The Employee Retention Credit (ERC) is a benefit for employees, who are prevented from expensing the cost of their American health insurance. Employers can reduce or eliminate the ERC for eligible employees who take a leave of absence or disability under the Family and Medical Leave Act (FMLA), or under their state or local family or medical leave laws. The ERC is also available to other exempt employees in special cases. The ERC is refundable to an eligible employer equal to 20% of the cost of health insurance premiums paid by the employee.
The ERC is based on the law’s definition of an employee and is not meant to serve as an employee benefit for other benefits provided by the employer. As such, the ERC does not apply to:
- Housekeeper or housekeeping assistance
- Personal services provided by third parties
- Employee benefits furnished by the employer (except for compensation of a contractual obligation to provide, which is generally excluded)
- Health and dental insurance benefits paid to the employee or a family member
- Total medical benefits paid to the employee, his/her family, or an employee related individual
- Tuition reimbursement benefits for an employee or family member
- Job-related expenses paid to an employee in connection with his/her employment
The IRS has defined an ERC eligible employee as an employee who meets one or more of the following conditions:
The employee:
- Is covered by a state or local family or medical leave law
- Is permitted to take leave without pay under the FMLA
- The employee is the primary support of a family member who is sick or disabled
- The employer pays a health insurance premium for the employee or his/her family
Employees who may be eligible for the ERC who are not eligible for the FMLA:
- The employee is covered by a state or local family or medical leave law but is not permitted to take leave without pay
- The employee is the primary support of a family member who is ill or disabled
- The employee’s employer does not provide health or other medical insurance coverage for the employee or his/her family
Note:
The ERC will not be available to an individual who becomes unemployed, if the ERC is not paid on the basis of employment until the individual is gainfully employed. The ERC is paid from the employee’s wages before itemized deductions. The tax return forms apply for the ERC can be found at http://www.irs.gov/pub/irs-pdf/p95qx.pdf
Benefits for an ERC eligible employee
If an ERC eligible employee takes the required leave or disability under FMLA or a similar law, the employee is not eligible to get the ERC unless the employer provides benefits that are excluded from the ERC. In this case, the employer would provide additional employee benefits that are not covered by the ERC. An employer could provide a paid family medical leave or a family caregiver program (e.g., compassionate leave). The family caregiver program may or may not meet the requirements. These programs typically provide family leave for primary caregivers and benefit nonfamily caregivers.
Employers should discuss the tax treatment of these and other employee benefits to determine which are ERC eligible. The requirements for making an ERC eligible employee eligible for such benefits may differ from state to state or from employer to employer. For more information about the ERC, including the requirements for making an ERC eligible employee eligible for such benefits, contact your tax professional or visit IRS.gov/payments/Employer-Coverage-and-Taxation.
Online calculators also can help employees and employers understand how to compute benefits under the ERC and plan for the costs. The IRS recommends that employees understand how to use the calculators because the calculations may be different for each employee. Additional ERC information can be found on IRS.gov by going to the “Employer Benefits” section.
Benefits Administration
Employees and their dependents often complain about financial and tax burdens caused by difficult and confusing employer and employee communication. In addition, the time and money required to verify or dispute a tax-deductible benefit could be more than the tax benefit would justify.
Generally, an employer should send a letter to each eligible employee or each dependent of a eligible employee before the start of the tax filing season, the time period in which employees and employers must make certain that they have created, corrected, or informed the IRS of each eligible employee’s benefit and claim in the tax return.
If an employee has a qualified dependent, the employer should also mail the benefit statement, either at the beginning or at the end of the tax filing season. However, the benefits statement, once received, is not necessary to claim the benefit under the ERC. The benefits statement shows how the employee and each dependent are to use the ERC during the tax filing season.
Also, benefits should be mailed at least 60 days before the start of the tax filing season. After the effective date of any law that affects an eligible employee’s ERC, benefits must be mailed at least 45 days before the tax filing season begins. In addition, employers should make the benefits available and the costs clearly understood through formal literature or printed material.
