401(k) Plans

The employer generally makes contributions on behalf of employees to a qualified plan. However, a qualified plan may also allow employees to contribute part of their before-tax compensation to the plan instead of receiving it in their paycheck. This type of plan is commonly known as a 401(k) plan; the before-tax contributions are called elective deferrals.

Self-employed persons may contribute part of their before-tax net earnings to a 401(k) plan. Employers that are corporations and partnerships can also have a 401(k) plan.

Elective deferrals:

An elective deferral is compensation which has been excluded from an employee's gross wages. In other words, the employee elects (chooses) to put off (defer) receiving part of his compensation in cash each payday and paying taxes currently on that pay with the expectation of receiving that money at a future date, including any accumulated earnings.

When the money is eventually distributed to the employee, it is reported on the employee's tax return where it is subjected to income taxes.

No tax deduction for employees for elective deferrals:

Since an elective deferral is compensation which has been excluded from an employee's gross wages, and therrefore is not currently taxed, the employee cannot take a deduction for such contributions on his tax return.

SIMPLE 401 (k) Plans

A SIMPLE 401(k) plan is a qualified retirement plan and generally must satisfy the rules for qualified plans, with some exceptions (see box below).

You can adopt a SIMPLE plan as part of a 401(k) plan (SIMPLE 401(k)) if you had 100 or fewer employees who earned $5,000 or more in compensation during the preceding year.

A SIMPLE 401(k) plan is not subject to the nondiscrimination and top-heavy rules associated with qualified plans if certain conditions are met.

The notification requirement that applies to SIMPLE IRA plans also applies to SIMPLE 401(k) plans.

Matching Contributions

Your plan can permit the employer to make matching contributions on behalf of employees who make an elective deferral to the 401(k) plan.

For example, the plan can provide that the employer contribute 50 cents for each dollar the employee contributes.

Nonelective Contributions

You can also make contributions for your participating employees, other than matching contributions, without giving them the choice to take cash instead in their paychecks.

File your personal and small business taxes (Schedule C)