Owners of standard 403(b) plans can deduct or exclude contributions to the plans from their incomes for tax purposes, but they still have to pay Medicare and Social Security taxes on the contributions, reports the Internal Revenue Service. The IRS also defers taxation of 403(b) earnings. Owners of 403(b) plans pay income tax on contributions and earnings when they withdraw the funds from the accounts.
Tax-exempt organizations such as hospitals, schools and churches set up 403(b) plans for their employees, according to CNN Money. They are similar to the 401(k) plans that for-profit businesses offer. Employers usually withhold a portion of employees' paychecks to fund 403(b) plans, explains the IRS. Sometimes employers add contributions or match contributions that employees make. Employees do not report 403(b) contributions on their tax returns, although employers enter the amounts of the contributions on Forms W-2.
Once owners of 403(b) plans become 59 1/2 years old, they can withdraw funds from their plans without penalty, but if they withdraw funds early, the distributions are subject to a 10 percent penalty tax in addition to the standard income tax, unless they qualify as exceptions, states About.com. Owners of 403(b) plans must begin withdrawing funds in required minimum distributions by the time they reach 70 1/2, or face a penalty tax of 50 percent of the amount that they should have withdrawn.