How Much Can Be Contributed on My Behalf?

The SEP rules permit an employer to contribute each year to each participating employee's SEP-IRA up to 15% of the employee's compensation or $30,000, whichever is less. Because only the first $170,000 of compensation is usually considered, the limit is actually the lesser of 15% of compensation or $25,500. These contributions are funded by the employer.

An employer who signs a SEP agreement does not have to make any contribution to the SEP-IRAs that are set up. But, if the employer does make contributions, the contributions must be based on a written allocation formula and must not discriminate in favor of highly compensated employees (defined in Publication 560).

Figuring the 15% Limit

For purposes of determining the 15% limit, compensation is generally limited to $170,000, not including your employer's contribution to your SEP-IRA.

Example. Barry's nonunion employer has a SEP for its employees. Barry's compensation for 2000, before his employer's contribution to his SEP-IRA, was $180,000. Because the 15% limit is less than the $30,000 limit, Barry's employer can contribute up to $25,500 (15% x $170,000) to Barry's SEP-IRA.

Deduction Limit for a Self-Employed Person

If you are self-employed and contribute to your own SEP-IRA, special rules apply when figuring your maximum deduction for these contributions.

Compensation for the self-employed. For determining the 15% limit on contributions, discussed above, your compensation is your net earnings from self-employment, defined later. Note that, for SEP purposes, your net earnings (compensation) must take into account your deduction for contributions to your own SEP-IRA. Because your deduction amount and your net earnings amount are each dependent on the other, this adjustment presents a problem.

To solve this problem, you make the adjustment to net earnings indirectly by, in figuring your maximum deduction, reducing the contribution rate called for in the plan. Use the following worksheets to find this reduced contribution rate and your maximum deduction. Make no reduction to the contribution rate for any common-law employees.

Example. You are a sole proprietor and have employees. The terms of your plan provide that you contribute 10 1/2% (.105) of your compensation, and 10 1/2% of your common-law employees' compensation. Your net earnings from line 31, Schedule C (Form 1040) is $200,000. In figuring this amount, you deducted your common-law employees' compensation of $100,000 and contributions for them of $10,500 (10 1/2% x $100,000). This net earnings amount is now reduced to $193,267 by subtracting your self-employment tax deduction of $6,733. You figure your self-employed rate and maximum deduction for employer contributions on behalf of yourself as follows:

Net earnings from self-employment. For SEP purposes, your net earnings are your gross income from your business minus allowable deductions for that business. Allowable deductions include contributions to your employees' SEP-IRAs. You also take into account the deduction allowed for one-half of your self-employment tax, and the deduction for contributions to your own SEP-IRA.

What to include. Include the following items in your net earnings.

1. Foreign earned income and housing cost amounts.
2. If you are a partner, your distributive share of partnership income or loss (other than separately treated items such as capital gains and losses).
3. If you are a limited partner, guaranteed payments for services to or for the partnership.
4. Elective contributions or deferrals under any of the following plans.
   1. 401(k) plans.
   2. 403(b) plans (tax-sheltered annuities).
   3. SEP plans (salary reduction arrangements).
   4. Savings incentive match plans for employees (SIMPLE plans).
   5. Cafeteria plans.
   6. 457 plans (plans of state and local governments and certain tax-exempt organizations).

What not to include. Do not include the following items in your net earnings.

• Tax-free items (or deductions related to them).
• If you are a limited partner, distributions of income or loss.

Time Limit for Contributions

To deduct contributions for a year, the employer must make the contributions by the due date (including extensions) of the employer's return for the year.

Overall Limit--Employer With Defined Contribution and SEP Plans

If an employer contributes to a defined contribution retirement plan (a plan under which an individual account is set up for each participant), annual additions to an account are limited to the lesser of (1) $30,000 or (2) 25% of the participant's compensation. Moreover, for purposes of these limits, contributions to more than one such plan must be added. Since a SEP is considered a defined contribution plan for purposes of these limits, employer contributions to a SEP must be added to other contributions to defined contribution plans.

Are My Employer's Contributions Taxable?

Your employer's contributions to your SEP-IRA are excluded from your income rather than deducted from it. Your employer's contributions to your SEP-IRA should not be included in your wages on your Form W-2 unless there are contributions under a salary reduction arrangement (explained later).

Unless there are excess contributions, you do not include any contributions in your gross income; nor do you deduct any of them.

Excess employer contributions. If your employer contributes more than is allowed, you must include the excess in your gross income, without any offsetting deduction.

Excess employer contributions you withdraw before your return is due. If your employer contributes more to your SEP-IRA than 15% of your compensation or $30,000, whichever is less, you will not have to pay the 6% tax (discussed in chapter 1 under Excess Contributions) on it if you withdraw this excess amount (and any interest or other income earned on it) from your SEP-IRA before the date for filing your tax return, including extensions. However, you may have to pay an additional 10% tax (discussed in chapter 1 under Early Distributions) on the early distribution of the interest or other income earned on the excess contribution.

Excess employer contributions you withdraw after your return is due. If employer contributions for the year are $30,000 or less, you can withdraw any excess employer contributions from your SEP-IRA after the due date for filing your tax return, including extensions, free of the 10% tax on early distributions, discussed earlier. However, the excess contribution is subject to the annual 6% excise tax. Also, you may have to pay the additional 10% tax on the early distribution of interest or other income earned on the excess contribution.

Can I Contribute to My SEP-IRA?

You can make contributions to your SEP-IRA independent of employer SEP contributions. You can deduct them the same way as contributions to a regular IRA. However, your deduction may be reduced or eliminated because, as a participant in a SEP, you are covered by an employer retirement plan. See How Much Can I Deduct? in chapter 1.

Excess contributions you make. For information on excess contributions you make to your SEP-IRA independent of employer SEP contributions, see What Acts Result in Penalties? in chapter 1.

Self-employed individuals. If you are self-employed (a sole proprietor or partner) and have a SEP plan, take your deduction for employer contributions to your own SEP-IRA on line 29, Form 1040. If you also make deductible contributions to your SEP-IRA (or any other IRA you own) independent of your employer contributions, take your deduction on line 23, Form 1040.

For more employer information on SEP-IRAs, get Publication 560.

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