Generally, you can convert an amount in your SIMPLE IRA to a Roth IRA under the same rules explained earlier under Converting From Any Traditional IRA.

However, you cannot convert any amount distributed from the SIMPLE IRA during the 2-year period beginning on the date you first participated in any SIMPLE IRA plan maintained by your employer.

You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the contribution.

How to recharacterize. To recharacterize a contribution, you generally must have the contribution transferred from the first IRA (the one to which it was made) to the second IRA in a trustee-to-trustee transfer. If the transfer is made by the due date (including extensions) for your tax return for the year during which the contribution was made, you can elect to treat the contribution as having been originally made to the second IRA instead of to the first IRA. It will be treated as having been made to the second IRA on the same date that it was actually made to the first IRA. You must report the recharacterization, and must treat the contribution as having been made to the second IRA, instead of the first IRA, on your tax return for the year during which the contribution was made.

Extension of time to recharacterize 1998 IRA contributions. You will have made a timely recharacterization of a 1998 IRA contribution, including a Roth IRA conversion for which you were not eligible, if all of the following apply.

1) The recharacterization occurred on or before December 31, 1999.

2) You timely filed your 1998 income tax return.

3) You file an amended 1998 tax return if the recharacterization is not properly reflected on the previously filed return.

If you would have liked to recharacterize 1998 Roth IRA contributions, including amounts contributed to Roth IRAs as conversions, you had until the end of 1999 to recharacterize your 1998 IRA contributions.

Conversion by rollover from traditional to Roth IRA. For recharacterization purposes, a distribution from a traditional IRA that is received in one tax year and rolled over into a Roth IRA in the next year, but still within 60 days of the distribution from the traditional IRA, is treated as a contribution to the Roth IRA in the year of the distribution from the traditional IRA.

Earnings must be transferred. The contribution will not be treated as having been made to the second IRA unless the transfer includes any net earnings allocable to the contribution.

No deduction allowed. No deduction is allowed for the contribution to the first IRA and any net earnings transferred with the recharacterized contribution are treated as earned in the second IRA. The contribution will not be treated as having been made to the second IRA to the extent any deduction was allowed with respect to the contribution to the first IRA.

Effect of previous tax-free transfers. If a contribution has been moved from one IRA to another in a tax-free transfer, such as a rollover, the contribution to the second IRA generally cannot be recharacterized. However, see Move from traditional to SIMPLE IRA, later.

Recharacterization of original contribution. A contribution to one IRA that has been moved between IRAs in tax-free transfers can be treated as if it remained in the first IRA, the IRA that received the original contribution. This means that you can elect to recharacterize the contribution to the first IRA by having a trustee-to-trustee transfer of the contribution made from the IRA in which it now resides to a second IRA and treating the contribution as having been made to the second IRA on the same date it was actually made to the first IRA. If both IRAs involved in the trustee-to-trustee transfer are maintained by the same trustee, you need only direct that trustee to transfer the contribution.

Roth IRA conversion contributions from a SEP-IRA or SIMPLE IRA can be recharacterized to a SEP-IRA or SIMPLE IRA (including the original SEP-IRA or SIMPLE IRA).

Move from traditional to SIMPLE IRA. If you mistakenly roll over or transfer an amount from a traditional IRA to a SIMPLE IRA, you can later recharacterize the amount as a contribution to another traditional IRA.

Applying excess contributions. You can recharacterize only actual contributions. If you are applying excess contributions for prior years as current contributions, you can recharacterize them only if the recharacterization would still be timely with respect to the tax year for which the applied contributions were actually made.

Employer contributions. You cannot recharacterize employer contributions (including elective deferrals) under a SEP or SIMPLE plan as contributions to another IRA. SEPs are discussed in chapter 4. SIMPLE plans are discussed in chapter 5.

Recharacterizations not counted as rollover. The recharacterization of a contribution is not treated as a rollover for purposes of the 1-year waiting period described in chapter 1 under Rollover From One IRA Into Another. This rule applies even if the contribution would have been treated as a rollover contribution by the second IRA if it had been made directly to the second IRA rather than as a result of a recharacterization of a contribution to the first IRA.

This chapter is for employees who need information about savings incentive match plans for employees (SIMPLE plans). It explains what a SIMPLE plan is, contributions to a SIMPLE plan, and withdrawals from a SIMPLE plan.

Under a SIMPLE plan, SIMPLE retirement accounts for participating employees can be set up either as:

Part of a 401(k) plan, or

A plan using IRAs (SIMPLE IRA ).

