- 4.72.17 Simplified Employee Pensions (SEPs) and Salary Reduction Simplified Employee Pensions (SARSEPs)
- 22.214.171.124 Program Scope and Objectives
- 126.96.36.199.1 Background
- 188.8.131.52.2 Authority
- 184.108.40.206.3 Program Controls
- 220.127.116.11.4 Acronyms and Forms
- 18.104.22.168 Overview
- 22.214.171.124 Technical Overview
- 126.96.36.199 Written Arrangement Requirement
- 188.8.131.52 Coverage and Participation Requirements
- 184.108.40.206.1 Member of Controlled Group, etc.
- 220.127.116.11.2 Leased Employees
- 18.104.22.168.3 Excludible Employees
- 22.214.171.124 Nondiscrimination Requirements
- 126.96.36.199 Contributions
- 188.8.131.52.1 Contribution Limits
- 184.108.40.206.2 Special Rules for Self-employed Individuals
- 220.127.116.11.3 Employer Deduction
- 18.104.22.168 Special Requirements for SARSEPs
- 22.214.171.124.1 Ineligible Employer
- 126.96.36.199.2 Nondiscrimination Test for Elective Deferrals
- 188.8.131.52.3 Limits on Deferrals
- 184.108.40.206 Top-Heavy Requirements
- 220.127.116.11 Distributions
- 18.104.22.168 Notice and Reporting Requirements
- 22.214.171.124.1 Disclosure to Employees
- 126.96.36.199.2 Annual Statements
- 188.8.131.52.3 General Reporting Requirements
- 184.108.40.206.4 SARSEP Notice and Reporting Requirements
- 220.127.116.11 EPCRS and DO 8-3 Closing Agreements
- 18.104.22.168 Examination Steps
- 22.214.171.124 Annual Statutory Limits Applicable to SEPs and SARSEPs
Part 4. Examining Process
Chapter 72. Employee Plans Technical Guidelines
Section 17. Simplified Employee Pensions (SEPs) and Salary Reduction Simplified Employee Pensions (SARSEPs)
4.72.17 Simplified Employee Pensions (SEPs) and Salary Reduction Simplified Employee Pensions (SARSEPs)
August 28, 2017
(1) This transmits revised IRM 4.72.17, Employee Plans Technical Guidelines, Simplified Employee Pensions (SEPs) and Salary Reduction Simplified Employee Pensions (SARSEPs).
(1) IRM 126.96.36.199, Program, Scope and Objectives, and the subsections thereunder, were added to meet the new internal controls requirements.
(2) Other minor editorial changes, including revisions to reflect plain language requirements, were made throughout the document.
Robert S. Choi
Director, Employee Plans
Tax Exempt and Government Entities
Purpose: IRM 4.72.17, Employee Plans Technical Guidelines, Simplified Employee Pensions (SEPs) and Salary Reduction Simplified Employee Pensions (SARSEPs), provides procedural and technical guidance for Employee Plans (EP) agents conducting SEP and SARSEP examinations. This section will also aid group managers in providing guidance, direction, and feedback to agents working SEP and SARSEP examinations.
Audience: This IRM provides procedures for agents, their group managers and support staff in EP Exam.
Policy Owner: Director, EP Examination.
Program Owner: EP Examination.
Program Authority: EP Examination’s authority to resolve issues is derived from its authority to make determinations of tax liability under IRC 6201.
Program Goals: The information contained in this IRM is designed to provide technical guidance for SEP and SARSEP examinations. To achieve this objective, this IRM discusses the applicable sections under IRC 408(k) as they relate to the establishment and operation of SEPs and SARSEPS.
EP Examination is the division designated to determine whether a SEP or SARSEP is in compliance with the Code and regulations.
The authority for conducting SEP and SARSEP examinations is primarily provided by IRC section 408(k) and the underlying regulations and the following laws:
Small Business Job Protection Act of 1996, P.L. 104-188, (SBJPA)
The Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16, (EGTRRA)
Job Creation and Worker Assistance Act of 2002 (JCWAA)
The Worker, Retiree, and Employer Recovery Act of 2008, P.L. 110-4582 (WRERA)
American Taxpayer Relief Act of 2012, P.L. 112-240
Tax Exempt Quality Measurement System (TEQMS) is the quality control system used to oversee the entire examination program. For more information on TEQMS, see IRM 188.8.131.52.3, Program Controls and Program Reports - TEQMS.
All examinations will be done in accordance with the Taxpayer Bill of Rights as listed in IRC 7803(a)(3).
This manual uses the following acronyms and references the following forms.
