How to Calculate SEP Contributions From Self-Employment
If you are self-employed, you can open a special type of retirement plan designed specifically for small businesses known as a SEP-IRA. A SEP, or Simplified Employee Pension, allows you to contribute more to your retirement account than you could to a traditional IRA. The general rule is that you can contribute up to 25 percent of your self-employed earnings to a SEP-IRA in any given year. However, calculating the maximum amount that you can contribute in any given year can be complicated, as the IRS imposes certain limits and calculation rules.
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Instructions
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Compute your net business income. If you are self-employed, you will usually find this figure on the Schedule C you file with your Form 1040.
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Subtract one-half of your self-employment tax from your net business income. If you are self-employed, the IRS allows you to deduct half of your self-employment tax from your net business income, so you can find this figure on your Form 1040. Once you subtract this amount from your net business income, you have your adjusted net business income.
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Determine your contribution percentage. The IRS limits SEP contributions to 25 percent of your compensation, so you cannot choose a contribution figure greater than 0.25.
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Add one to your contribution percentage. For example, if you want to contribute 20 percent of your earnings to your SEP, adding one to this percentage results in a figure of 1.20. This number is known as your contribution factor.
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Divide your adjusted net business income by your contribution factor to determine your adjusted earned income. For example, if your adjusted business income, after subtracting one-half of your self-employment tax, equals $21,000, and your contribution factor is 1.20, divide $21,000 by 1.20. In this example, your resulting adjusted earned income is $17,500.
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Check the current maximum allowable IRS income for SEP contribution purposes. As of 2011, this figure was $245,000 in compensation.
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Multiply your adjusted earned income by your contribution percentage. Use the lesser of your adjusted earned income or the current maximum allowable income. For example, if your compensation is $300,000 and the current IRS maximum is $245,000, you must use $245,000.
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Contribute to your SEP. Your allowable income figure times your contribution percentage provides you with the limit of your permissible SEP contribution. For example, if your adjusted earned income is $21,000 and your desired contribution rate is 20 percent, your maximum SEP contribution for that year is $4,200.
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