This chapter only discusses the SIMPLE plan rules that relate to SIMPLE IRAs. See Publication 560 for information on any special rules for SIMPLE plans that do not use IRAs.

TAX TIP If your employer maintains a SIMPLE plan, you must be notified, in writing, that you can choose the financial institution that will serve as trustee for your SIMPLE IRA and that you can roll over or transfer your SIMPLE IRA to another financial institution. See Rollovers and Transfers Exception, later.

A SIMPLE plan is a tax-favored retirement plan that certain small employers (including self-employed individuals) can set up for the benefit of their employees. See Publication 560 for information on the requirements employers must satisfy to set up a SIMPLE plan.

A SIMPLE plan is a written agreement (salary reduction arrangement ) between you and your employer that allows you, if you are an eligible employee (including a self-employed individual), to choose to:

Reduce your compensation by a certain percentage each pay period, and

Have your employer contribute the salary reductions to a SIMPLE IRA on your behalf. These contributions are called salary reduction contributions.

All contributions under a SIMPLE IRA plan must be made to SIMPLE IRAs, not to any other type of IRA. The SIMPLE IRA can be an individual retirement account or an individual retirement annuity, described in chapter 1. Contributions are made on behalf of eligible employees . Contributions are also subject to various limits .(See How Much Can Be Contributed on My Behalf?, later.)

In addition to salary reduction contributions, your employer must make either matching contributions or nonelective contributions .

Generally, rollovers and trustee-to-trustee transfers are not taxable distributions. See Two-year rule, next.

Two-year rule. To qualify as a tax-free rollover (or a tax-free trustee-to-trustee transfer), a rollover distribution (or a transfer) made from a SIMPLE IRA during the 2-year period beginning on the date on which you first participated in your employer's SIMPLE plan must be contributed (or transferred) to another SIMPLE IRA. The 2-year period begins on the first day on which contributions made by your employer are deposited in your SIMPLE IRA.

After the 2-year period, amounts in a SIMPLE IRA can be rolled over or transferred tax free to an IRA other than a SIMPLE IRA.

You can set up a SIMPLE IRA plan if you meet both of the following requirements.

l. You meet the employee limit.

2. You do not maintain another qualified plan unless the other plan is for collective bargaining employees.

Employee limit. You can set up a SIMPLE IRA plan only if you had 100 or fewer employees who earned $5,000 or more in compensation during the preceding year. Under this rule, you must take into account all employees employed at any time during the calendar year regardless of whether they are eligible to participate. Employees include self-employed individuals who received earned income and leased employees.

Once you set up a SIMPLE IRA plan, you must continue to meet the 100-employee limit each year that you maintain the plan.

Grace period for employers who cease to meet the 100-employee limit. If you maintain the SIMPLE IRA plan for at least one year and you cease to meet the 100-employee limit in a later year, you will be treated as meeting it for the 2 calendar years immediately following the calendar year for which you last met it.

A different rule applies if you do not meet the 100-employee limit because of an acquisition, disposition, or similar transaction. Under this rule, the SIMPLE IRA plan will be treated as meeting the 100-employee limit for the year of the transaction and the 2 following years if both the following conditions are satisfied:

l. Coverage under the plan has not significantly changed during the grace period.

2. The SIMPLE IRA plan would have continued to qualify after the transaction if you had remained a separate employer.

CAUTION:: The grace period for acquisitions, dispositions, and similar transactions also applies if, because of these types of transactions, you do not meet the rules explained under Who Can Participate in a SIMPLE IRA Plan?, below.

Other qualified plan. The SIMPLE IRA plan generally must be the only retirement plan to which you make contributions, or benefits accrue, for service in any year beginning with the year the SIMPLE IRA plan becomes effective.

Exception. If you maintain a qualified plan for collective bargaining employees, you are permitted to maintain a SIMPLE IRA plan for other employees.

You can convert a traditional IRA to a Roth IRA. The conversion is treated as a rollover, regardless of the conversion method used. Most of the rules for rollovers, described under Rollover From One IRA Into Another, under Traditional IRAs, earlier, apply to these rollovers. However, the 1-year waiting period does not apply.

Conversion methods. You can convert amounts from a traditional IRA to a Roth IRA in any of the following three ways.

1) Rollover . You can receive a distribution from a traditional IRA and roll it over (contribute it) to a Roth IRA within 60 days after the distribution.

2) Trustee-to-trustee transfer . You can direct the trustee of the traditional IRA to transfer an amount from the traditional IRA to the trustee of the Roth IRA.

