Are SIMPLE IRA contributions tax deductible?

A SIMPLE IRA is a retirement savings plan that provides self-employed individuals a simpler way to save for retirement. This retirement plan combines the features of a conventional IRA and 401(k), allowing both the employer and employee to contribute to the account. However, there are different rules on whether contributions can be deducted from the annual tax return.

Employee salary deferrals to a SIMPLE IRA are not tax-deductible from their income on Form 1040. If you have enrolled in your employer’s SIMPLE IRA plan, the retirement contributions are excluded from your gross income for federal withholding. Claiming a tax deduction on your tax return could amount to claiming the deduction twice.

How SIMPLE IRAs Work

A SIMPLE IRA provides small businesses with no more than 100 employees a way to save for retirement. For an employee to be eligible to enroll in the plan, they must have earned at least $5,000 in compensation in the previous two years, and expect to receive an equal amount or more in the current year.

An employee enrolled into a SIMPLE IRA account can contribute to the plan by making elective deferrals, either as a salary reduction contribution or cash. Employees can contribute up to $14,000 for 2022, or $17,000 for those above age 50. If you have another employer-sponsored retirement plan, the total cumulative deferrals should not exceed $20,500 in 2022.

The IRS also requires employers to contribute to each employee's SIMPLE IRA, by making a flat 2% of salary contribution, or a dollar-for-dollar match of up to 3% of salary. The employer must contribute to each eligible employee's account even if the employee does not contribute to their own SIMPLE IRA account.

Can you claim SIMPLE IRA contributions on your tax return?

When you contribute to a SIMPLE IRA, you contribute pre-tax money to the retirement account. This means the employer does not withhold part of the contribution for federal income tax before the funds are deposited in a SIMPLE IRA. Hence, the employer does not report the contributions as an income on W-2 form, and you won’t be required to report the contributions as income on your tax return.

However, different rules apply to businesses. The IRS allows employers to claim a tax deduction on matching contributions to employees' SIMPLE IRAs on Schedule C of the business tax return. As a result, the matching contributions are not reported on W-2 form of the employee participants.

If you are a sole proprietor or a business partner, you can deduct the salary reduction contributions and the matching or non-elective contributions made to your SIMPLE IRA on Form 1040 line 28.

How to Report SIMPLE IRA contributions on W-2 Form

The IRS requires employers who offer SIMPLE IRAs to report certain information on W-2 forms of employees enrolled in the plan. Like other retirement plans such as 401(k), the employer must report salary deferral contributions on the employee's W-2 form.

The employer deducts the employee’s contributions from the “Wages, tips, and other Compensation” box on W-2 form, and then selects box 13 “retirement plan” box.

The W-2 form does not list the annual employee contributions, but the employee must list and report the contributions separately. The employee reports the contributions on Form 1040. Employee salary deferrals are not liable to federal income tax withholding. However, these contributions are subject to Social Security, Medicare, and FUTA taxes.

When are SIMPLE IRA contributions due?

SIMPLE IRAs are funded in two ways i.e. employee contributions and employer contributions. These contributions must be deposited into the employee's account before the due date to avoid incurring penalties.

Employee contributions deducted from the employee's paycheck as salary reduction contributions must be deposited in the employee's account within 30 days of the month in which the payments were due. For example, if the contributions were taken from the employee's paycheck on April 30, they must be deposited in the employee’s SIMPLE IRA by May 30 of the same year.

If you are self-employed and there are no other employees in the business, the salary reduction contributions must be deposited by January 30 of the following year.

The employer can make contributions to each employee’s SIMPLE IRA, either as matched contributions or non-elective contributions. The employer contributions are due by the deadline for tax returns, usually October 15. If there is an extension, the due date for employer contributions can extend to Oct 15.

SIMPLE IRA vs. SEP IRA

A SEP IRA and SIMPLE IRA are available to small businesses and self-employed people. If a business has one or more employees, including sole proprietorships and partnerships, it qualifies to open a SEP IRA. For 2022, SEP IRA contributions are capped at 25% of employee compensation or $61,000, whichever is less. However, only employers can contribute to SEP IRAs.

On the other hand, SIMPLE IRAs are for businesses with up to 100 employees. This IRA is funded by both employer and employee contributions. However, SIMPLE IRAs have a lower contribution limit than SEP IRAs, and contributions are limited to $14,000 in 2022, or $17,000 if you are above 50.