For example, an employer could offer the benefit through a statement in the employee’s paycheck or by a booklet. By this action, the employer is assuming that employees understand the ERC, and it is responsible for communication. Employers may make their publications available to their employees, but they should consider only providing the information in an easily-read form.
Retirement Plans
Your retirement plan is generally an important benefit that your employees will count on to supplement Social Security and other retirement income. For that reason, it is very important that you keep your retirement plan in good order. For that reason, it is very important that you keep your retirement plan in good order.
However, if you leave your employer or your retirement plan provider, then it may be difficult to maintain your records. Therefore, before you leave your employer or your retirement plan provider, it is important that you make every effort to communicate your account records to them. This means that you should not automatically “inbox” your employee or your retirement plan provider every time you make a change in the plan.
Also, you should designate someone to help you keep your records. If you are not prepared to do this, then it may be a good idea for you to resign your position and change the plan provider. A good resource for establishing records for your former plan is the Publication 450, Publication 590, or Publication 593 from the Employee Retirement Income Security Act (ERISA) Board of Governors.
Benefits Contracting
Your employees, other than those of a non-profit entity, need to understand that they are required to select the plan they want on the first day of the benefit year. Many employees fail to sign the agreement on the first day of the benefit year. This could result in a loss of a benefit entitlement, a delay in the processing of benefits, and possibly a large payment due to the plan provider. Therefore, it is important that your employees understand that they need to sign the agreement on the first day of the benefit year.
Many employers issue a contract of employment that states that an employee agrees to join the company’s benefit plan during the time of hire and to remain a member during the rest of the employment. However, the contract may also state that an employee has the option to remain in the plan. In either case, the employee needs to understand that he/she has the option to remain in the plan during the rest of the employment.
The employee should have the opportunity to decide which type of plan to participate in. An employee should have the opportunity to decide which type of plan to participate in. In addition, the employee should have the opportunity to decide whether to remain in the plan during the rest of the employment. If a new employee becomes a beneficiary of a “work-based retirement plan,” then the employee needs to sign a contract of employment during the time of hire.
Many plans allow this option for new employees. However, it is always best to notify the employee in writing that the company requires the employee to sign a contract of employment. It is also important that the employee be informed that he/she has the option to remain in the plan and he/she should be informed that the plan is an individual retirement plan and that a vested employee may purchase a “non-vested” investor membership and retain the employer-matching percentage of employee contributions for that year. ERC plans also provide a “catch up” option to new employees who become non-vested investors during their first year.
Benefits Reporting
IRS Publication 590 provides guidelines for the termination and reporting of benefits. The amount of the termination payment and the time period during which the benefits are reported is generally four years. ERC5 says that any terminated benefit must be reported in the first quarter of the year in which the termination occurred. If the terminated benefit was an annuity, the payment must be reported within 90 days of the termination.
One specific example of a termination payment is a 401(k) bonus paid to an employee by his employer after the year ends. In this case, if the employee is required to have the payment paid into a tax-deferred account, the payment must be reported within 90 days of the payment. If an employee leaves before the end of the first year of service, he or she is not required to make the payment.
However, the employer still has to report the amount of the termination payment, and the employee must report the amount of the severance payment when he or she applies for unemployment benefits. The employee must also notify the plan provider of the termination and, if applicable, the plan’s administrator. The plan provider must be notified at least 60 days in advance of the termination. The termination report and the unemployment report must be filed annually.
Consultation and Advice
An employee should contact his/her insurance broker to obtain free consultation and guidance. The insurance broker can assist the employee in making a decision whether or not to sign a contract of employment and whether or not to participate in an ERC or an IRA. Some plans require a new employee to remain in the plan during the rest of the employment. In addition, if the company does not have an ERISA plan, the insurance broker can help an employee understand the steps needed to create one.
