The amount of the contribution you can make to your Keogh plan is determined by the amount of your "earned income" for the year. Earned income is defined as your gross income from a trade or business, less any allowable deductions. Income received by a passive partner is considered to be investment income rather than earned income.
Contribution limits. The limitations on contributions depend on the type of Keogh plan. A Keogh defined benefit plan is limited to the amount needed to eventually produce an annual pension payment of the lesser of (1) $160,000 or (2) 100 percent of your average compensation for your three highest years. The $160,000 limit is for 2002 ($140,000 for 2001) and may be periodically adjusted for inflation.
A Keogh defined contribution plan contribution is limited to the lesser of $40,000 for 2002 ($35,000 for 2001; this amount may be adjusted periodically for inflation) or 100 percent of the participant's earned income for the year (25 percent for 2001).
Deductions. The rules for deductions by self-employed individuals are as follows:
More than one business. If an owner-employee is engaged in more than one business, but only one business has a Keogh plan, contributions and deductions to that plan on behalf of the owner-employee can be based only on the earned income from the business that has the plan.
When do you have to make contributions? Both cash-basis and accrual-basis taxpayers may make Keogh contributions after the close of the taxable year if they are made on or before the due date, including extensions, for filing the income tax return for that tax year. You must set up the Keogh by the end of the tax year in order for your contributions made to it to be deductible for that tax year.