If you receive directors’ fees for serving on the board of a corporation, you may be able to defer the taxation on a portion of this income.
Given that directors' fees are considered self-employment income, they can be used to make tax-deductible contributions to a Keogh plan, a retirement plan for self-employed individuals. Since Keogh plans are qualified retirement plans, they are generally subject to the same qualification rules as employee retirement plans. Keogh plans can be either a traditional defined-benefit pension plan or a defined-contribution plan, such as a money-purchase pension plan or a profit-sharing plan. Essentially, deductible contributions of up to 20 percent of income—up to $50,000 for 2012—may be made to either type of defined-contribution Keogh plan. Keogh defined-benefit plans are funded in much the same manner as employee defined-benefit plans.
If a profit-sharing plan is selected, an additional benefit can be provided through the use of a cash or deferred arrangement, otherwise known as 401(k) plan. These one-participant 401(k) plans, sometimes called “mini” or “solo” 401(k) plans, allow for up to $17,000 in regular 401(k) contributions annually plus up to $5,500 in catch-up contributions for those age 50 and older in 2012. “Solo” 401(k) plan contributions are subject to the same $50,000 limit of deductible annual contributions as the profit-sharing plan contributions. In effect, the “solo” 401(k) plan contributions would help to fill a portion of the $50,000 deductible contribution limit not used by the profit-sharing plan contributions.
You may participate in a Keogh plan in addition to any qualified pension and profit-sharing plan in which you participate in as an employee. Your contribution and deduction limits under the Keogh plan are not affected by your participation in a non-401(k) employee retirement plan. However, the $17,000 limit on deductible contributions to a 401(k) plan applies on a per-person, rather than a per-plan basis. Therefore, any contribution made to a 401(k) plan outside of the Keogh plan would reduce the allowable $17,000 deductible contribution amount for the “solo” 401(k).
As mentioned, Keogh plans are qualified retirement plans and are subject to complex qualification rules, which come at a cost. These plans require proper written documents. Most qualified plans follow a standard form that has been approved by the Internal Revenue Service. These standard plans are commonly known as prototype plans, which are typically provided by financial institutions or investment companies. To take a tax deduction for contributions for a tax year, a Keogh plan needs to be set up by the last day of that tax year (Dec. 31). However, contributions (other than 401(k) contributions) to these plans can be made up until the due date of your tax return (including extensions). Unfortunately, Keogh plans are subject to annual reporting requirements.
If you are looking to reduce your current tax bill, setting up a Keogh plan to defer your director’s fees may be an option. As always, we recommend that you speak to a tax specialist for more guidance and information about how this approach may benefit you.
Mary-Ann F. Schaller can be reached at Email or 215.441.4600.