By Paul N. Gada, Business Owner's Toolkit Staff Writer

When Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (the Tax Relief Act) on May 26, 2001, it became the largest tax cut package in more than 20 years. President George W. Bush is expected to sign it into law in early June.

The Tax Relief Act basically offers a little something for everyone over the course of the next ten years. In terms of sheer volume, however, the bulk of the new tax provisions (at least a third) deal with pension reform.

Many of the new pension reform provisions directly or indirectly affect small business owners. Generally speaking, the provisions are intended to streamline the current pension laws while encouraging greater private retirement savings. In particular, a small business owner should be aware of the following newly created tax and retirement planning opportunities:

Credit for Retirement Plan Startup Costs. Many small business owners have been reluctant to provide retirement plans for their employees because of the costs associated with setting up and administering such plans. According to a survey presented before Congress, 25 percent of small business owners surveyed did not sponsor a retirement plan primarily because of the associated startup costs. If given the choice among several incentive options, the survey also revealed that 67 percent of nonsponsors would seriously consider changing their mind if a tax credit was provided.

Small business owners have just had their wish granted. Beginning in 2002, small business owners with no more than 100 employees will receive a tax credit for establishing new retirement plans. The credit amount is limited to $500 (50 percent of the first $1,000 of qualified startup costs) incurred in the first year of the new plan and in each of the two following years.

Employer plans eligible for the tax credit include a new qualified defined-benefit plan, defined-contribution plan (including a 401(k) plan), savings incentive plan for employees (SIMPLE) plan, or simplified employee pension (SEP) plan. If you started a plan before 2002, you are unfortunately not eligible for the credit. If you are currently considering starting a retirement plan, though, you may want to postpone setting one up until next year.

Elimination of IRS User Fees for Small Employer Plans. Upon request, the IRS will issue a determination letter evaluating an employer's retirement plan and providing its seal of approval on it. User fees for determination letters can run into the hundreds of thousands of dollars, depending on the category of the request.

Starting in 2002, the user fees for determination letter requests by small employers are eliminated to further encourage small employers to establish retirement plans.

Increased Deductibility of Employer Contributions to Certain Plans. Employer contributions to profit-sharing, stock bonus and money-purchase pension plans are deductible to 25 percent of an employee's contribution (up from 15 percent) beginning in 2002. This indirectly also helps avoid the 10 percent excise tax penalty on nondeductible contributions in the range between the former 15 percent and new 25 percent amount.

Retirement Plan Loans for Small Business Owners. Loans between a qualified retirement plan and a disqualified person are generally considered prohibited transactions under current law. If a prohibited loan occurs, the transaction amount is subject to an initial 15 percent excise tax penalty and, if not corrected in time, an additional 100 percent penalty.

The prohibited transaction rules are intended to prevent abuses like an owner-employee of a company raiding retirement plan funds. At the same time, many common and nonharmful arrangements between a plan and such a disqualified person are prohibited.

Beginning in 2002, the types of owner-employees who can take advantage of loans from retirement plans will be expanded. Subchapter S shareholders, partners in partnerships, and sole proprietors of unincorporated businesses will be exempt from the prohibited transaction rules. Congress hopes that the elimination of the loan restrictions will be an incentive for owner-employees to establish retirement plans or modify their existing plans to include a loan feature.

Credit to Low- and Middle-Income Individuals for Elective Deferrals and IRA Contributions. This provision and the one that follows are intended to increase private savings for retirement. Personal budget constraints often preclude lower- and middle-income taxpayers from saving any money, including money for retirement. At the same time, employers often need people in these income brackets to participate in their retirement plan to help qualify the plan for special tax treatment.

For tax years 2002 through 2006, a temporary nonrefundable tax credit has been created for contributions made by eligible taxpayers to a qualified plan. The maximum annual contribution eligible for the credit is $2,000. The actual credit amount is determined by multiplying the annual contribution by the following credit rates based on your adjusted gross income (AGI):

The AGI limits applicable to single taxpayers apply to married taxpayers filing separate returns. The credit is in addition to any deduction or exclusion that would otherwise apply with respect to the contribution. The credit offsets minimum tax liability as well as regular tax liability. The credit is available to individuals who are 18 or older, except for individuals who are full-time students or claimed as a dependent on another taxpayer's return.

The credit is available with respect to elective contributions to a 401(k) plan, 403(b) annuity, eligible deferred-compensation arrangement of a state or local government (457 plan), SIMPLE, SEP, traditional or Roth IRA, and voluntary after-tax employee contributions to a qualified retirement plan.

Increased Retirement Plan Contribution Limits. The annual amounts you can contribute to a 401(k), 403(b) annuity or SEP will increase from the current $10,500 to $11,000 in 2002, and then go up each year by $1,000 to a maximum $15,000 by 2006. Similarly, the maximum allowable SIMPLE plan contributions allowed each year will increase to $7,000 in 2002, and then go up each year by $1,000 to a $10,000 limit in 2005.

For both traditional and Roth IRAs, the contribution limits will rise from the current $2,000 annual limit to $3,000 for 2002 through 2004, $4,000 for 2005 through 2007, and $5,000 in 2008. Annual adjustments for inflation will occur after that.

The items mentioned above represent the highlights of approximately 50 new provisions that encourage the creation and use of retirement plans in a small business setting. As helpful as these changes may be, however, don't wait too long to take advantage of them.

Just like in the story of Cinderella, the Tax Relief Act has a built-in sunset provision. Without further intervention by Congress, the tax code will magically revert to its current (2001) version in the year 2011. If that isn't enough incentive for you to act sooner rather than later, consider the fact that last time Congress gave us a major tax break package, it only took four years before they started eliminating those breaks.

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