||2008 Tax Year
Simplified Employee Pension (SEP)
Topics - This chapter discusses:
Setting up a SEP
How much to contribute
Salary reduction simplified employee pensions (SARSEPs)
Reporting and disclosure requirements
Useful Items - You may want to see:
Forms (and Instructions)
Wage and Tax Statement
U.S. Individual Income Tax Return
Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement
Salary Reduction Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement
A SEP is a written plan that allows you to make contributions toward your own retirement (if you are self-employed) and your
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. A SEP-IRA is 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 in
chapter 1), but does not need to be set up for excludable employees (defined later).
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 $500 in compensation from you for 2007. In 2008, the $500 amount remains unchanged.
You can use less restrictive participation requirements than those listed, but not more restrictive ones.
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
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 Pub. 519, U.S. Tax Guide for Aliens.
There are three basic steps in setting up a SEP.
You must execute a formal written agreement to provide benefits to all eligible employees.
You must give each eligible employee certain information about the SEP.
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,
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.
You currently maintain any other qualified retirement plan. This does not prevent you from maintaining another SEP.
You have any eligible employees for whom IRAs have not been set up.
You use the services of leased employees (as described in chapter 1).
You are a member of any of the following unless all eligible employees of all the members of these groups, trades, or businesses
under the SEP.
An affiliated service group described in section 414(m).
A controlled group of corporations described in section 414(b).
Trades or businesses under common control described in section 414(c).
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
Credit for startup costs.
You may be able to claim a tax credit for part of the ordinary and necessary costs of starting a SEP that first became
effective in 2007. For more
information, see Credit for startup costs
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.
may be able to transfer or roll over certain property from one retirement plan to another. See Pub. 590 for more information
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 in chapter 1). 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
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
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.
Contributions you make for 2007 to a common-law employee's SEP-IRA cannot exceed the lesser of 25% of the employee's compensation
($46,000 for 2008). Compensation generally does not include your contributions to the SEP.
Your employee, Mary Plant, earned $21,000 for 2007. The maximum contribution you can make to her SEP-IRA is $5,250 (25% x
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,
Annual compensation limit.
You cannot consider the part of an employee's compensation over $225,000 when figuring your contribution limit for
that employee. However, $45,000
is the maximum contribution for an eligible employee. The annual compensation limit of $225,000 increases to $230,000 for
More than one plan.
If you contribute to a defined contribution plan (defined in chapter 4), annual additions to an account are limited
to the lesser of $45,000
($46,000 for 2008) or 100% 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 2007 that exceed
the lesser of the following
Excess contributions are included in the employee's income for the year and are treated as contributions by the employee to
his or her SEP-IRA.
For more information on employee tax treatment of excess contributions, see chapter 1 in Pub. 590.
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).
Generally, you can deduct the contributions you make each year to each employee's SEP-IRA. If you are self-employed, you can
contributions you make each year to your own SEP-IRA.
Deduction Limit for Contributions for Participants
The most you can deduct for your contributions (other than elective deferrals) for participants is the lesser of the following
Your contributions (including any excess contributions carryover).
25% of the compensation (limited to $225,000 per participant) paid to the participants during 2007 from the business that
has the plan, not
to exceed $45,000 per participant.
In 2008, the $225,000 and $45,000 amounts in (2) above increase to $230,000 and $46,000.
Compensation in (2) above includes elective deferrals (explained, later, under Salary Reduction Simplified Employee Pension
Elective deferrals are no longer subject to this deduction limit. However, the combined deduction for a participant's elective
deferrals and other SEP
contributions cannot exceed $45,000 ($46,000 for 2008).
Your SEP document may limit contributions to lower amounts because of elective deferrals.
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.
the deduction for contributions made to your own SEP-IRA, compensation is your net earnings from self-employment (defined
in chapter 1), which takes
into account both the following deductions.
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 chapter 5. Then
figure your maximum deduction by using the Deduction Worksheet for Self-Employed in chapter 5.
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 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 Employer
Deduction in chapter 4 for the carryover limit.
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 Employer Deduction
in chapter 4.
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 the yearly contributions on your tax return for the year within
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.
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
calendar year 2007 on your tax return for your tax year ending June 30, 2008.
Where To Deduct Contributions
Deduct the contributions you make for your common-law employees on your tax return. For example, sole proprietors deduct them
on Schedule C (Form
1040), Profit or Loss From Business, or Schedule F (Form 1040), Profit or Loss From Farming; partnerships deduct them on Form
1065, U.S. Return of
Partnership Income; and corporations deduct them on Form 1120, U.S. Corporation Income Tax Return, or Form 1120S, U.S. Income
Tax Return for an S
Sole proprietors and partners deduct contributions for themselves on line 28 of Form 1040, U.S. Individual Income Tax Return.
(If you are a
partner, contributions for yourself are shown on the Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits,
etc., you get from the
Salary Reduction Simplified Employee Pension (SARSEP)
A SARSEP is a SEP set up before 1997 that includes a salary reduction arrangement. (See the Caution, next.) Under a SARSEP, your
employees can choose to have you contribute part of their pay to their SEP-IRAs rather than receive it in cash. This contribution
is called an
“elective deferral” because employees choose (elect) to set aside the money, and they defer the tax on the money until it is distributed to
You are not allowed to set up a SARSEP after 1996. However, participants (including employees hired after 1996) in a SARSEP
set up before 1997 can
continue to have you contribute part of their pay to the plan. If you are interested in setting up a retirement plan that
includes a salary reduction
arrangement, see chapter 3.
Who can have a SARSEP?
