Question or Topic 

Please explain the SEP.  I have heard it,

1. offers a tax benefit
2. provides a pension for retirement
3. is simple to administer
4. is simple for my tax return

The Answer

Simplified Employee Pension (SEP)

A simplified employee pension (SEP) is a written plan that allows you to make contributions toward your own (if you are self-employed) and your employees' retirement without getting involved in a more complex qualified plan.

Under a SEP, you make the contributions to a traditional individual retirement arrangement (called a SEP-IRA) set up by or for each eligible employee. SEP-IRAs are owned and controlled by the employee, and you make contributions to the financial institution where the SEP-IRA is maintained.

SEP-IRAs are set up for, at a minimum, each eligible employee (defined later). A SEP-IRA may have to be set up for a leased employee (defined earlier under Definitions You Need To Know), but does not need to be set up for excludable employees (defined later).

Eligible employee. An eligible employee is an individual who meets all the following requirements.

• Has reached age 21.
• Has worked for you in at least 3 of the last 5 years.
• Has received at least $450 in compensation from you for 2000.

You can use less restrictive participation requirements than those listed, but not more restrictive ones.

Excludable employees. The following employees can be excluded from coverage under a SEP.

• Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees' union and you.
• Nonresident alien employees who have received no U.S. source wages, salaries, or other personal services compensation from you. For more information about nonresident aliens, see Publication 519, U.S. Tax Guide for Aliens.

Setting Up a SEP

There are three basic steps in setting up a SEP.

1. You must execute a formal written agreement to provide benefits to all eligible employees.
2. You must give each eligible employee certain information about the SEP.
3. A SEP-IRA must be set up by or for each eligible employee.

Many financial institutions will help you set up a SEP.
  

Formal written agreement. You must execute a formal written agreement to provide benefits to all eligible employees under a SEP. You can satisfy the written agreement requirement by adopting an IRS model SEP using Form 5305-SEP. However, see When not to use Form 5305-SEP, later.

If you adopt an IRS model SEP using Form 5305-SEP, no prior IRS approval or determination letter is required. Keep the original form. Do not file it with the IRS. Also, using Form 5305-SEP will usually relieve you from filing annual retirement plan information returns with the IRS and the Department of Labor. See the Form 5305-SEP instructions for details.

When not to use Form 5305-SEP. You cannot use Form 5305-SEP if any of the following apply.

1. You currently maintain any other qualified retirement plan. This does not prevent you from maintaining another SEP.
2. You have any eligible employees for whom IRAs have not been set up.
3. You use the services of leased employees (as described earlier under Definitions You Need to Know).
4. You are a member of any of the following unless all eligible employees of all the members of these groups, trades, or businesses participate under the SEP.
   1. An affiliated service group described in section 414(m).
   2. A controlled group of corporations described in section 414(b).
   3. Trades or businesses under common control described in section 414(c).
5. You do not pay the cost of the SEP contributions.

Information you must give to employees. You must give each eligible employee a copy of Form 5305-SEP, its instructions, and the other information listed in the Form 5305-SEP instructions. An IRS model SEP is not considered adopted until you give each employee this information.

Setting up the employee's SEP-IRA. A SEP-IRA must be set up by or for each eligible employee. SEP-IRAs can be set up with banks, insurance companies, or other qualified financial institutions. You send SEP contributions to the financial institution where the SEP-IRA is maintained.

Deadline for setting up a SEP. You can set up a SEP for a year as late as the due date (including extensions) of your income tax return for that year.

How Much Can I Contribute?

The SEP rules permit you to contribute a limited amount of money each year to each employee's SEP-IRA. If you are self-employed, you can contribute to your own SEP-IRA. Contributions must be in the form of money (cash, check, or money order). You cannot contribute property. However, participants may be able to transfer or roll over certain property from one retirement plan to another. See Publication 590 for more information about rollovers.

You do not have to make contributions every year. But if you make contributions, they must be based on a written allocation formula and must not discriminate in favor of highly compensated employees (defined earlier under Definitions You Need To Know). When you contribute, you must contribute to the SEP-IRAs of all participants who actually performed personal services during the year for which the contributions are made, even employees who die or terminate employment before the contributions are made.

