Some Places, It's Service With a Tax

QUESTION: I always thought that sales taxes were only applied to things that are sold. But my boss insists that services are also taxed. I just don't believe him

even if he is my boss. Can you settle this?--M. W.

ANSWER: If you live in California, you're right. But if you're a resident of Hawaii, Iowa, New Mexico, South Dakota or Florida, your boss is correct.

In those states, auto mechanics, lawyers, hair cutters and just about any other provider of a professional or commercial service is required to charge a sales tax. Medical services are exempt from the tax.

The tax on services has caused a furor in virtually every state that allows one. In Florida, for example, the state bar association has bitterly opposed the tax as a violation of the Sixth Amendment right to legal counsel.

Nevertheless, legislatures in Washington, Texas and Oklahoma are considering adopting a tax on services. California isn't.

Q: Are there any figures out yet on what has happened to participation in 401(k) plans since the tax reformers in their wisdom restricted them?--R. I.

A: The results might surprise you. More, rather than fewer, employees are taking advantage of their companies' 401(k) in the aftermath of the tax reform changes, according to a survey by Chicago-area management consultant Hewitt Associates.

More than 70 of the 200-plus U.S. companies that now offer so-called 401(k) retirement plans told Hewitt that participation in their plans has increased--by 1% to 6%--since the beginning of the year, when the restrictions took effect.

Under the old law, employees could contribute up to $30,000 or 25% of their annual compensation, whichever was less. Now, they are limited to an annual contribution of $7,000.

Employers who offer 401(k) plans permit employees to divert part of their salaries to a tax-deferred account. Part or all of the contributions generally are matched by the company, and the savings aren't taxed until they are withdrawn for retirement. These plans often are called salary-reduction plans because various taxes and other deductions are figured on the amount of the employee's salary after the 401(k) contribution is subtracted.

Some pension fund consultants had predicted that interest in these plans would wane because employees would be confused on hearing about the restrictions.

But, in fact, some companies have actually sweetened their 401(k) plans to help their employees offset the tax deductions that many will lose this year with the much more severe restrictions on tax-deferred individual retirement account plans. Under the new IRA rules, most employees are no longer allowed to take tax deductions for contributions to an IRA if their employer offers a retirement-savings plan.

As further encouragement, some employers have even added new loan provisions to their 401(k) plans, making it easier for employees to borrow against their savings. Most 401(k) plans don't allow participants to withdraw or borrow against the money before retirement except in extreme cases. As a result, many young employees who think they will need access to their money to educate children or buy a home haven't participated.

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