A SARSEP set up before 1997 is available to you and your eligible employees only if all the following requirements
At least 50% of your employees eligible to participate choose to make elective deferrals.
You have 25 or fewer employees who were eligible to participate in the SEP at any time during the preceding year.
The elective deferrals of your highly compensated employees meet the SARSEP ADP test.
SARSEP ADP test.
Under the SARSEP ADP test, the amount deferred each year by each eligible highly compensated employee as a percentage
of pay (the deferral
percentage) cannot be more than 125% of the average deferral percentage (ADP) of all non-highly compensated employees eligible
to participate. A
highly compensated employee is defined in chapter 1.
The deferral percentage for an employee for a year is figured as follows.
The elective employer contributions
(excluding certain catch-up contributions)
paid to the SEP for the employee for the year
The employee's compensation
(limited to $225,000 in 2007 and $230,000 in 2008)
The instructions for Form 5305A-SEP have a worksheet you can use to determine whether the elective deferrals of your highly
meet the SARSEP ADP test.
For figuring the deferral percentage, compensation is generally the amount you pay to the employee for the year. Compensation
includes the elective
deferral and other amounts deferred in certain employee benefit plans. See Compensation
in chapter 1. Elective deferrals under the SARSEP
are included in figuring your employees' deferral percentage even though they are not included in the income of your employees
for income tax
Compensation of self-employed individuals.
If you are self-employed, compensation is your net earnings from self-employment as defined in chapter 1.
Compensation does not include tax-free items (or deductions related to them) other than foreign earned income and
housing cost amounts.
Choice not to treat deferrals as compensation.
You can choose not to treat elective deferrals (and other amounts deferred in certain employee benefit plans) for
a year as compensation under your
Limit on Elective Deferrals
The most a participant can choose to defer for calendar year 2007 is the lesser of the following amounts.
25% of the participant's compensation (limited to $225,000 of the participant's compensation).
In 2008, the compensation limit in (1) of $225,000 increases to $230,000. The amount in (2) remains at $15,500 for 2008.
The $15,500 limit applies to the total elective deferrals the employee makes for the year to a SEP and any of the following.
A SARSEP can permit participants who are age 50 or over at the end of the calendar year to also make catch-up contributions.
contribution limit for 2007 and 2008 is $5,000. Elective deferrals are not treated as catch-up contributions for 2007 until
they exceed the elective
deferral limit (the lesser of 25% of compensation or $15,500), the SARSEP ADP test limit discussed earlier, or the plan limit
(if any). However, the
catch-up contribution a participant can make for a year cannot exceed the lesser of the following amounts.
Catch-up contributions are not subject to the elective deferral limit (the lesser of 25% of compensation or $15,500).
Overall limit on SEP contributions.
If you also make nonelective contributions to a SEP-IRA, the total of the nonelective and elective contributions to
that SEP-IRA cannot exceed the
lesser of 25% of the employee's compensation or $45,000 ($46,000 for 2008). The same rule applies to contributions you make
to your own SEP-IRA. See
Figuring the elective deferral.
For figuring the 25% limit on elective deferrals, compensation does not include SEP contributions, including elective
deferrals or other amounts
deferred in certain employee benefit plans.
Tax Treatment of Deferrals
Elective deferrals are no longer subject to the deduction limits discussed earlier under Deducting Contributions. However, the combined
deduction for a participant's elective deferrals and other SEP contributions cannot exceed $45,000.
Elective deferrals that are not more than the limits discussed earlier under Limit on Elective Deferrals are excluded from your
employees' wages subject to federal income tax in the year of deferral. However, these deferrals are included in wages for
social security, Medicare,
and federal unemployment (FUTA) tax.
For 2007, excess deferrals are the elective deferrals for the year that are more than the $15,500 limit discussed
earlier. For a participant who is
eligible to make catch-up contributions, excess deferrals are the elective deferrals that are more than $20,500. The treatment
of excess deferrals
made under a SARSEP is similar to the treatment of excess deferrals made under a qualified plan. See Treatment of Excess Deferrals
Elective Deferrals (401(k) Plans)
in chapter 4.
Excess SEP contributions.
Excess SEP contributions are elective deferrals of highly compensated employees that are more than the amount permitted
under the SARSEP ADP test.
You must notify your highly compensated employees within 2½ months after the end of the plan year of their excess SEP contributions.
you do not notify them within this time period, you must pay a 10% tax on the excess. For an explanation of the notification
requirements, see Rev.
Proc. 91-44 in Cumulative Bulletin 1991-2. If you adopted a SARSEP using Form 5305A-SEP, the notification requirements are
explained in the
instructions for that form.
Reporting on Form W-2.
Do not include elective deferrals in the “Wages, tips, other compensation
” box of Form W-2. You must, however, include them in the “Social
” and “Medicare wages and tips
” boxes. You must also include them in box 12. Mark the “Retirement plan
” checkbox in box 13.
For more information, see the Form W-2 instructions.
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,
distributions, and income tax withholding, see Pub. 590.
The tax advantages of using SEP-IRAs for retirement savings can be offset by additional taxes. There are additional taxes
for all the following
Making excess contributions.
Making early withdrawals.
Not making required withdrawals.
For information about these taxes, see chapter 1 in Pub. 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.
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
in chapter 4.
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
Reporting and Disclosure Requirements
If you set up a SEP using Form 5305-SEP, 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.
You must also give them notice of any excess contributions. For details about other information you must give them, see the
instructions for Form
5305-SEP or 5305A-SEP (for a salary reduction SEP).
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.
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