SEP IRA Deduction Rules for Employers

Saving for retirement is a top issue for today’s workforce, and business owners are responding with a variety of savings options. In addition to the peace of mind that comes with creating a retirement savings program, employers enjoy the tax benefits that come along with contributions to a qualified plan.

There are a variety of qualified plans to choose from, and one of the most popular for small- and medium-sized companies is the Simplified Employee Pension Individual Retirement Account (SEP IRA). Employers are attracted to this program’s easy setup and maintenance, as SEP IRAs do not require complex plan documents. Fees to establish and maintain the program are minimal. As a result, the SEP IRA deduction offers increased savings potential for business owners.

Eligibility for the SEP IRA Tax Deduction

Assuming that your SEP IRA program meets IRS requirements for a qualified plan, businesses are able to deduct certain SEP contributions from their taxable income. The easiest way to ensure that your SEP IRA meets the requirements for a qualified plan is to establish your program using an IRS template or a prototype document from your financial services provider.

Employer contributions to SEP IRA accounts on behalf of employees are not considered employee income until the funds are distributed. At that time, the employee pays taxes on the withdrawn amount. The IRS does apply contribution limits to SEP IRA accounts, which means for 2020, employers cannot deposit more than 25% of the employee’s income or $57,000, whichever one is less.

Taking a SEP IRA Tax Deduction

The timing of employer contributions to employee SEP IRA accounts is critical in determining whether and when business owners can take a tax deduction. The annual SEP IRA contribution is due no later than the company’s tax filing deadline. Fortunately, extensions are taken into consideration, so companies that file for an extension can make SEP IRA contributions until the extension date.

Contributions made before the tax filing deadline can be deducted from the tax return being filed – that is to say, contributions made up to the tax filing deadline are applied against the previous year’s tax liability. These contributions can be reported using IRS Form 5498. Failure to make contributions before the deadline results in an inability to deduct any of the contribution amount from that year’s business tax returns. However, contributions made after the filing deadline can be deducted from the following year’s tax returns.

Businesses are limited in the amount of SEP IRA contributions that can be deducted on tax returns. IRS regulations state that deductions must not exceed the lesser of 25% of employee income or the total amount of actual contributions. Self-employed SEP IRA participants use a separate calculation to determine their maximum business tax deduction.

Avoiding Common SEP IRA Errors

Contribution errors can impact the tax deductibility of SEP IRA contributions made on behalf of your employees, and in some cases, these errors can result in increased tax liability for impacted staff members. These steps will help you avoid the most common SEP IRA contribution errors:

• Check to be sure you are using a plan document updated with the most recent regulations.
• Ensure contributions are made for all eligible employees, including those over the age of 70 ½.
• Ensure that the percentage of income contributed to each employee’s SEP IRA account is consistent.
• Adhere to IRS contribution limits when calculating contribution amounts,

Fortunately, the IRS has procedures in place to assist you in correcting errors made in good faith. If you follow the appropriate steps, your SEP IRA plan will retain its qualified status, and there will not be additional tax liabilities.