalf of the employee as a match or a profit share. In any event, the company match is tax deductible to the company and is added to the employee’s account, taxed to the employee at distribution as in #2 discussed previously.
Two types of plans that fit these objectives without testing and are somewhat easy to administer include:
1. Savings Incentive Match Plan Individual Retirement Account (SIMPLE IRA). A SIMPLE IRA is a retirement plan that uses separate IRA accounts owned and managed by each participant.
a. This type of plan can be established if you have 100 employees or less who receive $5,000 or more in compensation for the prior year.
b. If you use a SIMPLE IRA, it is the only plan that you can have (unless you have union employees covered by a collective bargaining agreement).
c. The employee salary reduction contribution limit for 2013 is a maximum $12,000 and $14,500 for those older than 50.
d. Employer contributions:
i. The employer is generally required to match each employee’s salary reduction contribution on a dollar-for-dollar basis up to 3 percent of the employee’s compensation; or
ii. The employer may choose to make non-elective contributions of 2 percent for all eligible employees whether or not they make salary reduction contributions.
iii. There is no profit sharing provision with a SIMPLE IRA.
e. The plan can be set up at any time between Jan. 1 to Oct. 1 of the year you choose to operate the plan. If you are a new business formed after Oct. 1 you have until it is “administratively feasible” to set it up.
f. Employee contributions must be deposited prior to 30 days after the month they were deducted from the employee’s paycheck.
g. Employer contributions are due by the due date of the employer’s tax return, including extensions.
2. Safe Harbor 401(k) Plan. Since many plans can be “top heavy,” which negates most of the tax benefit to the company as well as the owners and managers, the IRS has provided criteria that, if followed, automatically satisfy the non-discrimination testing applicable to most 401(k) plans. A 401(k) safe harbor plan consists of:
a. Employee salary reduction contribution limit for 2013 maximum $17,500 and $23,000 for those older than 50.
b. Safe Harbor employer contributions:
i. The safe harbor employer contribution may be either a 3 percent contribution for all employees or a basic safe harbor matching contribution of 100 percent on the first 3 percent of salary deferrals and 50 percent on salary deferrals between 3 percent and 5 percent of pay (for a maximum of 4 percent); or
ii. Contribute 3 percent of the employee’s compensation for each eligible employee, regardless of whether the employee chooses to participate in the plan.
c. Discretionary profit sharing contributions.
In setting up and administering this type of plan:
a. It needs to be established by Dec. 31 of the year you are going to operate the plan.
b. I recommend setting the plan up with a financial professional as there are filing requirements as well other administration that needs to be done.
c. Employee contributions must be deposited as soon as administratively feasible, according to the Department of Labor.
d. The employer contribution must be made by the due date of the employer’s tax return including extensions.
Final Thoughts. Retirement plans can be a great way to save taxes at the company level, motivate employees and defer employee taxes. While in most cases traditional 401(k) plans in pest control firms usually result in significant restrictions on owners and managers, SIMPLE IRAs provide a method to bypass these restrictions and are relatively easy to administer. Safe Harbor 401(k) plans, while requiring more administration, also bypass the restrictions of the traditional 401(k) and also allow greater amounts to be contributed to the plan including a potential profit-sharing component. Want to save at tax time? Look into one of these plans.
Daniel S. Gordon is a CPA in New Jersey and owns an accounting firm that caters to PCOs throughout the United States. Visit www.pcobookkeepers.com for information about his firm, PCO Bookkeepers.