Who can sponsor
Available to employers with 100 or fewer employees who do not maintain another retirement plan. Easy to set up using IRS Form 5305-SIMPLE or Form 5304-SIMPLE — no plan document, no Form 5500.
Contribution structure
Employees elect salary reductions up to the SIMPLE limit (lower than 401(k)). Employer must either match dollar-for-dollar up to 3% of compensation OR contribute a nonelective 2% of compensation to all eligible employees regardless of whether they defer.
Eligibility
Generally any employee who earned at least $5,000 in any two prior years and is reasonably expected to earn $5,000 in the current year. Employers may set a less-restrictive eligibility standard but not a more-restrictive one.
Lower deferral limit
SIMPLE IRA elective deferral limit is significantly lower than a 401(k). For high-saving employees, this is the SIMPLE's biggest weakness. Catch-up contributions for age 50+ partially close the gap.
Two-year switching rule
Money in a SIMPLE IRA cannot be rolled to a non-SIMPLE retirement account during the first two years of plan participation without triggering an additional 25% early-distribution tax (vs the usual 10%). Plan rollover strategies accordingly.
Worked example with numbers
Consider a sole prop with $100,000 in gross receipts and $30,000 in legitimate Schedule C deductions, including this category. Each additional $1,000 of qualifying expense reduces Schedule C net profit by $1,000, which reduces self-employment tax by approximately $1,000 × 92.35% × 15.3% ≈ $141, and reduces income tax by $1,000 × marginal rate. At a 22% federal marginal rate, the combined federal tax savings on each additional $1,000 of legitimate deduction is roughly $361, and state savings sit on top of that. The math is why disciplined categorization throughout the year pays for itself.
Common mistakes that disallow the deduction
The recurring ways this deduction gets disallowed in examination cluster in four categories: (1) personal-use expenses bundled with business (the deduction is disallowed entirely or apportioned downward); (2) inadequate substantiation (no receipt, no invoice, no business-purpose note); (3) the wrong line on Schedule C (not fatal, but it weakens audit defense); and (4) double-counting with another line (for example, deducting an expense on Schedule C and also on Form 8829, or as a personal itemized deduction on Schedule A). The fix in every case is contemporaneous bookkeeping and a clean chart of accounts.