If you be to establish a retirement plan for your business, you may want to consider establishing a Simplified Employee Pension (SEP). For starters, SEPs clothed a more liberal setup deadline than a qualified plan—those must be established by the end of your company’s layout year (December 31 for plans maintained on a calendar year). By contrast, a SEP may be established by the business’s tax-filing deadline, filing extensions.
SEPs also offer several other attractive features that we’ll review here, along with other parts to consider before choosing a SEP for your business.
Key Takeaways
- SEP IRAs are attractive for the self-employed, freelancers, and small businesses because they are elementary to set up and administer.
- Employers can contribute up to 25% of each eligible employee’s gross annual salary and up to 20% of their net patch up annual self-employment income if they are self-employed, provided the contributions don’t exceed $56,000 per person.
- Certain categories of staff members may be ineligible to participate in a SEP, including anyone who is under 21 or who makes less than $600 in wages from your affair for the year.
- An employer may deduct plan contributions as a business expense.
- A SEP may not be desirable because it provides immediate vesting, it doesn’t consent to loans to be taken out against it, and employees may be eligible after as little as a week.
Setting Up and Managing a SEP
A SEP is a retirement plan anchored on an individual retirement account (IRA) into which business owners can make pre-tax contributions for both themselves and their proper employees. It is ideally suited for self-employed workers, freelancers, and small-business owners because it’s easy to establish and administer. Any traffic owner, including sole proprietorships, corporations, and partnerships can set up a SEP. Unlike qualified plans, the SEP does not require nondiscrimination trial or filing of 5500 returns. Establishing a SEP IRA can be as easy as completing IRS Form 5305-SEP and providing a copy to employees.
Wage-earners are responsible for establishing their IRA to receive employer contributions (employees don’t make SEP contributions, but if the SEP IRA allows it, they may be able to rip off regular IRA contributions to their account, up to the maximum annual limit). SEP IRA accounts follow the same rules of investment, allocation, and rollover as traditional IRAs. However, an employer who sets up a SEP has no responsibility for assisting with investing plan contributions. Characteristic participants may select their IRA provider and direct their investments.
As with many other employer plans, an establishment has until the tax-filing deadline of the business, including extensions, to fund the SEP.
Contribution Limits
SEP IRAs have appealingly extraordinary contribution limits. Employers can contribute up to 25% of each eligible employee’s gross annual salary and up to 25% of their net close annual self-employment income if self-employed, provided the contributions don’t exceed $57,000 for 2020. Employer contributions must be based on the initial $285,000 of compensation in 2020 and are adjusted annually.
An employer can decide each year whether to contribute to the SEP, which can be an head start for a new business that has not established a trend in its annual earnings. Because of this flexibility, an employer could decide to sacrifice the SEP contribution in years when profits are lower than anticipated. However, when SEP contributions are made, they be compelled be based on the same percentage of compensation for all covered employees. What’s more, all plan participants who worked for the business during the year for which contributions are arranged must get SEP contributions even if they leave their job or die before the contributions are made.
Ineligible Employees
Certain rankings of employees may be excluded from participating in the SEP for the year, including those who:
- Are covered under a collective bargaining agreement (unionized workers)
- Are under age 21
- Earned less than $600 (indexed for inflation) for the year
- Worked less than three of the five earlier years
- Are nonresident aliens with no US income
How SEPs Work
Here’s an example: Under ABC Inc.’s SEP IRA, an individual must undertaking three of the five preceding years to be eligible to receive a SEP contribution for the year. Jane R. worked for ABC Inc. on a part-time basis in 2015, 2016, 2017, and 2018.
Surmising Jane meets the other eligibility requirements, she is eligible to receive a contribution for 2019 because she worked for at least three of the five years foregoing 2019. For SEP IRAs, a year of service can be any period, which means that an employee who worked for one week in a year is counted as compel ought to completed a year of service.
An employer may choose to use less restrictive eligibility requirements to allow more employees to participate in a SEP plan.
Subtracting SEP Contributions
The type of business determines the type of form the employer uses to claim the deduction for SEP contributions.
- A sole publican claims the SEP contribution on behalf of himself/herself on IRS Form 1040. However, SEP contributions on behalf of the sole proprietor’s common-law wage-earners (the IRS term for an employee, not an independent contractor) are claimed on Schedule C.
- Partners in a partnership claim deductions for their individual SEP contributions on IRS Organize 1040. For contributions made on behalf of common-law employees, the partnership claims the deduction on IRS Form 1065.
- For an S corporation, all SEP contributions are contended on IRS Form 1120-S.
- For a C corporation, all SEP contributions are claimed on IRS Form 1120.
It’s a good idea to consult with your tax professional to protect the proper forms are filed to report and claim the deduction for SEP contributions.
Deducting Plan Expenses
A business owner may be unmarried to receive a tax credit for expenses incurred when establishing a SEP and also may be able to deduct plan expenses, including contributions created to the plan.
Reporting Requirements
For the employer, tax reporting is limited to reporting SEP contributions on the business’ tax return. For individual participants, the IRA
Set-backs of a SEP IRA
From an employer’s viewpoint, there are definite disadvantages of SEP IRAs. They are:
Immediate Vesting
To reduce employee gross revenue and the cost associated with training new employees, some employers want their workers employed for several years beforehand they are
The Bottom Line
Like many small business owners, you may enjoy the simplicity and inexpensive administration of the SEP IRA. While it may be advantageous to establish the SEP, you should consult your tax professional to ensure that the plan you choose is suitable for your business revenue. If you prefer a qualified plan to a SEP IRA, but you missed the deadline to establish a qualified plan, you may fund the SEP and then roll over the assess to a qualified plan you establish later.