Payments made to a Simplified Employee Pension (SEP) IRA are tax-deductible for employers, but there is an annual limit on contributions. SEP IRAs are funded solely by the employer using tax-deductible dollars. For 2021, an employer can contribute up to 25% of an employee's compensation or $58,000, whichever is less, and in 2022 that amount rises to $61,000.
Key Takeaways
- Employers can deduct payments to a Simplified Employee Pension (SEP) IRA for an employee up to set limits.
- Business owners who start up a SEP IRAmay be eligible for a tax credit of up to $500 per year.
- SEP IRA contributions and earnings can be withdrawn at any time, subject to the general limitations imposed on traditional IRAs.
What Is a SEP IRA?
A SEP IRA is a type of traditional IRA available to self-employed individuals, freelancers, and small-business owners. Employees are not able to contribute to a SEP IRA that the company opens on their behalf. Contributions come solely from the employer, and they are not required to contribute every year.
When making SEP IRA contributions, employers are required to contribute an equal percentage of income for every employee. This applies to every employee who performed services during the year, even for employees who die or terminate employment before the contributions are made.
Additionally, business owners who start up a SEPmay be eligible for a tax credit of up to $500 per year for the first three years that theSEP account is open.
The self-employed are permitted to contribute up to 25% of net earnings to a SEP IRA, or the annual contribution limit, whichever is less.
What Is the Eligibility for an Employer’s SEP?
Once a business owner has set up a SEP IRA, they must include all eligible employees on the plan, which is defined as:
- Employees 21 or older, who
- Have worked for you for at least three of the past five years, and who
- Have earned at least $650 in income from your business for 2021 and 2022
An employer could lower eligibility thresholds, for example, by lowering the age or minimum service requirements. However, the eligibility requirements must apply to everyone equally.
For individuals who are not self-employed, the compensation used to determine SEP IRA contributions includes wages, salaries, fees for professional services, commissions and tips, fringe benefits, and bonuses. Compensation generally includes amounts deferred, at the employee's election, under benefits plans such as 401(k) plans, 403(b) plans, SIMPLE IRAs, Section 457 plans, and Section 125 cafeteria plans.
Contribution Deadline and Withdrawals
The deadline for establishing a SEP IRA planand making contributions is the filing deadline for the employer's tax return, including extensions. Catch-up contributions are not allowed in SEP IRAs as they are made by individuals rather than employers.
SEP IRA contributions and earnings can be withdrawn at any time subject to the general limitations imposed on traditional IRAs. A withdrawal is taxable in the year received. If a participant makes a withdrawal before age 59½, a 10% additional tax generally applies. SEP IRA contributions and earnings may be rolled over tax-free to other IRAs and retirement plans after two years of participation.
Who Can Contribute to a SEP IRA?
Only an employer can contribute to a SEP IRA -- a variation of a traditional IRA that is strictly for self-employed people, freelancers, and small business owners. The employer doesn't have to contribute every year, but must include an equal percentage of income for each employee.
Will a SEP IRA Reduce Taxes?
For an employer, a SEP IRA will reduce taxes, but it won't be for an individual. SEP IRAs are funded by tax-deductible dollarsand are limited to 25% of an employee's total compensation or $58,000 (whichever is less) in 2021, rising to $61,000 in 2022.
Does a SEP IRA Reduce Self-Employment Tax?
If you are a self-employed person who contributes to a SEP-IRA, you will see a reduction in your self-employment tax as the contribution will lift business expenses, lowering net profit, and therefore reducing the self-employment tax and income tax.
FAQs
Ease of setup and administration: SEP IRAs are easier than other workplace retirement plans to set up and maintain, which makes them so attractive to self-employed individuals. Tax-deductible contributions: As a self-employed individual, your business can deduct your SEP IRA contributions.
Is a SEP IRA contribution tax-deductible? ›
Ease of setup and administration: SEP IRAs are easier than other workplace retirement plans to set up and maintain, which makes them so attractive to self-employed individuals. Tax-deductible contributions: As a self-employed individual, your business can deduct your SEP IRA contributions.
Are employee SIMPLE IRA contributions tax-deductible? ›
Can employees deduct the salary reduction contributions they make to the SIMPLE IRA plan on their Form 1040? No, employee contributions to a SIMPLE IRA plan are not deductible by participants from their income on their Form 1040.