Acronym Definition ADP Actual Deferral Percentage DO Delegation Order EACA Eligible Automatic Contribution Arrangement EGTRRA The Economic Growth and Tax Relief Reconciliation Act of 2001, EP Employee Plans EPCRS Employee Plans Compliance Resolution System HCE Highly Compensated Employees IRA Individual Retirement Arrangements IRC Internal Revenue Code JCWAA Job Creation and Worker Assistance Act of 2002 LRM Listing of Required Modification NHCE Non-Highly Compensated Employees SARSEP Salary Reduction Simplified Employee SBJPA Small Business Job Protection Act of 1996 SCP Self-Correction Program SEP Simplified Employee Pension SIMPLE Savings Incentive Match Plan for Employees TEQMS Tax Exempt Quality Measurement System TWB Taxable Wage Base VCP Voluntary Correction Program WRERA The Worker, Retiree, and Employer Recovery Act of 2008
Forms, Schedules and Publications
Form Name Form W-2 Wage and Tax Statement Form 1040 U.S. Individual Income Tax Return Form 1040, Schedule C Profit or Loss From Business (Sole Proprietorship) Form 1065 U.S. Return of Partnership Income Form 1065, Schedule K-1 Partner's Share of Income, Deductions, Credits, etc Form 1099-R Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Form 1120 U.S. Corporation Income Tax Return Form 5305-SEP Simplified Employee Pension-Individual Retirement Accounts Contribution Agreement Form 5305-A SEP Salary Reduction Simplified Employee Pension-Individual Retirement Accounts Contribution Agreement Form 5306-A Application for Approval of Prototype Simplified Employee Pension (SEP) or Savings Incentive Match Plan for Employees of Small Employers (SIMPLE IRA Plan) Form 5330 Return of Excise Taxes Related to Employee Benefit Plans Form 5498 IRA Contribution Information Form 5500 Annual Return/Report of Employee Benefit Plan Pub 560 Retirement Plans for Small Business Pub 590-B Distributions from Individual Retirement Arrangements (IRAs)
This IRM reflects the statutory changes made by the American Taxpayer Relief Act of 2012, P.L. 112-240 relating to SEPs and SARSEPs.
The information contained in this IRM is designed primarily to assist EP examination agents in identifying relevant issues relating to SEPs and SARSEPs.
Examination procedures for SEPs and SARSEPs are found in IRM 4.71.17, Employee Plans Examination of Returns, Non-Return Unit Examination Procedures. See IRM 184.108.40.206, Examination of SEPs, SARSEPS and SIMPLE Plans.
The requirements for SEPs are set forth in IRC 408(k).
A SEP is a written arrangement (a plan) that allows an employer to make contributions towards its employees’ retirement without becoming involved in more complex retirement plans.
A self-employed individual may also establish a SEP.
The contributions are made to traditional IRAs (not Roth or SIMPLE IRAs) of the plan participants.
Traditional IRAs used to receive contributions under a SEP are often referred to as "SEP-IRAs," and the SEP participant (IRA owner) can make his or her own regular IRA contributions ($5,500 for 2015, $6,500 if 50 or over) to these IRAs.
Under a SEP, IRAs are set up for each eligible employee. They do not have to be set up for excludable employees. These terms are described further below in this IRM.
SARSEPs are defined in IRC 408(k)(6).
A SARSEP is a SEP that includes a salary reduction arrangement.
Under this type of arrangement, the employee can elect to contribute part of his or her pay to the SEP.
The SBJPA prospectively repealed SARSEPs. No new SARSEPs can be established after December 31, 1996. However, employers that established SARSEPs prior to January 1, 1997 can continue to maintain them, and new employees of the employer hired after December 31, 1996 can participate in the existing SARSEP.
SEP/SARSEP compliance with IRC 408(k) and SIMPLE IRA compliance with IRC 408(p) is determined on a year-by-year basis.
If it is determined that a SEP/SARSEP is not in conformity with IRC 408(k) in a given year, that year of non-conformity stands alone and remains in non-conformity until a closing agreement is entered into covering that specific year.
An IRA-based Plan that does not conform in a particular year is not automatically considered to be in non-compliance in a subsequent year. In order to be considered to be non-compliant in a subsequent year, IRC 408(k) or 408(p) must also be violated in the subsequent year.
IRA-based Plans are different than qualified plans under IRC 401(a) in that the IRS does not issue individual plan rulings for qualification for IRA-based Plans. When EP finds an operational failure in an IRA-based Plan and the taxpayer does not agree to correct the issue, each individual year with a failure is treated as an ineligible plan year. Subsequent plan years are not automatically disqualified as they are with a 401(a) plan.
EGTRRA, as amended by the Job Creation and Worker Assistance Act of 2002, made several changes to the Code affecting SEPs, that are effective beginning in 2002. Rev. Proc. 2002-10, 2002-4 I.R.B. 401, provides procedures and deadlines for amending SEPs for the new law.
WRERA added IRC 414(w)(5)(D) so that a SARSEP could contain an "eligible automatic contribution arrangement" (EACA).
