Payroll in Practice: 9.6.2022

Question: An employee participating in an employer’s SIMPLE retirement plan will turn 72 in 2022 and will continue his employment beyond the end of the year. Can the employee continue participating in the SIMPLE plan after turning 72?

Answer: Yes, an employee may continue participating in the SIMPLE plan after age 72 so long as the participation requirements are met. As with a traditional individual retirement account, required minimum distributions must be taken starting at age 72.

A Savings Incentive Match Plan for Employees plan allows an employer and its employees to contribute to traditional IRAs created under the SIMPLE plan. These IRA accounts are owned by the individual employees.

Employer and employee contributions to a SIMPLE plan do not affect the amount an employee can contribute to a traditional IRA or Roth IRA. However, an IRA under a SIMPLE plan cannot be a Roth IRA.

Employer contributions to the plan are not taxed to the employee until they are distributed from the plan., Employers may deduct their contributions to the plan once they are made, but the contributions must be either matching or nonelective in accordance with federal law.

Employee contributions are made on a salary-reduction pretax basis, and the maximum annual contribution is more than what is allowed for a traditional IRA. The employee contribution limit in 2022 is $14,000. An additional $3,000 in catch-up contributions is allowed for employees ages 50 or older. The SIMPLE plan also coordinates with other qualified plans with respect to the 2022 overall salary-reduction contribution limit of $20,500.

Since the enactment of SECURE Act in 2020, employees may continue to participate and contribute to the SIMPLE plan after reaching age 72. Further, employers may not exclude employees who meet the plan participation requirements.

To participate in the plan, an employee must have earned at least $5,000 during any two preceding calendar years and must reasonably expect to earn at least $5,000 during the year that contributions are to be made. The employer may set less restrictive requirements but cannot impose additional qualifications for participation.

Even though the employee is allowed to continue to make contributions to the SIMPLE plan, the employee must take required minimum distributions from the plan after reaching age 72.

Question: A New Jersey employer has heard that some employee benefits, such as Section 125 plan benefits and 401(k) plan deferrals are excluded from income for federal income tax but taxable for New Jersey income tax. What are the differences between New Jersey and federal rules?

Answer: Under New Jersey law, for 401(k) plans, both employee and employer elective contributions are excluded from New Jersey income tax. For Section 457 and 403(b) plans, employee contributions are included while employer contributions receive tax-deferred treatment. For SIMPLE, SEP, and SARSEP plans, both employer and employee contributions are included in taxable income and do not receive tax deferral treatment.

Employer contributions to 401(k) plans that that the employee could have elected to receive cash in lieu of contributions are subject to New Jersey tax. The recently enacted New Jersey Secure Choice Savings Program Act also requires employers subject to the act to pay pretax amounts deducted from employee pay “less any amount withheld for State income tax” into the state fund created by the act.

Employees should keep good records of any retirement plan contributions that are excluded for federal income tax purposes but included for New Jersey income tax. Retirement distribution amounts attributable to these contributions, while taxable at the federal level, are not taxable for New Jersey tax purposes.

New Jersey has not adopted federal income tax treatment for Section 125, commonly referred to as cafeteria plans. Most Section 125 plan benefits that are excluded from employee wages under federal law are taxable under New Jersey law.

However, New Jersey law does provide a limited exclusion for benefits under one type of cafeteria plan. This exclusion does not include any arrangement that involves salary reduction contributions.

For the benefit to be excluded from New Jersey income, four conditions must be met.

First, the cafeteria plan must meet the IRS requirements under IRC Section 125 and the value of the option must be excludible from federal taxable income.

Second, any option to receive cash under the plan must be a New Jersey “qualified option” in which the employee may only elect to receive cash in lieu of the benefit if the employee has a similar benefit from a source other than the employer. For example, the employee is covered by a similar benefit provided the spouse’s employer.

Third, the benefit cannot be provided under a salary reduction agreement through which the employee individually elects to reduce or forego increases in compensation and have that amount provided as a benefit by the employer. For example, a benefit provided under a flexible spending arrangement or premium conversion option would not qualify.

Fourth, the employee elects to receive the qualified cafeteria plan benefit instead of cash.

If the employee elects to receive cash in lieu of the benefit, the cash is not excluded from the employee’s income.

For example, a cafeteria plan that reduces an employee’s compensation to partially fund its health insurance benefit is not excludable from New Jersey income taxation.

Similarly, an employee may elect to contribute $2,850 to a health insurance flexible spending account through a salary-reduction arrangement in 2022. At the federal level, taxable wages are reduced by $2,850. However, for New Jersey, the $2,850 is included in taxable wages and is subject to tax and withholding.

In both cases, the benefits are not excluded from New Jersey income because they are provided under a salary-reduction arrangement.

In another example, a cafeteria plan offers employees $2,850 a year, as a supplement to regular salary, to use for a health insurance benefit or to receive in cash.

For federal purposes, the benefit is excluded from taxable income if the employee elects to receive the health insurance but is taxable if the employee elects to receive cash. For New Jersey the benefit is taxable regardless of whether the employee elects the benefit or cash because the option to receive cash is not conditioned on the employee receiving a similar benefit from another source.

However, if the plan only allows employees to receive the cash supplement if the employee derives a similar health insurance benefit from another source and the employee elects to receive the benefit, the value of the benefit may be excluded from New Jersey income. If the employee elects to receive cash, the cash benefit is taxable for both federal and New Jersey purposes

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., or its owners.

Author Information

Patrick Haggerty is the owner of a tax practice in Chapel Hill, N.C., and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.

Do you have a question for Payroll in Practice? Send it to phaggerty@prodigy.net.