Maximum Keogh contributions for the self-employed: a simplified approach.

• Author: Harrison, Robert E.

In many cases, determining the amount of the contribution required to be made to a defined contribution qualified retirement plan f or a business's employees is a relatively simple calculation. Each employee's eligible compensation, as defined in the plan document, is multiplied by the employer's contribution percentage, also stated in the plan document. The total amount for all employees is then taken as a deduction in arriving at net income from the trade or business.

However, determining the amount of the contribution for a self-employed individual is not as simple. In order to compute the allowable deduction for a self-employed individual to a retirement plan (Keogh), the contribution percentage applied to an individual's net income derived from the trade or business must be modified. The percentage stated in the plan is actually applied to the net income from the individual's trade or business after deducting the sum of (1) one-half of the Social Security (OASDI and Medicare) self-employment taxes and (2) the deduction for contributions to the self-employed retirement plan by the self-employed individual.

In computing the self-employment taxes, the applicable tax rates are applied to 92.35% of the net income from the trade or business. The applicable combined OASDI and Medicare tax rate is 15.3% of net self-employment earnings of up to $57,600 for 1993 ($60,600 for 1994). Due to the uncoupling of the OASDI and Medicare base limitations, the Medicare tax of 2.9% applies to the excess of net self-employment income above the OASDI threshold limit. The Medicare tax base is limited to $135,000 for 1993. After 1993 there is no limitation, and all net self-employment income is subject to the Medicare tax.

There are two additional limitations that apply to both employees and the self-employed. The amount of the Keogh contribution for a defined contribution plan for each employee and self-employed person is limited to $30,000. This amount will be increased for inflation when the cost-of-living adjustments cause the annual limitation for a defined benefit plan to exceed $120,000 (for 1994 the limit is $118,800). In addition, the amount of income that may be considered in computing the contribution is also limited. Prior to the Revenue Reconciliation Act of 1993 (RRA), the income limitation was $200,000 adjusted for inflation ($23,9,840 for 1993). The RRA reduced the income limitation to $150,000 for plan years beginning after Dec. 31, 1993. The...