The American Taxpayer Relief Act of 2012, P.L. 112-240, repealed the sunset provision contained in EGTRRA that otherwise would have ended all of EGTRRA’s changes at the end of 2012.
The SEP or SARSEP must be part of a written arrangement. Prop. Reg. 1.408-7(b) provides that the employer must execute a written instrument within the time prescribed for making deductible contributions (that is, no later than the due date for filing, including extensions, of the employer’s income tax return for the year). The written instrument must include: the name of the employer, the requirements for employee participation, the signature of a responsible official, and a definite allocation formula.
This means that a SEP may be set up after the end of the year for which contributions are made, which is more generous than the rule for qualified plans under IRC 401(a). A qualified plan must be executed by the end of the taxable year for which the employer wants to take a deduction.
A SEP or SARSEP can be established using a model, a prototype document or an individually designed document.
An employer may use Form 5305-SEP or Form 5305A-SEP, whichever is applicable, to satisfy the written arrangement requirement.
The form is not filed with the Service but is retained in the employer’s records.
A model SEP or SARSEP is considered to be adopted when IRAs have been established for all eligible employees, all blanks on the form (without modification) have been completed, and specified information has been given to all eligible employees as stated in the instructions to the model.
The model forms may not be used by an employer who:
Maintains any other qualified retirement plan (except for another SEP or SARSEP).
Uses the services of leased employees.
Wants a plan year other than the calendar-year.
Wants an integrated SEP or SARSEP.
In addition, each employee’s IRA set up to receive contributions made under the SEP must be a pre-approved traditional IRA; i.e., either a model traditional IRA or a prototype traditional IRA. The IRAs may not be Roth IRAs or SIMPLE IRAs.
A sponsor (usually a mutual fund or a bank) can request from the IRS an opinion letter for a prototype SEP. An opinion letter states that a SEP agreement is acceptable in form. The sponsor must accompany any request for an opinion letter with the proper user fee and Form 5306-A. The IRS has prepared a Listing of Required Modifications (LRMs), or sample language, to assist sponsors in drafting an acceptable prototype SEP. The LRMs are available on the IRS website, www.irs.gov.
An employer using a prototype document, rather than a model, to establish a SEP can:
Use a plan year, other than the calendar year, that is the same as the employer’s taxable year,
Use an integrated allocation formula, and
Contribute a top-heavy minimum only when the plan is actually top-heavy.
All eligible employees must be allowed to participate. An eligible employee is an employee who:
Is at least 21 years old. See IRC 408(k)(2)(A).
Has performed service for the employer in at least three of the immediately preceding five years. See IRC 408(k)(2)(B).
Has received at least $450 in compensation (as adjusted under IRC 408(k)(8)) from the employer for the current year. See IRC 408(k)(2)(C). Also see IRM 220.127.116.11 for the SEP minimum compensation limits.
An employer may establish less restrictive eligibility requirements than these.
"Service," as referenced in IRM 18.104.22.168 (1) b) above, means any work performed for the employer for any period of time, however short.
A SEP may not impose a length of service requirement. If a SEP requires an employee to work during at least one of the five years immediately preceding the current year, and the employee is otherwise eligible, the length of time he or she worked for the employer in that period is irrelevant. Even if the employee worked for one day he or she is eligible, assuming the employee otherwise meets the requirements for SEP participation.
Example 1: Employer X maintains a calendar year SEP. Under the SEP, an employee must perform services in at least three of the immediately preceding five years, reach age 21, and earn the minimum amount of compensation during the current year. Employee A worked for Employer X during his summer breaks from school in 2012, 2013, and 2014 but never more than 34 days in any year. In July 2015, Employee A turns 21. In August 2014, Employee A begins working for Employer X on a full-time basis, earning $8,000 a year. Employer X makes a contribution to the SEP for eligible employees for 2015. Employee A is an eligible employee in 2015 and Employer X must make a contribution for Employee A because he has met the minimum age requirement, has worked for Employer X in three of the five preceding years, and has met the minimum compensation requirement for 2015.
Example 2: Employer Y designs its SEP to provide for immediate participation regardless of age, service or compensation. Employee B is age 18, and begins working part-time for Employer Y in 2015. Employer Y must make a contribution for Employee B for 2015.
IRC 414(b), IRC 414(c) and IRC 414(m) provide, in relevant part, that for purposes of IRC 408(k) all employees of all corporations that are members of a controlled group of corporations, trades or businesses under common control, or members of an affiliated service group are treated as employed by a single employer.
Since SEPs must cover all employees, the employer sponsoring the SEP must cover employees of such related employers.
The person or firm for whom services are performed may have to include in a SEP any leased employee who is treated as an employee of the recipient.
In general, a leased employee is any person who is not an employee of the recipient but who is hired by a leasing organization and performs services for the recipient. See IRC 414(n).