In addition, insurance brokers are experts in evaluating the risk of the plan. They can recommend whether it makes sense for the employee to continue in a plan that requires an initial contribution. They can recommend whether it makes sense for the employee to enroll in an IRA. In addition, the insurance broker can offer advice regarding the risks associated with the different products that the employee may have. He or she can also help the employee understand the plan’s restrictions and rules.
ERC and IRA Placement
With an IRA, a new employee can have a vested percentage of the contribution and employer match. Since the employee is permitted to remain in the plan until the age of 59 ½, the employer’s matching percentage remains in effect and remains subject to income tax withholding. However, the employee’s vesting period does not begin until the vesting period in the IRA expires. The employer will match the employee’s contributions for the employee’s vesting period, but will not contribute to the IRA during the vesting period. Thus, to continue receiving the full employee match, the employee will need to make contributions every year to the IRA, during the vesting period.
If the employee is in an IRA, he or she can either continue in the 401(k) or use an IRA custodian to open a new IRA account. The employee cannot remain in the 401(k) if the IRA custodian offers the same or better benefits. With an ERC, the employee will receive the full benefit amount on an annual basis unless the employee terminates or is terminated within the vesting period, at which time the employee is required to surrender the benefit and begin contributing to a Roth IRA. With the Roth IRA, the employee’s contributions are tax deferred, and the contribution and employer match will be subject to income tax withholding. However, the employee may withdraw the contribution at any time.
Individual Retirement Plans
Unlike a 401(k) plan, an individual retirement plan requires the employee to be enrolled during the entire vesting period. He or she is also subject to the Roth IRA requirement, but without the withholding requirement. Unlike an IRA, an individual retirement plan is not subject to income tax withholding for contributions. However, it is still a qualified plan. Qualified plans must also comply with a number of rules concerning contribution limits and annual contribution limits.
The IRA and ERC and IRA types are complicated, and the financial services industry has developed several special rules to meet those needs. The financial services industry can also assist employees with drafting IRAs or ERCs. The special rules can help employees avoid major pitfalls or self-dealing by employers.
However, if an employee receives advice from a company not willing to provide this information, it is very possible that he or she will end up choosing the plan with the highest 401(k) match. Thus, employees need to understand the features of the various retirement plans.
Individual Retirement Accounts
The Individual Retirement Account is another type of retirement plan offered by the financial services industry. Unlike the Individual Retirement Account, the IRA is subject to income tax withholding. Also, the Roth IRA is the one with the lowest contribution limits. However, unlike an IRA, the Roth IRA contribution can only be made up to the IRA’s income tax withholding. Therefore, the employee cannot contribute more than the percentage that is calculated by IRS withholding.
For example, if a 60 year-old IRA participant has earned $45,000 in 2017, he or she will be able to contribute $5,500 to his or her IRA. The contribution will be subject to $3,500 in tax withholding. However, if the participant can afford to, he or she can contribute $6,000 without being subject to additional taxes or penalties. Thus, with the Roth IRA, the maximum contribution is the lesser of the participant’s income tax withholding or his or her income tax liability, but neither will be more than the amount of contribution to the Roth IRA.
Required Distributions
If the employee is not participating in the plan and has met the required contributions, then the employer is required to deposit an amount equal to ½ of the employee’s contributions into the employee’s Individual Retirement Account. An IRA’s first distributions are made during the first year after the IRA’s inception. The employer is also required to make a minimum contribution to the employee’s Individual Retirement Account equal to ½ of the employee’s contributions, or $6,000 in 2017.
As the IRS has recently explained, the IRS and the Department of Labor have issued rule on contribution limits for the IRA in 1996 and the Employee Retirement Income Security Act (ERISA) in 1974, and they have updated these rules multiple times to recognize changing labor market conditions and legislative changes. Today, under a long-standing tax policy, the contribution limit has not changed. On one hand, as shown in the graphic, the maximum contribution is at an all-time high, and on the other hand, the contribution limit has not changed in 37 years.
