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ID Form 5305-SIMPLE: What You Should Know

I received a phone call from a client (the National Federation of Independent Business, or FIB, a “business federation” with roughly 2,100,000 employees) who claimed an exception for its members to pay SIMPLE tax by electing to have the SIMPLE IRA distribution tax withheld from their Social Security taxes, but I did not think it was good policy. There was no explanation of that exception, of whether it were allowed, and of the need for some type of special rule to make sure no one who had no other income was taxed for the SIMPLE IRA on the amount of the distribution. It is not reasonable to expect a small business to pay taxes on the amounts of his retirement savings that have been contributed to a SIMPLE IRA. Also, as a financial planner, my experience with the Form 5304 for SIMPLE IRA distribution was that in 90 percent of the cases, the employee did not report income on the Form 5304 and the plan did not withhold tax on the individual's Social Security tax payments. In the last ten percent, I learned that this was not the employee's plan but the employer's plan (which would also not report income), the distribution was tax-free, and the employer had deducted the distributions at source from his employees' Social Security taxes. The employee still had to pay the tax on the Social Security benefits, or on the Social Security equivalent, which is less than the regular amount. I think Form 5304 must be revised to clarify that the employer must continue to withhold tax on the Social Security equivalent of the SIMPLE IRA withdrawal and, in cases where income on the distribution is not reported (and so the plan had no tax withholding at year-end), the employee must still pay tax on the Social Security equivalent of the distribution. Note that employees who participate in a SIMPLE IRA only on a part-time basis should not file a Form 5304 to request comments on the Form 5305 for use with a designated financial institution as an employer because the employer could be in compliance even without the Form 5305 submission. However, if the SIMPLE IRA plan is part of a larger SIMPLE IRA plan that is not a designated financial institution, a Form 5304 is required, even if the Form 5305 would be sufficient.

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