In addition to employees who do not meet the minimum age, service, and compensation requirements, the following employees do not have to be covered:
Employees covered by a collective bargaining agreement whose retirement benefits were bargained for in good faith by the employer and the union
Employees who are nonresident aliens who did not earn U.S. source income from the employer
Unlike the participation requirements for qualified plans, there are no rules for SEPs that would allow the exclusion of certain percentages of employees. Thus, when the employer is part of a controlled group or uses leased employees, all such eligible employees must be covered under the SEP.
IRC 408(k)(3) imposes nondiscrimination requirements on employer contributions to SEPs. Under IRC 408(k)(3)(A), contributions may not discriminate in favor of HCEs.
IRC 408(k)(3)(C) states that contributions shall be considered discriminatory unless they bear a uniform relationship to participants’ compensation that does not exceed $200,000 (as adjusted under IRC 408(k)(8)). See IRM 22.214.171.124, Annual Statutory Limits Applicable to SEPs and SARSEPs.
Per IRC 414(q) an HCE is any employee who:
Was a 5-percent owner at any time during the year or the preceding year or
For the preceding year, had compensation from the employer in excess of $80,000 and, if the employer so elects, was in the top-paid group for the preceding year. The $80,000 amount is adjusted at the same time and in the same manner as under IRC 415(d) except that the base period is the calendar quarter ending September 30, 1996.
A rate of contribution that actually decreases as compensation increases (for example, the same dollar amount to all participants) is considered uniform. The requirement that contributions bear a uniform relationship to compensation generally means that the SEP may not provide for varying levels of contributions for various classes of employees, such as a higher percentage for senior employees. However, the uniformity requirement is not considered violated in the case of:
Salary reduction contributions made under a SARSEP
Contributions made under an integrated allocation formula. See IRC 408(k)(3)(D) and IRC 401(l).
Under an integrated allocation formula, a SEP is permitted to provide limited disparity in contributions, under the same rules that apply to defined contribution plans under IRC 401(a).
A SEP may provide employees whose compensation is above the Social Security taxable wage base (TWB) a contribution that is a higher percentage of their compensation than the percentage provided for employees earning less than the TWB.
IRC 402(h)(2)(B) effectively reduces the $53,000 (for 2015) contribution limit for HCEs in an integrated SEP by the product of the excess contribution percentage and the integration level.
For example, if a SEP had an allocation formula of 16 percent of compensation up to the TWB ($118,500 in 2015) plus 21.7 percent of compensation in excess of the TWB, the 415 dollar limit is reduced by $6,754.50 ($118,500 x 5.7 percent) for 2015.
Example 3: Employer X adopts a SEP with a contribution formula providing for an allocation of 10 percent of compensation to each employee who worked for five or less years for the employer and 12 percent of compensation to each employee who has worked for more than five years. This is discriminatory because the rate of contributions does not bear a uniform relationship to each employee’s compensation.
Under IRC 408(k)(5), SEP contributions must be made under a written allocation formula.
A SEP may provide that contributions are a fixed percentage of employees’ compensation, a fixed dollar amount for each participant, or that contributions are to be determined each year by the employer (a discretionary contribution).
Discretionary contribution formulas are the most common.
The employer may uniformly vary the percentage of compensation contributed year by year (e.g., change from a fixed contribution to a discretionary contribution) or contribute nothing for a particular year
The SEP document must state how the employer contribution will be allocated and it must be timely amended if the allocation formula changes.
A SEP is treated as a defined contribution plan for purposes of the limitations under IRC 415.
Contributions made under an employer’s SEP to a participant’s IRA cannot exceed the lesser of $53,000 (for 2015) or 100 percent of a participant’s compensation.
All of an employer’s defined contribution plans must be aggregated for purposes of these limits.
Under IRC 404(h)(1)(C), an employer cannot deduct contributions that exceed 25% of employees’ compensation for the year
Nondeductible contributions are subject to a 10% tax per IRC 4972.
A SEP participant cannot exclude SEP contributions that exceed 25% of compensation from gross income per IRC 402(h).
For these reasons, SEP plan documents must limit contributions to 25% (the deduction/exclusion limit) of a participant’s compensation.
Since a SEP is statutorily required to have a written allocation formula, and since the 25% limit must be in the plan, if a contribution exceeds 25% of a participant’s compensation, the entire arrangement will be in non-compliance for the year. See IRM 126.96.36.199, Examination of SEPs, SARSEPS and SIMPLE Plans, and IRM 188.8.131.52.1, Procedures for IRA-based Plans Found to Be in Non-compliance and Not Resolved Through a Closing Agreement.
Example 4: Employee A earns $200,000 in taxable compensation from Employer X during 2015. Under IRC 415(c), Employer X could contribute up to $53,000 to the SEP on behalf of Employee A for 2015. However, the maximum contribution for Employee A would be $50,000 for 2015 (200,000 x 25%).