How does Simplified employee Pension SEP plan participation affect an employee's IRA contributions? ›
Under a SEP, an employer contributes directly to traditional individual retirement accounts (SEP-IRAs) for all employees (including themselves). A SEP is easier to set up and has lower operating costs than a conventional retirement plan and allows for a contribution of up to 25 percent of each employee's pay.
Are employee pension contributions tax-deductible? ›
Most employers can deduct, subject to limits, contributions they make to a retirement plan, including those made for their own retirement. The contributions (and earnings and gains on them) are generally tax-free until distributed by the plan.
Where do SEP IRA contributions go on a tax return? ›
If you have a SEP, contributions you make for yourself are deductible on line 28 of your Form 1040. Contributions you make for employees are deductible on line 19 of your Schedule C. There are many details surrounding SEP IRA's that we have not included on this page.
Can you write-off losses in a SEP IRA? ›
Can I deduct losses in my IRA on my income tax return? No, do not take IRA losses or gains into account on your tax return while the IRA is still open. See Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs), for more information on losses in IRAs.
Which IRA contributions are not tax deductible? ›
Roth IRA. Contributions are never tax-deductible. SELF-EMPLOYED OR OWN A SMALL BUSINESS?
What is a SEP IRA vs SIMPLE IRA? ›
Both SIMPLE IRA and SEP IRA retirement plans are suited for small businesses but a SIMPLE IRA allows for employer and employee contributions. A SEP IRA only allows contributions from the employer.
Are employee retirement contributions tax deductible? ›
Unless you're a business owner, you won't claim your 401(k) contributions as tax deductible when you fill out your Form 1040. Instead, the money is taken out of your paycheck before federal taxes on your income are figured. This is how you save on taxes today.
A Simplified Employee Pension (SEP) plan provides business owners with a simplified method to contribute toward their employees' retirement as well as their own retirement savings. Contributions are made to an Individual Retirement Account or Annuity (IRA) set up for each plan participant (a SEP-IRA).
What is the downside of SEP IRA? ›
Disadvantages of a SEP IRA
Employees don't make their own contributions and you must contribute the same percentage of employee compensation as you do to your own SEP account. No catch-up contributions: If you're over the age of 50, there are no catch-up contributions like you see with IRAs and 401(k)s.
Where are SEP IRA contributions reported? ›
SEP- IRA contributions are not included on the Form W-2, Wage and Tax Statement. The financial institution/trustee handling employees' SEP-IRAs provides the IRS and participating employees with an annual statement containing contribution and fair market value information on Form 5498, IRA Contribution Information.
Can you write off SEP IRA contributions? ›
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. 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.
Can I deduct health insurance premiums taken from my pension? ›
You take the deduction by reducing the taxable amount of your pension by the amount you paid for insurance premiums when completing Form 1040 or Form 1040A, ”U.S. Individual Income Tax Return.” The health insurance or long-term care insurance coverage can include the member, spouse, and dependents.
Do pension contributions reduce AGI? ›
A 401(k) retirement plan will reduce both your AGI and MAGI, as contributions are taken out of your salary before taxes are deducted. This in effect reduces your salary in relation to taxes. Because your salary is now "lower," you end up paying less taxes.
How much can a self-employed person contribute to a SEP IRA? ›
SEP-IRA contribution limits
You can contribute up to 25% of your total compensation or a maximum of $66,000 for 2023 tax year or $69,000 for the 2024 tax year, whichever is less. If you're self-employed, your contributions are generally limited to 20% of your net income.
Are IRA contributions tax-deductible? ›
Your traditional IRA contributions may be tax-deductible. The deduction may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels.
Where to put SEP contributions? ›
Per Form 1120-S Instructions, line 17: Enter the deductible contributions not claimed elsewhere on the return made by the Corporation for its employees under a qualified pension, profit-sharing, annuity, or simplified employee pension (SEP) or SIMPLE plan, or any other deferred compensation plan.
Do retirement plan contributions reduce self-employment tax? ›
One of the more common questions we receive from self-employed business owners seeking to establish a Solo 401(k) plan is whether it can reduce self-employment tax. The short answer is no. In general, when one make a contribution to a Solo 401(k) plan, it's typically after self-employment tax.
