Answers to your tax questions

March 4, 2005

About retirement funds

Q I understand that I can put 20 percent of my unincorporated practice income into a Simplified Employee Pension plan (SEP) for myself. Is it too late to make a contribution for last year?

A No, you have until April 15 (the due date for filing your 2004 return) to adopt the plan and deposit your contribution into an IRA under it. Keep in mind that in figuring your 20 percent contribution, you must first subtract half your self-employment tax from the net income (maximum $205,000) shown on line 31 of your Schedule C. Also, if your plan covers any employees, you must contribute 25 percent of their salaries for them.

Q Do payments for operating my practice's retirement plan and managing its investments in 2004 count as plan contributions?

Q I have to take $40,000 out of my profit-sharing plan by April 1, because I turned 70½ last year. But since I'm not quitting practice, can I make a plan contribution for 2004 in spite of the required withdrawal? If so, how do I handle the two transactions on my return?

A You can claim a deduction for the contribution on your 2004 return, even though the money didn't go into the plan until this year. If your practice is unincorporated, list the amount as an adjustment to income on line 32 of Form 1040. But don't report the required withdrawal on that return. Since you made it this year, you'll show it as income on your 2005 return, along with the amount you must withdraw by Dec. 31, 2005. You'll base the second minimum withdrawal on your plan account balance as of year-end 2004, but don't include the delayed 2004 contribution in that total.

Q My wife and I had a joint AGI of less than $100,000 last year, so I took the opportunity to convert a $20,000 traditional IRA to a Roth account. But now it turns out that we'd get a sizable tax saving by filing separately for 2004. Is a single filer subject to a lower AGI ceiling on Roth conversions?

A No, but you'd be "married filing separately," not a single filer, and you're barred from converting to a Roth account if you lived with your spouse at any time during the year. If the two of you file separate returns, the regulations treat the conversion as a contribution, so you could be hit with a 6 percent excess-contribution penalty on $17,000 ($20,000 minus the $3,000 annual Roth IRA contribution limit) and a 10 percent penalty on the early withdrawal from your traditional IRA. To avoid these penalties, you can either file a joint return for 2004 or instruct the IRA trustees to cancel the conversion by April 15. (If you need more time, ask the IRS for an extension.)

Q I put a total of $43,000 into my combined 401(k) and profit-sharing plan last year. Now I hear that the deductible limit for such plans was $41,000. What do I have to do to avoid being penalized for overcontributing?

A Nothing, if you were at least 50 years old in 2004, because you were allowed an additional $3,000 "catch up" contribution to your 401(k), boosting the overall limit to $44,000. If you were younger than 50 last year, withdraw $2,000 of your 401(k) contribution and the earnings on that amount. The $2,000 excess contribution counts as income for 2004, but the earnings count for 2005. You won't be penalized if you complete the distribution by April 15.