3) Same trustee transfer . If the trustee of the traditional IRA also maintains the Roth IRA, you can direct the trustee to transfer an amount from the traditional IRA to the Roth IRA.

Same trustee. Conversions made with the same trustee can be made by redesignating the traditional IRA as a Roth IRA, rather than opening a new account or issuing a new contract.

Converting from any traditional IRA. You can convert amounts from a traditional IRA into a Roth IRA if, for the tax year you make the withdrawal from the traditional IRA, both of the following requirements are met.

1) Your modified AGI (explained earlier) is not more than $100,000.

2) You are not a married individual filing a separate return. (See Married filing separately exception, under Filing status, earlier.

Required distributions. Amounts that must be distributed from your traditional IRA for a particular year (including the calendar year in which you reach age 70 1/2) under the required distribution rules (discussed under Traditional IRAs, earlier) cannot be converted.

Inherited IRAs. If you inherited a traditional IRA from someone other than your spouse, you cannot convert it to a Roth IRA.

Income. You must include in your gross income amounts that you withdraw from a traditional IRA that you would have to include in income if you had not converted them into a Roth IRA. You do not include in gross income any part of a withdrawal from a traditional IRA that is a return of your basis, as discussed earlier under Traditional IRAs .

Conversion of 1998 withdrawal from a traditional IRA. If you withdrew an amount from a traditional IRA in 1998 and converted it to a Roth IRA, any amount you had to include in income as a result of the withdrawal is generally included ratably over a 4-year period, beginning with 1998. This means you included one-quarter of the amount in income in 1998, and must include one-quarter in 1999, one-quarter in 2000, and one-quarter in 2001. However, see Later withdrawals from Roth IRA, next.

Later withdrawals from Roth IRA. If you are including the taxable part of a 1998 conversion ratably over the 4-year period and in 1999 or 2000 you withdraw from the Roth IRA any amount allocable to the taxable part of the conversion, you will generally have to include in income both the ratable (one-quarter) portion for the year and the part of the withdrawal made during the year that is allocable to the taxable part of the conversion. See Ordering rules for withdrawals, later for information on how to determine the amount allocable to the taxable part of the conversion.

Death of IRA owner during 4-year period. If a Roth IRA owner who is including amounts ratably over the 4-year period dies before including all of the amounts in income, any amounts not included must generally be included in the owner's gross income for the year of death. However, if the owner's surviving spouse receives the entire interest in all the owner's Roth IRAs, that spouse can elect to continue to ratably include the amounts in income over the remaining years in the 4-year period. See Publication 590 for more information on making this election.

Converting from a SIMPLE IRA. Generally, you can convert an amount in your SIMPLE IRA to a Roth IRA under the same rules explained earlier under Converting from any traditional IRA.

However, you cannot convert any amount distributed from the SIMPLE IRA during the 2-year period beginning on the date, you first participated in any SIMPLE IRA plan maintained by your employer.

More information. For more detailed information on conversions, see Publication 590.

A SIMPLE IRA plan is a retirement plan that uses SIMPLE IRAs for each eligible employee. Under a SIMPLE IRA plan, a SIMPLE IRA must be set up for each eligible employee. For the definition of an eligible employee, see Who Can Participate in a SIMPLE IRA Plan?, later.

Any employee who received at least $5,000 in compensation during any 2 years preceding the current calendar year and is reasonably expected to earn at least $5,000 during the current calendar year is eligible to participate. The term "employee " includes a self-employed individual who received earned income.

You can use less restrictive eligibility requirements (but not more restrictive ones) by eliminating or reducing the prior year compensation requirements, the current year compensation requirements, or both. For example, you can allow participation for employees who received at least $3,000 in compensation during any preceding calendar year. However, you cannot impose any other conditions on participating in a SIMPLE IRA plan.

Excludable employees. The following employees do not need to be covered under a SIMPLE IRA plan.

l. Employees who are covered by a union agreement and whose retirement benefits were bargained for in good faith by their union and you.

2. Nonresident alien employees who have no U.S.-source wages, salaries, or other personal services compensation from you.

Compensation. Compensation for employees is the total amount of wages required to be reported on Form W-2, including elective deferrals (deferred amounts elected under any 401(k) plans, 403(b) plans, government (section 457(b)) plans, SEP plans, and SIMPLE IRA plans). If you are self-employed, compensation is your net earnings from self-employment (line 4 of Short Schedule SE (Form 1040)) before subtracting any contributions made to the SIMPLE IRA plan for yourself.