Let’s look at the IRS (United States Internal Revenue Service) Publication 590-A and Department of Labor (Department of Labor) Publication 590-B. Under these rules, a pre-tax employer contribution to an IRA is limited to the IRA’s total contribution and its first distribution. Let’s look at an example:
Total contribution limit for 2017 401(k) contributions: $18,000
First distribution: $6,000
Maximum pre-tax contributions: $18,000 ($18,000 × ½)
Maximum employer contribution: $18,000 ($18,000 × ½)
Maximum employee contribution: $6,000
Maximum employee distribution: $6,000 ($18,000 × ½)
Under this scenario, the maximum contribution to the employee’s IRA is equal to ½ of the employee’s total contribution and the first distribution. Therefore, for each $6,000 the employee can contribute, he or she will be limited to $4,000 in employer contributions.
The amount the employee can contribute to his or her IRA is also determined by the IRA contribution limits. The maximum IRA contribution is reduced by 50 cents for each dollar the employee contributes, up to the total amount of contribution limits. For example, if the employee’s contribution to the IRA is $4,000, he or she can contribute $2,500 or $5,500 in order to participate in a Roth IRA, depending on whether the employer offers a Roth IRA or a traditional IRA.
To calculate the employee’s IRA contribution limit, the current contribution maximum amount, as well as the first distribution amount, may be determined by working backward. The employee’s contribution limit is multiplied by 50 cents for each dollar he or she contributes, up to the total contribution amount, and the first distribution is the amount the employee will be eligible to make after the contribution has been deducted for the contribution.
What Are The Taxes And Minimum Distributions For IRA Distributions?
Under the IRA distribution rules, the employee’s IRA custodian will calculate the IRA beneficiary’s tax bill, which is based on the value of the IRA assets at the time of the distribution. The IRS has provided a table to illustrate the IRA beneficiary tax consequences:
Net value of IRAs for year 2022 – this table shows the value of the IRAs at the time of the distribution of distributions for the IRA beneficiaries and is based on distributions for 2022, and assumes that there is no Roth IRA distribution. Dividends and/or distributions will be shown for each IRA.
Taxable income percentage of IRA distributions – calculated by the current owner of the IRA from the capital gain on sale of the assets.
Independent living allowance (ILA) and lifestyle adjustment factor (LAF) – these are the additional percentage of IRA distributions that are taken into account by the IRA owner for the purposes of meeting a minimum age requirement.
Optional distribution – a distribution that may be eligible for the ILA (the amount of a distribution is determined by the employee and his or her broker), or the LAF (the amount of a distribution is determined by the IRA owner and his or her broker). This is not a required distribution and it is optional and not subject to required minimum distribution requirements. The minimum distribution amounts may be calculated by the IRA owner and the IRA custodian, but they may also be determined by the IRS.
Gifts – any transfers of IRA assets to a spouse, child, parent, grandchild, legal guardian or grandchild, who becomes the beneficiary of the IRA, must be included in the calculation of the distribution amount. The IRA owner is responsible for the source of the gift and is responsible for any required paperwork and reporting.
- Example 1. The IRA owner purchases a $10,000 position in an S&P 500 index fund on a date that is one year in the future. If this purchase of $10,000 is made in the year 2019, then the IRA owner will need to include in the IRA beneficiary tax return a distribution of $9,300 in 2019 and $3,100 in 2020 for a total distribution of $10,500. If the annual contribution limit to the IRA is $5,500 in 2019 and $6,500 in 2020, then the annual contribution limit is the greater of $7,100 or the IRA owner’s tax filing limit for the year 2019.
- Example 2. The IRA owner is 70 years old and decides to convert his IRA to a Roth IRA by making two $4,000 contributions to the Roth IRA. If the IRA owner were to elect a full Roth conversion, then the $4,000 contribution will be considered a tax-deductible contribution that is included in the IRA owner’s IRA distribution.
- Example 3. If the IRA owner was to make three $4,000 contributions to his IRA, two in 2019 and one in 2020, the three $4,000 contributions will be considered as one $7,000 IRA distribution.
