Table of Contents
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Setting up a SEP
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How much to contribute
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Deducting contributions
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Salary reduction simplified employee pensions (SARSEPs)
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Distributions (withdrawals)
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Additional taxes
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Reporting and disclosure requirements
Publication
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590 Individual Retirement Arrangements (IRAs)
Forms (and Instructions)
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W-2
Wage and Tax Statement -
1040
U.S. Individual Income Tax Return -
5305-SEP
Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement -
5305A-SEP
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 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. 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).
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Has reached age 21.
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Has worked for you in at least 3 of the last 5 years.
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Has received at least $500 in compensation from you for 2007. In 2008, the $500 amount remains unchanged.
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Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees' union and you.
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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.
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You must execute a formal written agreement to provide benefits to all eligible employees.
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You must give each eligible employee certain information about the SEP.
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A SEP-IRA must be set up by or for each eligible employee.
Many financial institutions will help you set up a SEP.
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You currently maintain any other qualified retirement plan. This does not prevent you from maintaining another SEP.
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You have any eligible employees for whom IRAs have not been set up.
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You use the services of leased employees (as described in chapter 1).
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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.
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An affiliated service group described in section 414(m).
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A controlled group of corporations described in section 414(b).
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Trades or businesses under common control described in section 414(c).
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You do not pay the cost of the SEP contributions.
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 Pub. 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 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 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.
Contributions you make for 2007 to a common-law employee's SEP-IRA cannot exceed the lesser of 25% of the employee's compensation or $45,000 ($46,000 for 2008). Compensation generally does not include your contributions to the SEP.
Example.
Your employee, Mary Plant, earned $21,000 for 2007. The maximum contribution you can make to her SEP-IRA is $5,250 (25% x $21,000).
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25% of the employee's compensation (or, for you, 20% of your net earnings from self-employment).
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$45,000.
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.
The most you can deduct for your contributions (other than elective deferrals) for participants is the lesser of the following amounts.
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Your contributions (including any excess contributions carryover).
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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 (SARSEP)). 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.
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 in chapter 1), which takes into account both the following deductions.
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The deduction for one-half of your self-employment tax.
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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 chapter 5. Then figure your maximum deduction by using the Deduction Worksheet for Self-Employed in chapter 5.
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.
When you can deduct contributions made for a year depends on the tax year on which the SEP is maintained.
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If the SEP is maintained on a calendar year basis, you deduct the yearly contributions on your tax return for the year within which the calendar year ends.
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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.
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 Corporation.
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 partnership.)
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 them.
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.
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At least 50% of your employees eligible to participate choose to make elective deferrals.
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You have 25 or fewer employees who were eligible to participate in the SEP at any time during the preceding year.
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The elective deferrals of your highly compensated employees meet the SARSEP ADP test.
The elective employer contributions
(excluding certain catch-up contributions) paid to the SEP for the employee for the year |
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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 compensated employees meet the SARSEP ADP test.
The most a participant can choose to defer for calendar year 2007 is the lesser of the following amounts.
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25% of the participant's compensation (limited to $225,000 of the participant's compensation).
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$15,500.
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.
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Cash or deferred arrangement (section 401(k) plan).
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Salary reduction arrangement under a tax-sheltered annuity plan (section 403(b) plan).
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SIMPLE IRA plan.
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The catch-up contribution limit.
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The excess of the participant's compensation over the elective deferrals that are not catch-up contributions.
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.
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 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 actions.
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Making excess contributions.
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Making early withdrawals.
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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 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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