The compensation upon which the 25% is based cannot exceed $265,000 (for 2015) and under IRC 402(h)(2) it does not include any elective deferrals or other amounts not includible in gross income. See IRM 184.108.40.206, Annual Statutory Limits Applicable to SEPs and SARSEPs, for annual limits from 2006 through 2017.
In the case of self-employed individuals, in determining the 25% of compensation limit on contributions, compensation means "net earnings from self-employment."
Net earnings from self-employment for SEP purposes means gross income from the business minus allowable deductions for that business (net earnings).
For SEP purposes, net earnings must take into account the deductions for contributions to the self-employed individual’s own SEP.
Because the deduction amount and the net earnings amount are each dependent on the other, this adjustment presents a problem.
To solve this problem, adjustments are made indirectly by reducing the contribution rate called for in the plan, in figuring the maximum deduction.
Allowable deductions include contributions to common-law employees’ SEPs. It also takes into account the deduction allowed for half of the self-employment tax.
For more information on the deduction limitations for self-employed individuals, see Pub 560, Retirement Plans for Small Business.
An employer cannot deduct contributions to a SEP that exceed 25% of employees’ compensation for the year, and if the employer also maintains a stock bonus, a profit-sharing or a money purchase pension plan, the limits on contributions to those plans are reduced by the contributions to the SEP. If more than 25% is contributed for a year, the excess can be deducted in subsequent years up to 25% of compensation in the subsequent year.
To deduct contributions for a year, the employer must make the contributions not later than the due date (including extensions) of the employer’s tax return for the year. See IRC 404(h)(1).
A SARSEP is a SEP that accepts contributions made pursuant to a salary reduction arrangement.
It is the employee who decides whether and to what extent money will be contributed to a SEP-IRA established for the employee under the SARSEP, rather than being paid to the employee as compensation. See IRC 408(k)(6).
SARSEPs are similar in some respects to cash or deferred arrangements under IRC 401(k). As in IRC 401(k) plans, contributions funded through salary reduction elections are called "elective deferrals" because the contributions are made at the election of the employee and because the principal tax effect is to defer payment of income taxes until actually distributed to the employee from the IRA.
Section 1421(c) of SBJPA added IRC 408(k)(6)(H), effective for years beginning after 1996, prohibiting the establishment of any new SARSEPs. SARSEPs existing prior to 1997 can continue.
As with regular SEPs, SARSEPs can be adopted using a model form, a prototype document or an individually designed document.
Form 5305A-SEP, Salary Reduction, Simplified Employee Pension - Individual Retirement Accounts Contribution Agreement, is the model SARSEP issued by the IRS.
If a SARSEP is individually designed it must have language that satisfies IRC 408(k)(6).
In Rev. Proc. 91-44, 1991-2 C.B. 733, the IRS provided a model amendment for SEP prototype plans with the result that adoption of the amendment would turn the SEP into a SARSEP.
Rev. Proc. 91-44 also sets forth the requirements for obtaining opinion letters on prototype SARSEPs.
Rev. Proc. 2002-10 sets forth procedures and deadlines for amending SARSEPs to reflect the law as amended by EGTRRA.
A SARSEP may not be maintained by a tax-exempt organization or by a state or local government, or any political subdivision, agency or instrumentality of a state or local government.
Elective deferrals cannot be made to a SARSEP for a year if the employer had more than 25 employees who were eligible to participate at any time during the preceding year.
Example 5: Employer X established a SARSEP in 1995. In 2010, the employer expanded its business and hired new employees. In 2014, under the terms of the SARSEP more than 25 employees were eligible to participate. As a result, in 2015 Employer X's employees cannot make elective deferrals under the SARSEP since there were more than 25 employees eligible to participate in the preceding year. However, if Employer X had 25 or fewer eligible employees during all of 2015, elective deferrals under the SEP could be made in 2016.
Elective deferrals cannot be made to a SARSEP for a year unless at least 50% of the employer’s employees who are eligible to participate, make or have in effect, a salary reduction election under the SARSEP for that year.
SARSEPs are subject to a nondiscrimination test similar to the test imposed on IRC 401(k) plans, but more restrictive.
Under IRC 408(k)(6)(A)(iii), the deferral percentage for a year of each HCE eligible to participate must not be more than the average of the deferral percentages for such year of all employees (other than HCEs) eligible to participate, multiplied by 1.25 (the "deferral percentage test" ).
Elective deferrals of an HCE in excess of this limit are called "excess SEP contributions."
The deferral percentage for a participant for a year is the ratio, expressed as a percentage, of elective deferrals made for the year (other than catch-up contributions, discussed later) to the participant's compensation.
Compensation in excess of $265,000 (for 2015) cannot be considered in determining an employee’s deferral percentage. See IRC 408(k)(6)(D).
This test is different than the actual deferral percentage (ADP) test described in IRC 401(k)(3) applicable to IRC 401(k) plans.