The contributions you make under a SEP are treated as if made to a qualified pension, stock bonus, profit-sharing, or annuity plan. Consequently, contributions are deductible within limits, as discussed later, and generally are not taxable to the plan participants.

A SEP-IRA cannot be designated as a Roth IRA. Employer contributions to a SEP-IRA will not affect the amount an individual can contribute to a Roth IRA.

Time limit for making contributions. To deduct contributions for a year, you must make the contributions by the due date (including extensions) of your tax return for the year.

Contribution Limits

Contributions you make for a year to a common-law employee's SEP-IRA cannot exceed the lesser of 15% of the employee's compensation or $30,000. Compensation generally does not include your contributions to the SEP. However, if you have a salary reduction arrangement, see Employee compensation under Salary Reduction Simplified Employee Pension (SARSEP), later.

Example. Your employee, Mary Plant, earned $21,000 for the year. The maximum contribution you can make to her SEP-IRA is $3,150 (15% x $21,000).

Contributions for yourself. The annual limits on your contributions to a common-law employee's SEP-IRA also apply to contributions you make to your own SEP-IRA. However, special rules apply when figuring your maximum deductible contribution. See Deduction Limit for Self-Employed Individuals, later.

Annual compensation limit. You cannot consider the part of an employee's compensation over $170,000 when figuring your contribution limit for that employee. Therefore, $25,500 is the maximum contribution for an eligible employee whose compensation is $170,000 or more.

More than one plan. If you contribute to a defined contribution plan (defined later under Qualified Plans), annual additions to an account are limited to the lesser of $30,000 or 25% of the participant's compensation. When you figure this limit, you must add your contributions to all defined contribution plans. Because a SEP is considered a defined contribution plan for this limit, your contributions to a SEP must be added to your contributions to other defined contribution plans.

Tax treatment of excess contributions. Excess contributions are your contributions to an employee's SEP-IRA (or to your own SEP-IRA) for a year that exceed the lesser of the following amounts.

• 15% of the employee's compensation (or, for you, 13.0435% of your net earnings from self-employment).
• $30,000.

Reporting on Form W-2. Do not include SEP contributions on your employee's Form W-2 unless contributions were made under a salary reduction arrangement (discussed later).

Deducting Contributions

Generally, you can deduct the contributions you make each year to each employee's SEP-IRA. If you are self-employed, you can deduct the contributions you make each year to your own SEP-IRA.

Deduction Limit for Your Contributions on Behalf of Employees

The most you can deduct for your contributions for participants is the lesser of the following amounts.

• Your contributions (including any elective deferrals and excess contributions
  carryover).
• 15% of the compensation (limited to $170,000 per participant) paid to them during the year from the business that has the plan.

Deduction Limit for Self-Employed Individuals

If you contribute to your own SEP-IRA, you must make a special computation to figure your maximum deduction for these contributions. When figuring the deduction for contributions made to your own SEP-IRA, compensation is your net earnings from self-employment (defined under Definitions You Need To Know), which takes into account both the following deductions.

• The deduction for one-half of your self-employment tax.
• The deduction for contributions to your own SEP-IRA.

The deduction for contributions to your own SEP-IRA and your net earnings depend on each other. For this reason, you determine the deduction for contributions to your own SEP-IRA indirectly by reducing the contribution rate called for in your plan. To do this, use the Rate Table for Self-Employed or the Rate Worksheet for Self-Employed, whichever is appropriate for your plan's contribution rate, in the Appendix. Then figure your maximum deduction by using the Deduction Worksheet for Self-Employed in the Appendix.

Deduction Limits for Multiple Plans

For the deduction limits, treat all your qualified defined contribution plans as a single plan and all your qualified defined benefit plans as a single plan. See Kinds of Plans, later, under Qualified Plans for the definitions of defined contribution plans and defined benefit plans. If you have both kinds of plans, a SEP is treated as a separate profit-sharing (defined contribution) plan. A qualified plan is a plan that meets the requirements discussed later under Qualification Rules. For information about the special deduction limits, see Deduction limit for multiple plans under Qualified Plans, later.