- Example 4. If the IRA owner is a long-term care insurance policy holder, she or he needs to make annual payments in addition to the regular premiums. If the policy holder lives into her or his 80s, and the payments increase each year, then the policy holder may be subject to the death taxes. Each $1,000 of lifetime coverage is subject to a death tax at a rate of 3.8%. If the policy holder were to make annual payments of $5,000 to her or his policy, then there would be three $5,000 death taxes.
In the year 2022, the IRA owner would have made three annual payments to his IRA in 2019, 2020, and 2022. In 2022, the IRA owner would have three $5,000 death taxes as a result of the IRA owner’s lifetime coverage. Generally, any distribution of IRA assets (including distributions within an IRA) is taxed in the year it is made and reported on the beneficiary’s tax return as either a single or married filing joint. All contributions to a Roth IRA are tax-free and withdrawals from a Roth IRA are tax-free, but not all withdrawals are tax-free.
For 2022, the law provides that a Roth IRA withdrawal is exempt from the required minimum distribution, but only if the withdrawal is made by December 31 of the year following the year in which the IRA owner reaches age 59½ or age 70½. The withdrawal must be made by December 31 if the distribution will exceed the IRA owner’s adjusted gross income (AGI) for the year (or a reduction in penalty for early withdrawal applies). If the IRA owner does not want the withdrawal to count as part of his or her AGI for the year, then the withdrawal must be made no later than the end of the tax year. The withdrawal is still subject to the required minimum distribution if the IRA owner is not yet 59½ years old or the distribution exceeds $100,000.
Estate and Gift Taxes for IRA and Roth IRA Owners
Taxpayers who have Individual Retirement Accounts (IRAs) or Roth IRAs are required to make estate and gift tax (E&G) gift plans for their beneficiaries. A E&G gift plan is a plan that ERC S and IRAs owners create for their beneficiaries. A gift plan provides the beneficiary with a written statement in the event of the IRA owner’s death that lists assets the IRA owner has established to be transferred to the beneficiary. These assets include a set of assets in proportion to the beneficiary’s contribution history and range of legal size, such as $20,000 to $100,000. Estate and gift tax planning often occurs when a person dies.
It involves determining how the beneficiary should manage an IRA or Roth IRA trust, which will receive the IRA or Roth IRA assets. E&G plans are often included as part of the estate plan. For example, if the beneficiary dies before the required distribution period, there is no need for the beneficiary to make the required distribution and this will allow the assets in the IRA to continue to grow until the required distribution date. A beneficiary who wishes to make a withdrawal must make the required distribution in the same year the asset is transferred into the trust. For example, a beneficiary who wishes to withdraw a $40,000 IRA account in 2019 would need to make the required distribution in 2019. The remaining $20,000 would continue to grow tax-free and may be withdrawn in 2020 for the beneficiary’s benefit.
Required distributions and withholding taxes of IRA and Roth IRA Distributions
Also, IRA owners are required to make distributions of their IRA assets in exchange for a tax benefit. These distributions are called required minimum distributions (RMDs). For 2018, the RMDs are computed based on IRA assets at the beginning of the year and for a person who reached age 70½ at the beginning of the year. If a person did not take required distributions during the prior year, the RMDs will be increased by 10% for every year of not taking the distributions during the prior year.
In addition, some states have state income tax withholding on IRA distributions. The state of residency determines the percentage of the distribution that will be withheld. The percentage is determined by the state’s tax rate, which is either a flat income tax or an income tax that applies to a person’s total income, even though it is not a tax on wealth. State withholding generally begins the year after the IRA owner reaches age 70½ or the year after the RMD is calculated and paid to the state, whichever occurs later.
Any IRA or Roth IRA distributions that are not exempt from income tax and estate tax as the result of a Roth IRA or Roth 401(k) rollover, distribution from a qualified charitable distribution, or a qualified charitable distribution that does not include interest income, must be included in the owner’s income for federal income tax purposes. Therefore, taxpayers must report all of their IRA and Roth IRA distributions for tax purposes.
