SARSEP Fix-It Guide - Total contributions (employee elective deferrals and nonelective employer contributions) exceeded the maximum legal limits
|Mistake||Find the Mistake||Fix the Mistake||Avoid the Mistake|
|7) Total contributions (employee elective deferrals and nonelective employer contributions) exceeded the maximum legal limits.||Calculate 25% of each employee’s compensation and compare the total contribution made for the employee to the lesser of that amount or the dollar limitation for that year ($51,000 in 2013).||Two possible correction methods:
a. Distribution method
b. Retention method
|After the initial calculation of allocations based on the terms of the plan, check to make sure none of the proposed allocations would violate the Internal Revenue Code.|
Internal Revenue Code Sections 402(h) and 415 limit the amount of contributions made to an employee’s SEP-IRA (including employee elective deferrals) to the lesser of $51,000 in 2013 (subject to cost-of-living adjustments for later years) or 25% of the eligible employee’s compensation. The amount of compensation taken into account is limited to $255,000 in 2013 (subject to cost-of-living adjustments). If your SARSEP plan document specifies lower contribution limits, then the lower limits control.
There are special rules if your business is a sole-proprietorship or partnership. They apply to those employees who are self-employed individuals, such as partners or owner employees. When calculating the deduction for contributions made to your own SEP-IRA, compensation is your net earnings from self-employment, which takes into account both the deduction for one-half of your self-employment tax and the deduction for contributions to your own SEP-IRA. For this reason, you determine the deduction for contributions to your own SEP-IRA indirectly by reducing the contribution rate called for in your plan. For more information on the deduction limitations for self-employed individuals, see Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans).
Employer contributions to a SEP-IRA will not affect the amount an individual can contribute to a Roth IRA or a traditional IRA. However, this may preclude an individual from receiving a tax deduction for contributions to a traditional IRA. See Publication 590, Individual Retirement Arrangements (IRAs), for details.
How to find the mistake:
Calculate 25% of each employee’s compensation (limited to $255,000 in 2013) and compare the total contribution made for the employee to the lesser of that amount or the dollar limitation for that year ($51,000 in 2013). Review the special calculations in Publication 560 for self-employed individuals.
How to fix the mistake:
There are two alternative methods to correct a failure to limit employer contributions to employees as required under the Internal Revenue Code.
The amount in excess of the annual limit, adjusted for earnings through the date of correction, should be distributed from the affected employee’s SEP-IRA and returned to the employer if it exceeds $100. If it isn’t feasible to determine what the actual investment earnings would have been, you may use a reasonable rate of interest (see Revenue Procedure 2013-12 sections 6.11(4) and 6.02(5)(a)).The distributed amount isn’t included in the income of the affected employee, but is reported on Form 1099-R with a taxable amount of zero.
Alternatively, if a VCP submission is made, the excess amount may be retained in the SEP-IRA, but only if the plan sponsor pays an additional fee of 10% of the excess amount, excluding earnings. Note that the additional compliance fee will only apply if the excess amount is above $100. Under both correction methods, the plan sponsor is not entitled to a deduction for the excess contributions (see Revenue Procedure 2013-12 section 6.11(5)).
Example: Employer I maintains a SARSEP plan. For the 2010 year, the contributions made for two employees, T and U, exceeded the limit in IRC Section 415. Employee T had an excess of $3,000 and U had an excess of $300.
Generally, Employer I would have to get Employees T and U to take the excess monies as adjusted for earnings out of each SEP-IRA by taking distributions and returning it to Employer I.
Correction programs available:
The example illustrates an operational problem, because the employer failed to follow the terms of the plan by improperly exceeding the 402(h) and 415 limitations provided for in the plan document and the Internal Revenue Code. Therefore, if the other eligibility requirements of SCP are satisfied, Employer I may be able to use SCP to correct the failure by using the distribution of excess amounts correction method. Employer I would have to determine whether:
- Appropriate practices and procedures were originally in place to facilitate compliance with requirements regarding maximum contribution limits.
- The failure is insignificant.
Voluntary Correction Program:
Under VCP, correction is the same as described under “Corrective action.” Employer I files a VCP submission in accordance with Revenue Procedure 2013-12, using the model documents, including Schedule 3 and Forms 8950 and 8951. The fee for the VCP submission is $250. If Employer I corrects under the alternative retention method described under “Corrective action,” there is an additional fee equal to at least 10% of the excess amount excluding earnings.
Audit Closing Agreement Program:
Under Audit CAP, correction is the same as described under “Corrective action.” Employer I and the IRS enter into a Closing Agreement outlining the corrective action and negotiate a sanction based on the maximum payment amount.
How to avoid the mistake:
After the initial calculation of allocations based on the terms of the SARSEP plan document, check to make sure none of the proposed allocations would violate Internal Revenue Code Sections 402(h) and 415. If there is a problem, you can adjust it before you transfer the money into the SEP-IRAs.