SEP and profit-sharing plan. If you also contribute to a qualified profit-sharing plan, you must reduce the 15% deduction limit for that profit-sharing plan by the allowable deduction for contributions to the SEP-IRAs of those participating in both the SEP plan and the profit-sharing plan.

Carryover of Excess SEP Contributions

If you made SEP contributions that are more than the deduction limit (nondeductible contributions), you can carry over and deduct the difference in later years. However, the contributions carryover, when combined with the contribution for the later year, is subject to the deduction limit for that year. If you also contributed to a defined benefit plan or defined contribution plan, see Carryover of Excess Contributions under Qualified Plans, later, for the carryover limit.

Excise tax. If you made nondeductible (excess) contributions to a SEP, you may be subject to a 10% excise tax. For information about the excise tax, see Excise Tax for Nondeductible (Excess) Contributions under Qualified Plans, later.

When To Deduct Contributions

When you can deduct contributions made for a year depends on the tax year on which the SEP is maintained.

• If the SEP is maintained on a calendar year basis, you deduct contributions made for a year on your tax return for the year with or within which the calendar year ends.
• If you file your tax return and maintain the SEP using a fiscal year or short tax year, you deduct contributions made for a year on your tax return for that year.

Example. You are a fiscal year taxpayer whose tax year ends June 30. You maintain a SEP on a calendar year basis. You deduct SEP contributions made for calendar year 2000 on your tax return for your tax year ending June 30, 2001.

Where To Deduct Contributions

Deduct contributions for yourself on line 29 of Form 1040. You deduct contributions for your employees on Schedule C (Form 1040), on Schedule F (Form 1040), on Form 1065, on Form 1120, U.S. Corporation Income Tax Return, on Form 1120-A, U.S. Corporation Short-Form Income Tax Return, or on Form 1120S, U.S. Income Tax Return for an S Corporation, whichever applies to you.

If you are a partner, the partnership passes its deduction to you for the contributions it made for you. The partnership will report these contributions on Schedule K-1 (Form 1065). You deduct the contributions on line 29 of Form 1040.

Distributions (Withdrawals)

As an employer, you cannot prohibit distributions from a SEP-IRA. Also, you cannot make your contributions on the condition that any part of them must be kept in the account.

Distributions are subject to IRA rules. For information about IRA rules, including the tax treatment of distributions, rollovers, required distributions, and income tax withholding, see Publication 590.

Additional Taxes

The tax advantages of using SEP-IRAs for retirement savings can be offset by additional taxes. There are additional taxes for all the following actions.

• Making excess contributions.
• Making early withdrawals.
• Not making required withdrawals.

For information about these taxes, see chapter 1 in Publication 590. Also, a SEP-IRA may be disqualified, or an excise tax may apply, if the account is involved in a prohibited transaction, discussed next.

Prohibited transaction. If an employee improperly uses his or her SEP-IRA, such as by borrowing money from it, the employee has engaged in a prohibited transaction. In that case, the SEP-IRA will no longer qualify as an IRA. For a list of prohibited transactions, see Prohibited Transactions under Qualified Plans, later.

Effects on employee. If a SEP-IRA is disqualified because of a prohibited transaction, the assets in the account will be treated as having been distributed to the employee on the first day of the year in which the transaction occurred. The employee must include in income the fair market value of the assets (on the first day of the year) that is more than any cost basis in the account. Also, the employee may have to pay the additional tax for making early withdrawals. For more information, see Taxes on Prohibited Transactions under Qualified Plans, later.

Reporting and Disclosure Requirements

If you set up a SEP using Form 5305-SEP or Form 5305A-SEP (for a SARSEP), you must give your eligible employees certain information about the SEP when you set it up. See Setting Up a SEP, earlier. Also, you must give your eligible employees a statement each year showing any contributions to their SEP-IRAs. If you set up a salary reduction SEP, you must also give them notice of any excess contributions. For details about other information you must give them, see the instructions for either of these forms.

Even if you did not use Form 5305-SEP or Form 5305A-SEP to set up your SEP, you must give your employees information similar to that described above. For more information, see the instructions for either Form 5305-SEP or Form 5305A-SEP.

Solutions

Solutions are dependent upon facts & circumstances, law and the objectives.  These elements vary from one time to another, from one circumstance to another and from person or entity to another