The deferral percentage test for SARSEPs compares the deferral percentage of each HCE with the average of the deferral percentages of all NHCEs.
In contrast, the ADP test in IRC 401(k)(3) compares the average of the deferral percentages of all HCEs with the average of all NHCEs.
Unlike IRC 401(k) cash or deferred arrangements, nonelective contributions from the employer in a SARSEP cannot be used to help the SARSEP satisfy the test and SARSEP HCE.
Unlike a 401(k) plan, HCE deferral percentages in a SARSEP are compared with those of NHCEs within the same (testing) year; the HCE deferrals for the testing year may not be compared with the NHCE deferrals in the prior year.
If there is an excess SEP contribution, the employer must notify each affected HCE within 2 1/2 months following the end of the plan year to which the excess SEP contribution relates, of any excess SEP contribution to the HCE’s SEP-IRA for the applicable year. The notice must:
Excess SEP contributions of an employee who is age 50 or older by the end of the year do not have to be removed from the employee's SEP-IRA to the extent the employee has not reached his or her catch-up contribution limit. See IRM 220.127.116.11.3, Limits on Deferrals.
The total income that can be deferred in a SARSEP for a participant who is less than 50 years old is limited to $18,000 for 2015. See IRC 402(g)(1) and IRM 18.104.22.168, Annual Statutory Limits Applicable to SEPs and SARSEPs.
In the case of a participant who is 50 years old or older by the end of the year, IRC 414(v)(2) allows for an additional annual catch-up contribution (limited to $6,500 for 2015). See IRM 22.214.171.124, Annual Statutory Limits Applicable to SEPs and SARSEPs.
The catch-up contribution limit is adjusted for cost-of-living increases under IRC 414(v)(2)(C).
The SARSEP document must permit catch-up contributions in order for a participant to make catch-up contributions.
Catch-up contributions are not counted in the deferral percentage test for either HCEs or NHCEs.
Most catch-up contributions can be determined when made – for example, they exceed the regular IRC 402(g) limit.
When a plan fails the deferral percentage test, an HCE can reclassify deferrals to catch-up contributions in order to pass the test without reducing total deferrals. This holds true even if the HCE hasn’t exceeded the regular IRC 402(g) limit. See IRM 126.96.36.199.2, Nondiscrimination Test for Elective Deferrals and Example 6, below.
If the employee has other elective deferrals made under another SARSEP, an IRC 401(k) plan or a salary reduction agreement used to purchase an IRC 403(b) annuity, such elective deferrals are added to the elective deferrals under the SARSEP for purposes of the IRC 402(g) annual limit.
If an employee has more elective deferrals made on his or her behalf for a taxable year than allowed under the applicable IRC 402(g) limit, the employee must include the excess in income for the taxable year for which the excess deferrals were made.
The excess over the IRC 402(g) limit is also included in income a second time when it is distributed from the SEP-IRA unless:
If elective deferrals in excess of the 402(g) limit have been made to one or more plans (including SARSEPs) of an employer for a year, and the excess amount plus attributable earnings (through the end of the taxable year) are not distributed by April 15, the plan or plans (including the SARSEPs) will be in non-compliance for the year. See IRM 188.8.131.52, Examination of SEPs, SARSEPS and SIMPLE Plans, and IRM 184.108.40.206.1, Procedures for IRA-based Plans Found to Be in Non-compliance and Not Resolved Through a Closing Agreement.
In addition to the deferral percentage test, elective deferrals under a SARSEP are subject to the overall 25% limit applicable to SEPs. See paragraph (2) of IRM 220.127.116.11, Contribution Limits.
Example 6: In 2015, HCE A, age 55, defers $9,000 (10 percent of his compensation of $90,000) under his employer's SARSEP, which also provides for catch-up contributions. Assume that none of the $9,000 is initially classified as catch-up contributions prior to the running of the deferral percentage test so that all of his deferrals are included in the test. After calculating the NHCEs' average deferral percentage for 2015, it is determined that HCE A has deferred $1,125 over the amount permitted under the deferral percentage test. Since none of HCE A's deferrals for 2015 have so far been classified as catch-up contributions, the entire amount of HCE A's excess SEP contributions ($1,250) may be classified as catch-up contributions and are not required to be distributed to HCE A.
SEPs and SARSEPs must meet the top-heavy requirements of IRC 416.
Both SEPs and SARSEPs must provide for immediate vesting; this satisfies the top-heavy vesting requirements of IRC 416.
A SEP is treated as a defined contribution plan for purposes of the top-heavy minimum contributions required under IRC 416 for participants who are non-key employees.
Since most SEPs and SARSEPs are top-heavy, the plans are usually drafted to operate as if they were always top-heavy, eliminating the need to make the annual 60 percent top-heavy determination. The model SARSEP (Form 5305-A SEP) and nearly all prototype SARSEPs are drafted so that minimum contributions will be made to meet the top-heavy contribution requirement.
