Compensation planning can be very important for business owners both individually and as a means by which to maintain the services of employees. As a Denver business attorney and tax attorney, John McGuire works with businesses to create and implement compensation plans. A Denver tax attorney can also assist you with the tax implications of certain plans and other tax issues.
There are multiple types of qualified retirement plans that can be submitted to the IRS for qualification. A qualified plan is a plan that has met the requirements of the code, regulations and other pronouncements to receive tax exempt status. The most important tax advantages of a qualified plan are: 1) the employee does not include in their gross income their interest in the employer contribution or the income earned by the trust fund until the employee receives funds from the plan; 2) the employer may deduct contributions to the plan; 3) the earnings of the plan are exempt from tax while held in the trust; 4) certain distributions may be eligible for special income tax treatment.
Defined Benefit Plans
Defined benefit pension plans are plans where the employer provides payment of definite and determinable benefits to employees over a period of years. Usually benefits are paid to employees for their life after retirement. The benefits received by the employees in retirement are usually measured by factors such as years of service to the employer and compensation received by the employer. There are three general types of defined benefit plans: 1) Fixed benefit formula providing a fixed amount of benefits that is unrelated to years of service by the employee or the employee’s earnings and compensation 2) Flat benefit formula providing retirement benefits equal to a fixed percentage of the employee’s salary regardless of the time of services; and 3) Unit benefit formula that provides the employee with retirement benefits at a specific percentage of each years average or actual compensation paid to the employee multiplied by the years of service.
Under ERISA the employer is usually required to make annual payments into the trust that would be necessary to fund the benefits. The benefits of the plan are partially guaranteed by the Pension Benefits Guaranty Corporation. Defined benefit plans promise employees very specific benefits at retirement. No individual accounts are created for the individual employees and no assets are separated from within the plan.
Defined Contribution Plans
Defined contribution plans hold individual accounts for each participant in the plan and for benefits based on the amount the participant contributes to their account. There are three types of defined contribution plans: 1) Profit sharing plans are established and maintained by employers providing a share of the employer profits with employees. Contributions can be determined by the employer or based upon a fixed equation or formula. The plan must provide a specific pre-determined equation or formula for the allocation of contributions that are made to the plan by the plan participants; 2) Stock bonus plans are established and maintained by the employer providing similar benefits to a profit sharing plan, but the benefits are distributable in stock of the employer company; 3) Money purchase plans are a defined contribution plans with individual accounts similar to profit sharing plans. The amount of the annual contribution is determined by applying a specific equation or formula.
Employers considering the creation of a qualified retirement plan should consult with their business attorney and tax attorney regarding their obligations to the plan and the tax implications to their business.