Are SEP Contributions Deductible?
The Simplified Employee Pension plan (SEP) is a type of retirement plan designed to simplify contributions that employers make to their employees' retirement accounts. SEP is also designed to simplify the way self-employed individuals contribute to their own retirement accounts. These contributions are made to an IRA that is set up for each employee and called a SEP-IRA.
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Definition
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An SEP is a retirement plan set up by employers who desire to contribute to their employees' retirement accounts in a simple way that meets IRS criteria. The IRS document "Publication 560" explains that a SEP is an agreement between the employer and the employees that allows for retirement contributions to an IRA and that substitutes a profit-sharing plan (which needs to be established with a trust.) With a SEP plan, employers can contribute directly to each employee's IRA and make contributions to their personal IRAs.
Employee Contributions
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Contributions an employee makes to his own SEP-IRA account are tax deductible for him until distributions start at retirement age (65). However, these deductible contributions are limited by annual amounts---the same limit for deductible contributions in a traditional IRA or a Roth IRA. As of 2010, the maximum contribution an employee can make to his own IRA is the amount of his taxable compensation for the year up to $5,000. If an employee is older than 50, he is allowed to make a higher contribution than other employees: he can contribute his taxable compensation up to $6,000.
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Employer Contributions
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Contributions an employer makes to his employee's SEP-IRA are also limited. As of 2010 and 2011, an employer cannot exceed 25 percent of his employee's annual compensation up to $49,000 for 2010 and 2011. Employer contributions must be made in cash. If a self-employed individual makes the contributions, he can only contribute 20 percent of his net earnings (up to $49,000) to his SEP-IRA. Employers are allowed to deduct all the contributions they make to their employees' SEP-IRAs up to 25 percent of the compensation paid to employees. Self-employed individuals are also allowed to deduct their own contributions, and their deduction depends on their net earnings and the amount of tax they pay.
Carryover
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Employers and employees are allowed to make non-deductible contributions into a SEP-IRA. These nondeductible contributions occur when they exceed the deduction limits set by the IRA. However, according to the IRS document "Publication 560," individuals can carry these contributions over and deduct them in later years. Nondeductible contributions into a SEP-IRA can be subject a 10-percent excise tax.
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