If a SEP or SARSEP does need to be tested to see if the plan is top-heavy, employer contributions may be aggregated to determine if the 60 percent threshold under IRC 416(g)(1)(ii) has been crossed. See IRC 416(i)(6).
For purposes of IRC 416:
Elective deferrals in a SARSEP are considered employer contributions.
Elective deferrals may not be used to satisfy the minimum contribution requirements under IRC 416.
For purposes of determining the top-heavy minimum contribution, all elective deferrals made by key employees (other than catch-up contributions) must be counted, but all elective deferrals made by non-key employees are not counted towards satisfying the minimum contribution.
A SEP must permit employees to withdraw employer contributions at any time. Employer contributions to an employee’s SEP-IRA cannot be conditioned on the retention of any amount contributed. See IRC 408(k)(4).
Since traditional IRAs are the funding vehicles for SEPs, the rules governing distributions from SEP-IRAs are similar to the rules for other traditional IRAs. See Pub 590-B.
In a SARSEP, a transfer or rollover of contributions is prohibited before the deferral percentage test has been run and the plan has passed the test. See IRC 408(d)(7) and IRC 408(k)(6)(F).
SEPs and SARSEPS are not required to file Form 5500.
Within a reasonable time after a SEP or SARSEP is adopted and after a new employee becomes employed, the employer must furnish the following information to each eligible employee:
Notice that the plan has been adopted
Requirements an employee must meet to receive an allocation
The basis upon which the employer’s contributions will be allocated
Any other information the Commissioner may prescribe
Each year the employer must furnish an annual statement to each employee participating in the SEP, showing the amount contributed to the employee’s SEP for that year. See IRC 408(l) and Prop. Reg. 1.408-9.
The annual statement for a calendar year SEP must be furnished no later than January 31, following the calendar year for which the contribution is made, or, if later, 30 days after the contribution.
An employer who makes a contribution on behalf of an employee and fails to furnish an annual statement showing the amount contributed is liable for a $50 penalty for each failure, unless the failure is due to reasonable cause. See IRC 6693(a). See IRM 18.104.22.168.1, Penalties Under IRC 6693(a).
Distributions from a SEP-IRA are subject to the same withholding rules that apply to distributions from other traditional IRAs. See IRC 3405.
Form 5498 must be submitted to the IRS by the trustee or issuer of a SEP-IRA to report contributions to the SEP-IRA. A separate Form 5498 must be submitted for each SEP participant.
Form 1099-R is used to report distributions from a SEP-IRA.
SEP contributions are deducted by:
Corporate employers on Form 1120
Sole proprietors on Form 1040, Schedule C for their employees and on line 28 of Form 1040 for contributions made for themselves
Partnerships on Form 1065 for their common-law employees; but contributions for partners are reported on Schedule K-1 issued to partners who deduct contributions made of their behalf on their own Form 1040
In addition to the notice and reporting requirements described above, SARSEPs have special notice and reporting requirements when distributions of elective deferrals are made to satisfy the rules in IRC 408(k)(6).
Information on reporting these distributions can be found in Notice 89-32, 1989-1 C.B. 671; Rev. Proc. 91-44, 1991-2 C.B. 733; as well as in the instructions to Form 1099-R.
Amounts in excess of the deferral percentage limits are excess SEP contributions on behalf of the affected HCE(s). See IRC 408(k)(6)(C).
The employer must notify each affected HCE, within 2 1/2 months following the end of the plan year to which the excess SEP contributions relate, of any excess SEP contributions to the HCE’s SEP-IRA for the applicable year.
The notice must specify the amount of the excess SEP contributions, the calendar year in which the contributions are includible in income, and must explain the applicable penalties if the excess contributions are not withdrawn in a timely manner.
If the employer fails to notify any affected HCE within the 2 1/2 month period, the employer must file Form 5330 and pay a excise tax under IRC 4979 equal to 10 percent of the excess SEP contributions. See IRM 4.71.5, Form 5330 Examinations.
If the employer does not notify its employees by the last day of the 12 month period following the year of excess SEP contributions, the SEP will no longer be considered to meet the requirements of IRC 408(k)(6) for that year. See IRM 22.214.171.124, Examination of SEPs, SARSEPS and SIMPLE Plans, and IRM 126.96.36.199.1, Procedures for IRA-based Plans Found to Be in Non-compliance and Not Resolved Through a Closing Agreement.
If more than half of the eligible employees choose not to make elective deferrals during a plan year, all elective deferrals made by all employees during that plan year are considered "disallowed deferrals."
The employer must notify each affected employee within 2 1/2 months following the end of the plan year to which the disallowed deferrals relate, that his or her deferrals are no longer considered SEP-IRA contributions.
The disallowed deferrals are includible in the employee’s gross income in the calendar year as of the earliest date that any elective deferrals by the employee during the plan year would have been received by the employee had he or she originally elected to receive the amounts in cash.
