Publication 560 - Retirement Plans For Small Business

A common-law employee is a person who

The limit on elective deferrals is discussed in

Leased employee. A leased employee who is

performs services for an employer who has the

chapter 2 under Salary Reduction Simplified

not your common-law employee must generally

right to control and direct the results of the work

Employee Pension (SARSEP) and in chapter 4.

be treated as your employee for retirement plan

and the way in which it is done. For example, the

purposes if he or she does all the following.

Other options. In figuring the compensa-

employer:

•

tion of a participant, you can treat any of the

Provides services to you under an agree-

•

Provides the employee’s tools, materials,

following amounts as the employee’s compen-

ment between you and a leasing organiza-

and workplace, and

sation.

tion.

•

Can fire the employee.

The employee’s wages as defined for in-

Has performed services for you (or for you

come tax withholding purposes.

and related persons) substantially full time

Common-law employees are not self-em-

for at least 1 year.

•

The employee’s wages you report in box 1

ployed and cannot set up retirement plans for

•

of Form W – 2, Wage and Tax Statement.

Performs services under your primary di-

income from their work, even if that income is

rection or control.

•

self-employment income for social security tax

The employee’s social security wages (in-

purposes. For example, common-law employ-

cluding elective deferrals).

Exception. A leased employee is not

ees who are ministers, members of religious

treated as your employee if all the following

orders, full-time insurance salespeople, and

Compensation generally cannot include either

conditions are met.

of the following items.

U.S. citizens employed in the United States by

foreign governments cannot set up retirement

•

1) Leased employees are not more than 20%

Reimbursements or other expense al-

plans for their earnings from those employ-

of your non-highly compensated work

lowances (unless paid under a nonac-

ments, even though their earnings are treated

force.

countable plan).

as self-employment income.

•

2) The employee is covered by the leasing

Deferred compensation (either amounts

However, a common-law employee can be

organization under its qualified pension

going in or amounts coming out) other

self-employed as well. For example, an attorney

plan.

than certain elective deferrals unless you

can be a corporate common-law employee dur-

choose not to include those elective defer-

ing regular working hours and also practice law

3) The leasing organization’s plan is a money

rals in compensation.

in the evening as a self-employed person. In

purchase pension plan that has all the fol-

another example, a minister employed by a con-

lowing provisions.

gregation for a salary is a common-law em-

Contribution. A contribution is an amount you

ployee even though the salary is treated as

a) Immediate participation.

pay into a plan for all those participating in the

self-employment income for social security tax

plan, including self-employed individuals. Limits

b) Full and immediate vesting.

purposes. However, fees reported on Schedule

apply to how much, under the contribution

C (Form 1040), Profit or Loss From Business, for

c) A nonintegrated employer contribution

formula of the plan, can be contributed each

performing marriages, baptisms, and other per-

rate of at least 10% of compensation

year for a participant.

sonal services are self-employment earnings for

for each participant.

qualified plan purposes

Deduction. A deduction is the plan contribu-

However, if the leased employee is your

tions you can subtract from gross income on

Compensation. Compensation for plan allo-

common-law employee, that employee will be

your federal income tax return. Limits apply to

cations is the pay a participant received from

your employee for all purposes, regardless of

the amount deductible.

you for personal services for a year. You can

any pension plan of the leasing organization.

generally define compensation as including all

Earned income. Earned income is net earn-

the following payments.

ings from self-employment, discussed later,

Net earnings from self-employment. For

from a business in which your services materi-

SEP and qualified plans, net earnings from

1) Wages and salaries.

ally helped to produce the income.

self-employment is your gross income from your

You can also have earned income from prop-

2) Fees for professional services.

trade or business (provided your personal ser-

erty your personal efforts helped create, such as

vices are a material income-producing factor)

3) Other amounts received (cash or noncash)

royalties from your books or inventions. Earned

minus allowable business deductions. Allowable

for personal services actually rendered by

income includes net earnings from selling or

deductions include contributions to SEP and

an employee, including, but not limited to,

otherwise disposing of the property, but it does

qualified plans for common-law employees and

the following items.

not include capital gains. It includes income from

the deduction allowed for one-half of your

licensing the use of property other than goodwill.

self-employment tax.

a) Commissions and tips.

If you have more than one business, but only

Net earnings from self-employment do not

b) Fringe benefits.

one has a retirement plan, only the earned in-

include items excluded from gross income (or

come from that business is considered for that

their related deductions) other than foreign

c) Bonuses.

plan.

earned income and foreign housing cost

amounts.

For a self-employed individual, compensa-

Employer. An employer is generally any per-

For the deduction limits, earned income is

tion means the earned income, discussed later,

son for whom an individual performs or did per-

net earnings for personal services actually ren-

of that individual.

form any service, of whatever nature, as an

dered to the business. You take into account the

Compensation also includes amounts de-

employee. A sole proprietor is treated as his or

income tax deduction for one-half of self-em-

ferred in the following employee benefit plans,

her own employer for retirement plan purposes.

ployment tax and the deduction for contributions

unless you choose not to include any amount

However, a partner is not an employer for retire-

to the plan made on your behalf when figuring

contributed under a salary reduction agreement

ment plan purposes. The partnership is treated

net earnings.

that is not included in the gross income of the

as the employer of each partner.

Net earnings include a partner’s distributive

employee. These amounts are elective defer-

share of partnership income or loss (other than

rals.

Highly compensated employee. A highly

separately stated items, such as capital gains

compensated employee is an individual who:

•

Qualified cash or deferred arrangement

and losses). It does not include income passed

•

(section 401(k) plan).

Owned more than 5% of the capital or

through to shareholders of S corporations.

profits in your business at any time during

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Guaranteed payments to limited partners are

Salary reduction agreement to contribute

the year or the preceding year, or

to a tax-sheltered annuity (section 403(b)

net earnings from self-employment if they are

•

plan), a SIMPLE IRA plan, or a SARSEP.

For the preceding year, received compen-

paid for services to or for the partnership. Distri-

sation from you of more than $85,000 and,

butions of other income or loss to limited part-

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Section 457 nonqualified deferred com-

if you so choose, was in the top 20% of

ners are not net earnings from self-employment.

pensation plan.

employees when ranked by compensa-

For SIMPLE plans, net earnings from

•

Section 125 cafeteria plan.

tion.

self-employment is the amount on line 4 of Short

Chapter 1 Definitions You Need To Know

Page 5

Publication 560 - Retirement Plans For Small Business - 2001 Page 5

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