Also, if the RMD is not the result of an exchange from an IRA to a Roth IRA, it must be included in income for federal income tax purposes even if the amount is not tax-free. Furthermore, IRS Publication 529 gives complete details on RMDs from a qualified charitable distribution, as well as for income tax purposes for distributions from an IRA to a Roth IRA, or from a Roth IRA to a traditional IRA.
Should IRA owners be concerned about required distributions?
A taxpayer who cannot afford to pay for his or her required distributions will be referred to the state agency that administers state law. In the case of the state of New York, the state agency will impose penalties for failure to make the distributions on a person who cannot afford to make them. In the case of New York, a person who cannot pay $350 to the state agency each year can satisfy the required distribution by gifting the IRA assets to a New York state or local charity (or by giving the state agency the funds as a cash contribution).
In the case of California, if the person cannot pay the $350 to the state agency and only wants to transfer the IRA assets to a state or local charity, the state agency will determine the amount of the transfer on a case-by-case basis. If the transfer exceeds the amount that the state agency determines is necessary, it will assess a penalty on the transfer. The California law does not address the value of a qualified charitable distribution from a 401(k) to a charity, and therefore it is not clear whether the $350 will be assessed in the same way as the transfer from a traditional IRA to a qualified charitable distribution.
For taxpayers in the states that use California for the determination of the amount of the transfer, the situation is similar to that of the New York state agency. In this instance, the state agency will also determine the value of a qualified charitable distribution. Generally speaking, some taxpayers will not be able to accomplish the required distributions unless they have access to funds to accomplish them. For this reason, if you expect you will not have sufficient access to funds to fulfill a required distribution, you should establish an appointment with a qualified tax advisor to discuss your options.
ERC Voluntary and Form 10755
A taxpayer who has a pre-tax IRA or a retirement plan that meets the requirements of the ERC Voluntary Distribution Rule is able to allow any charity with a Schedule A with a Schedule C income tax form to receive an ERC Voluntary Distribution from the IRA or plan for which the distribution is made. In addition to receiving a distribution, the charity is also required to file an income tax return and pay the income tax on its portion of the distribution. These provisions are known as the Form 10755 and the ERC Voluntary Distribution Rule (or Voluntary Distribution Ruling for 401(k) plans). They were established by the Internal Revenue Code (IRC) in 2000.
The provisions are available to any tax-qualified retirement plan. It does not have to be an IRA or a 401(k) plan, but it must have an income test (as required for taxable plans) that meets the requirements of the IRC. A pre-tax retirement plan that meets the income requirements can participate. A Form 10755-R, Voluntary Distribution, is required to be filed by the beneficiary of a distribution, if requested by the beneficiary, or by the IRA owner, if requested by the IRA owner. If the distribution is to a charity, the beneficiary, the IRA owner or the retirement plan participant must request the distribution from the distribution administrator. The distribution can be made on Form 709 or Form 1120, Form 1065 or Form 1095-B, or Form 10695. If the distribution is to a charity that is tax-exempt, the distribution can be made on Form 1120.
There are two exceptions to the ERC Voluntary Distribution Rule that may apply:
A deduction is allowable if the distribution is less than the total of the investment income and the distribution income for the preceding tax year. For example, a distribution of $20,000 in an IRA or a 403(b) plan is taxed at the regular income tax rates of 20% and 33% (plus a 3.8% Medicare tax), and the distribution of $20,000 to a qualified charity is taxed at the standard tax rates on the full amount of the distribution. Charitable organizations are permitted to receive a distribution if the distribution is above the distribution income and other distribution tax liability of the organization.
A separate question is whether a distribution to a charity will be recognized as being made to the taxpayer (as opposed to being taxed by the charity) if the distribution is in excess of the amount the taxpayer needed to make the distribution. If the distribution is made in excess of the total of investment and distribution income, the distribution will be recognized as being made to the taxpayer as opposed to the charity. If the amount contributed is less than the total of income and investment income, a charitable contribution will be made to the charity.