SEP Plan Fix-It Guide - Contributions to the SEP-IRA exceeded the maximum legal limits
Find the Mistake
Fix the Mistake
Avoid the Mistake
6) Contributions to the SEP-IRA exceeded the maximum legal limits
Determine the total contribution made for each employee and make sure that amount does not exceed the lesser of:
1) 25% of that employee’s compensation, or
2) the dollar limitation for that year ($51,000 for 2013 and $52,000 for 2014)
Either distribute or retain the excess amount
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 Code
All contributions made to a SEP are employer contributions.
Internal Revenue Code Sections 402(h) and 415 limit the amount of contributions made to an employee’s SEP-IRA to the lesser of $51,000 for 2013 ($52,000 for 2014, 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 ($260,000 in 2014, subject to cost-of-living adjustments for later years). If your SEP plan document specifies lower contribution limits, then the lower limits control.
There are special rules if you're self-employed, such as a partner or an owner-employee. 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 won't affect the amount you can contribute to a Roth IRA or a traditional IRA. However, it may preclude you 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 $260,000 in 2014) and compare the total contribution made for the employee to the lesser of that amount or the dollar limitation for that year ($51,000 for 2013 and $52,000 for 2014). 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 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. The distributed amount is not included in the income of the affected employee, but is reported on Form 1099-R with a taxable amount of zero. If it isn’t feasible to determine what the actual investment results would’ve been, you may use a reasonable rate of interest, such as the interest rate used by the Department of Labor’s Voluntary Fiduciary Correction Program Online Calculator (see Revenue Procedure 2013-12 sections 6.11(4) and 6.02(5)(a)).
Alternatively, if a submission is made under the VCP program, the excess amount may be retained in the SEP-IRA, but only if the plan sponsor pays an additional compliance fee of 10% of the excess amount, excluding earnings. Note that the additional compliance fee will only apply if the excess amount is under $100. Under both correction methods, the plan sponsor is not entitled to a deduction for the excess contributions.
Employer I maintains a SEP plan. For the 2011 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 the funds adjusted for earnings to the plan sponsor.
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 IRC. If the other eligibility requirements of SCP are satisfied, Employer I might be able to use SCP to correct the mistake. Employer I would have to determine whether:
- 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 above under “Corrective action.” If the plan is not under audit, Employer I may make a VCP submission using the model documents in Appendix C, 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, there’s a fee equal to at least 10% of the excess amount excluding earnings in addition to the $250 submission fee.
Audit Closing Agreement Program:
Under Audit CAP, correction is the same as described above 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 SEP plan document, you should check to make sure none of the proposed allocations would violate IRC Sections 402(h) and 415. If there’s a problem, you can adjust it before you transfer the money into the SEP-IRAs.