Notification Requirements If you adopt a SIMPLE IRA plan, you must give each employee the following information before the beginning of the election period.

1) The employee's opportunity to make or change a salary reduction choice under a SIMPLE IRA plan.

2) Your choice to make either reduced matching contributions or nonelective contributions (discussed later).

3) A summary description and the location of the plan. The financial institution should provide you with this information.

4) Written notice that his or her balance can be transferred without cost or penalty if you use a designated financial institution.

Election period. The election period is generally the 60-day period immediately preceding January 1 of a calendar year (November 2 to December 31 of the preceding calendar year). However, the dates of this period are modified if you set up a SIMPLE IRA plan in mid-year (for example, on July 1) or if the 60-day period falls before the first day an employee becomes eligible to participate in the SIMPLE IRA plan.

A SIMPLE IRA plan can provide longer periods for permitting employees to enter into salary reduction agreements or to modify prior agreements. For example, a SIMPLE IRA plan can provide a 90-day election period instead of the 60-day period. Similarly, in addition to the 60-day period, a SIMPLE IRA plan can provide quarterly election periods during the 30 days before each calendar quarter, other than the first quarter of each year.

Contribution Limits Contributions are made up of salary reduction contributions and employer contributions. You, as the employer, must make either matching contributions or nonelective contributions, defined later. No other contributions can be made to the SIMPLE IRA plan. These contributions, which you can deduct, must be made timely. See Time limits for contributing funds, later.

Salary reduction contributions. The amount the employee chooses to have you contribute to a SIMPLE IRA on his or her behalf cannot be more than $6,000 for 1999. These contributions must be expressed as a percentage of the employee's compensation unless you permit the employee to express them as a specific dollar amount. You cannot place restrictions on the contribution amount (such as limiting the contribution percentage), except to comply with the $6,000 limit.

If an employee is a participant in any other employer plan during the year and has elective salary reductions or deferred compensation under those plans, the salary reduction contributions under a SIMPLE IRA plan also are an elective deferral that counts toward the overall $10,000 annual limit on exclusion of salary reductions and other elective deferrals.

If the other plan is a deferred compensation plan of a state or local government or a tax-exempt organization, the limit on elective deferrals is $8,000.

Employer matching contributions. You are generally required to match each employee's salary reduction contributions on a dollar-for-dollar basis up to 3% of the employee's compensation. This requirement does not apply if you make nonelective contributions as discussed later.

Example. In 1999, your employee, John Rose, earned $25,000 and chose to defer 5% of his salary. You make a 3% matching contribution. The total contribution you can make for John is $2,000, figured as follows.

Salary reduction contributions
($25,000 x .05)................................................ $ 1,250
Employer matching contribution
($25,000 x .03)................................................       750
Total contributions............................................ $ 2,000

Lower percentage. If you choose a matching contribution less than 3%, the percentage must be at least 1%. You must notify the employees of the lower match within a reasonable period of time before the 60-day election period (discussed earlier) for the calendar year. You cannot choose a percentage less than 3% for more than 2 years during the 5-year period that ends with (and includes) the year for which the election is effective.

Nonelective contributions. Instead of matching contributions, you can choose to make nonelective contributions of 2% of compensation on behalf of each eligible employee who has at least $5,000 of compensation from you for the year. Only $160,000 of the employee's compensation can be taken into account to figure the contribution limit.

If you choose this 2% contribution formula, you must notify the employees within a reasonable period of time before the 60-day election period (discussed earlier) for the calendar year.

Example 1.

In 1999, your employee, Jane Wood, earned $36,000 and chose to have you contribute 10% of her salary. You make a 2% nonelective contribution. The total contributions you can make for her are $4,320, figured as follows.

Salary reduction contributions
($36,000 x .10)................................................ $ 3,600
2% nonelective contributions
($36,000 x .02)................................................       720
Total contributions............................................ $ 4,320

Example 2.

Using the same facts as in Example 1, above, the maximum contribution you can make for Jane if she earned $75,000 is $7,500, figured as follows.

Salary reduction contributions
(maximum amount)............................................... $ 6,000
2% nonelective contributions
($75,000 x .02)................................................    1,500
Total contributions............................................ $ 7,500

Time limits for contributing funds. You must make the salary reduction contributions to the SIMPLE IRA within 30 days after the end of the month in which the amounts would otherwise have been payable to the employee in cash. You must make matching contributions or nonelective contributions by the due date (including extensions) for filing your federal income tax return for the year.