What is a SEP?
A Simplified Employer Pension (SEP) plan is an employer-established retirement plan. An individual who is not in business may not set up a SEP-IRA. An individual may set up a regular traditional IRA or Roth IRA.
A SEP is ideal for self-employed small business owners who want a simple, tax-favored way to make retirement plan contributions for themselves and their employees (if any). Contributions to a SEP-IRA are made only by the employer and not by employees. SEP-IRA contributions are not included in compensation unless excess contributions are made.
SEP-IRA contributions are not subject to federal income taxes, Social Security taxes, Medicare taxes, or FUTA taxes.
Unlike other plans, there is no requirement to make contributions every year to a SEP. So, if your short of cash one year, you can simply skip making contributions that year. However, if you have employees, then in years you do make contributions, you must make them for all eligible employees.
You are considered self-employed if you are a sole proprietor, partner in a general partnership, or LLC member where no election was made to treat the LLC as a C or S corporation.
If you're self-employed, you can establish a SEP plan. Once the plan is established, you can then set up a SEP-IRA account for yourself.
If you have employees who are eligible to participate in the SEP plan, they can set up their own SEP-IRA accounts at their own financial institution. You, as the employer, make contributions into your employee's SEP-IRA accounts at the financial institution where their accounts are located.
Special Computation for Self-Employed Persons
When figuring the contribution for your own SEP-IRA, compensation is your net earnings from self-employment, less the following deductions:
- one-half of your self-employment tax and
- contributions to your own SEP-IRA.
A SEP must cover all employees who are at least age 21, earn over $550, and who have worked for the employer at any time during at least three of the past five years. You may generally exclude union employees covered by union agreements.
Setting Up a SEP Plan
IRS Form 5305-SEP can be used to establish a SEP plan. It's a short, simple form to complete. Using Form 5305-SEP will satisfy the written requirement for establishing a SEP plan. Do not file Form 5305-SEP with the IRS; keep it for yourself as evidence that you established a SEP plan.
Once the plan is established, the employer makes deductible plan contributions directly into SEP-IRA accounts set up by or for the employees; employees do not make their own contributions.
SEP-IRA Contribution Limits:
The 2014 and 2015 contribution limits for SEP-IRAs are as follows:
- Contributions an employer can make to an employee's SEP-IRA cannot exceed the lesser of:
- 25% of the employee's compensation, or
- $52,000 for 2014 ($53,000 for 2015)
Note: Elective deferrals and catch-up contributions are not permitted in SEP plans.
SEP-IRA contributions are not subject to federal income taxes, Social Security taxes, Medicare taxes, or FUTA taxes. Therefore, do not include SEP-IRA contributions in an employee's gross wages, Social Security wages, or Medicare wages.
However, excess SEP contributions (contributions that exceed the annual limit) are included in gross wages.
Where to Deduct SEP Contributions
Self-employed persons deduct SEP contributions made for themselves on Form 1040, line 28 where the contribution is subtracted from gross income.
Note: Do NOT make the mistake of deducting SEP contributions made for yourself on Schedule C (or F) if you are self-employed.
Note: If you are a member of an LLC that made an election to treat the LLC as either a C or S Corporation for tax purposes, SEP contributions for yourself, as well as your employees, are deducted on Form 1120 (for a C corp.) or 1120S (for an S corp.). In other words, you are treated as an employee, the same as any other employee.
Contributions Made by Employer on Behalf of Employees:
An employer simply contributes to the employee's SEP-IRA account and deducts the contribution as a business expense on the applicable tax form.
- A sole proprietor deducts SEP contributions made on behalf of employees on Schedule C.
- A partnership deducts SEP contributions for employees on Form 1065.
- A C corporation deducts SEP contributions on Form 1120.
- An S corporation deducts SEP contributions on form 1120S.
SEP-IRA Contributions vs Regular IRA Contributions:
SEP-IRAs are established by businesses and permit larger contributions than are allowed for regular, non-business, IRAs (traditional and Roth IRAs).
For example, for 2014 and 2015 total contributions to all your regular (non-business) traditional and Roth IRAs cannot be more than $5,500 ($6,500 if you’re age 50 or older), whereas SEP-IRA contributions can be as much as $52,000 for 2014 ($53,000 for 2015).
Annual Compensation Limit For SEP Contributions
For 2014, you cannot consider the part of an employee's compensation over $260,000 ($265,000 for 2015) when figuring your contribution limit for that employee.
Vesting in a SEP-IRA
Contributions are immediately 100% vested and grow tax free until distributed. The employee owns and controls his SEP-IRA.
Distributions from a SEP-IRA cannot be prohibited by the employer.
Reporting Requirements for SEP-Plans
Unlike qualified plans, which have an annual reporting requirement, a SEP does not.
As previously mentioned, you do not report SEP contributions made on behalf of employees on their annual W-2 forms unless excess contributions are made (contributions exceeds annual limit).
Excess contributions are included in an employee's gross pay and a 6% penalty tax may apply unless the excess contributions and related earnings are withdrawn by the due date of the return, plus extensions.
In addition, if you are under age 59 1/2, a 10% early distribution penalty may apply to the withdrawal of income earned on the excess contribution(s).
Timing SEP Deductions
A SEP plan can be established and deductible contributions made for a particular year as late as the due date of your return, plus extensions, for that particular year. For tax year 2014, contributions may be made as late as April 15, 2015. For example, to deduct contributions for calendar year 2014, you can establish the plan and make deductible contributions as late as April 15, 2015, plus extensions.
- Return to the Retirement Plans Table of Contents to find related links