Implementation Of A 401(K) Plan Program
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Bakersfield Lighting Corporation (BLC) wants to know the tax benefits and tax implications of implementing a 401(k) program plan for present and incoming employees. First the Human Resources manager would like to know the tax implications of the 401(k) program and what possible deductions it would give BLC. The manager has already estimated a savings of $100,000 in employee turnover and improved employee performance. BLC will be contributing an estimated $250,000 annually to the 401(k) program plan. Since management is concerned with the additional costs of providing the 401(k) plan program, in this report I will show that the benefits will outweigh the disadvantages of implementing the plan. I will also be including the tax accounting benefits of implementing compensation programs and pensions with BLC being a multinational organization (CTU Course Material, 2008). First we will discuss the 401(k) program that BLC wants to be implemented.
The 401(k) plan is tax deferred for the employee and for BLC. BLC’s present and incoming employees who chose to contribute to the plan will be contributing a percentage of their weekly gross wages. BLC will make a 50% match for each employee contribution up to 8% of gross wages. These contributions are done on pre-tax or gross wages. BLC employees will not have to pay income tax withholdings when the contributions are taken, and they will not be included on the tax year return since the contributions are taken out of the gross wages. The W-2 form where the income is reported will show different amounts in boxes 1 versus 2 and 3, with 2 and 3 being at an increase. Boxes 2 and 3 show the total gross income that is subject to social security, Medicare, and federal unemployment tax deductions (irs.gov).
BLC are required to make certain stipulations as they implement the 401(k) plan program. There are several types of 401(k) plans that need to be discussed; the Simple 401(k) Plan, the Elective Deferrals (401(k), and the Roth Contribution 401(k) Plan. To qualify for a plan BLC must meet certain qualification rules. These rules include:
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Assets for the plan must not be redirected,
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BLC must meet the minimum coverage requirement of the lesser of 50 employees or the greater of 40% of total employees or two employees,
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All employees must be eligible for the contributions or benefits,
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The limits of the contribution or benefits must be met,
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BLC must set and keep their minimum vesting standards,
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Participants must be at least 21 and have at least 1 year of service,
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Any employee that is considered a leased employee is treated as an employee,
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Distributions payments must begin then required unless otherwise stated, and
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Must provide for survivors with a survivors benefit.
Once BLC develops a written plan that provides for the above qualification rules, they can then decide which plan they would like to offer their employees that will benefit the employees and BLC. Since it is a defined contribution plan that is also an employee benefit plan, BLC must sponsor the plan meaning that the plan must be implemented by BLC otherwise it becomes a self-implemented plan (irs.gov).
BLC cannot choose the Simple 401(k) Plan since they have more than 100 employees. To qualify for the Simple 401(k) Plan they must have no more than 100 employees. In order to qualify for an elective deferrals plan, BLC can choose between several different types of plans, but they have decided to implement a 401(k) program plan. BLC has the choice of a Roth Contribution 401(k) plan and a traditional 401(k) plan. The difference between the traditional 401(k) plan and the Roth Contribution 401(k) plan the way the plan is taxed. A traditional 401(k) plan contribution is taxed after distributions. The Roth Contribution 401(k) plan, on the other hand, is taxed prior to contributions. If BLC considers both plans, they must provide for this option with the Roth Contribution 401(k) plan. Also, the income or earnings from the investments in these plans are not taxable (irs.gov). The ceiling for annual contributions for an employee under 50 years of age is $15,500 ($20,500 for those 50 and over) for 2008 and $500 each year thereafter (Qualified Plan Administrators, Inc., 2008).
Let’s assume that BLC wants to provide their present and future employees with both options of the Roth Contribution and the traditional 401(k) plan. BLC must make the additional rule for qualified contributions, which is that the employees’ taxable income must not decrease. This means that if an employee is taking the Roth option, then if he or she makes a weekly gross income of $450.00 that income should be not decrease until after all deductions are taken out of the gross income including the deduction for the Roth Contribution 401(k) plan. Also, any distributions must be made no less than five years after the initial contribution and after the employee or account owner turns 59 and a half. The employee must understand that this option is not eligible for conversion into a pre-tax option. BLC must keep the two account types separate and must account for all funds that are contributed into each account. The funds for the Roth Contribution 401(k) plan must be distinguished as a Roth treatment (irs.gov).
Other stipulations that must be made in the 401(k) program plan is the employer, BLC, can make contributions but they must not exceed the limits set forth by the Internal Revenue Service. These limits are considered to be a total amount of contribution with the employee and the employer. The limits cannot exceed the lesser of 100% of the employee’s compensation or $46,000 for 2008. BLC can also make contributions on behalf of the Roth Contribution 401(k) plan, but they must be a pre-tax basis contribution. These limits are set to help lower paid or non highly-compensated employees to contribute to their 401(k) plan. Highly-compensated employees who make $100,000 more or own more than 5% of the company have a limit on their deferral amounts. The IRS has required employers to limit the amount of deferrals for highly-compensated employees. The percentage of contributions for the highly-compensated employees cannot be higher than 2% of the non highly-compensated employees (irs.gov).
The tax treatment for BLC with the 401(k) program plans would be that these benefits would be excluded from the gross profits in calculating