Income allocable to the disallowed deferrals is includible in the employee’s gross income in the year of withdrawal from the IRA. See Rev. Proc. 91-44.
The IRS has a comprehensive system of correction programs for sponsors of retirement plans that are intended to satisfy the applicable Code requirements but have not met these requirements. This system, the Employee Plans Compliance Resolution System "EPCRS" ), permits plan sponsors to correct these failures and thereby continue to provide their employees with retirement benefits on a tax-favored basis.
Correction procedures for employers that sponsor SEPs are explained in section 6.11 of Rev. Proc. 2013-12 and in Rev. Proc. 2015-27.
Under Rev. Proc. 2013-12, employers can self-correct insignificant SEP failures under the self-correction program (SCP) and can apply to the Service for correction of certain other failures under the Voluntary Correction Program (VCP).
If a failure is first identified on audit, the employer may correct the failure and pay a sanction under the audit closing agreement program (Audit CAP).
Relief is not available under SCP for EGTRRA non-amenders or late amenders who have adopted EGTRRA amendments after December 31, 2008. This issue must be resolved through Audit CAP.
If a failure cannot be corrected through EPCRS, issues may be resolved through a DO 8-3 Closing Agreement. See IRM 188.8.131.52.2, DO 8-3 Closing Agreements.
A SEP or SARSEP that is eligible for this program that corrects a failure to satisfy the requirements of IRC 408(k) in accordance with the program will be treated as not failing to meet IRC 408(k). Depending on the particular circumstances, defects involving form, plan operation, and employer eligibility, among others, may be corrected under the program.
Coordinate any closing agreement with the Area CAP Coordinator.
See IRM 184.108.40.206.1, Procedures for IRA-based Plans Found to Be in Non-compliance and Not Resolved Through a Closing Agreement for procedures to follow when a SEP or SARSEP is determined to be noncompliant and the issues are not corrected.
A plan document must be timely adopted with all of the required provisions. See IRM 220.127.116.11, Written Arrangement Requirement.
If the plan is a SARSEP, verify that it was established prior to 1997 through the review of third-party documentation and/or employees' Forms W-2 showing SARSEP deferrals.
Verify plan form compliance. If the SEP or SARSEP IRA uses the higher contribution limitations of EGTRRA, then the document used for the plan must be either an IRS model plan with a revision date of March 2002 or later or an approved prototype plan with an EGTRRA opinion letter.
If the SEP/SARSEP uses a model form, check that it meets all of the special requirements and restrictions specified on the form.
Make sure all eligible employees are participating in the plan. Verify that the participation requirements are correctly applied.
Check payroll records, dates of birth, hire, participation and termination, and any reason for non-participation, if applicable.
Ensure that all employees who were required to receive contributions did so.
Check documentation to verify the establishment of SEP-IRAs and contributions made, such as bank statements, broker statements, etc.
If the employer is a member of a controlled group, check that all employees who should be included in the SEP are included. For example, if there has been a recent merger involving the employer, changes in the required coverage for the SEP may have occurred, resulting in an increase in participation in the SEP. See IRM 18.104.22.168, Coverage and Participation Requirements.
Verify that the nondiscrimination rules were met.
Identify HCE (defined at IRC 414(q)) through payroll and ownership records, and ensure that the employer has not added contribution conditions that discriminate in favor of HCEs.
There can be no conditions placed on receiving a contribution other than those in IRM 22.214.171.124, Nondiscrimination Requirements. For example, the SEP could not have a last-day requirement for an allocation or have an allocation formula that provides higher-paid employees a greater allocation when measured as a percentage of compensation, unless the SEP is a SARSEP or is integrated.
If the SEP is integrated, check to determine that:
If it is a SARSEP, the plan sponsor adopted a prototype plan
It does not use a model SEP form
Contributions to HCEs comply with the reduced limit under IRC 402(h)(2)(B).
Verify that the correct definition of compensation is used in determining the contribution limit under the plan and that compensation in excess of $265,000 (for 2015) is disregarded. See IRM 126.96.36.199, Contributions.
If a self-employed individual has a SEP, check to make sure the special limits on contributions and deductions for the self-employed individual have been met. See IRM 188.8.131.52, Contributions.
Check that all applicable limits have not been exceeded.
If the SEP is not a model plan, the employer may maintain another kind of plan. Special attention should be paid to verify that IRC 415 limits have not been exceeded when all plans are considered.
Nondeductible contributions are subject to the 10% tax under IRC 4972.
Check the deduction amount on the employer's Form 1120 (if the employer is a corporation), Form 1065 and Form(s) 1040 (if the employer is a partnership), and Form 1040 (if the employer is a sole proprietorship) including Schedule C (if there are common-law employees in the SEP).
If the plan is a SARSEP:
Confirm that the employer is not an ineligible employer (e.g., a tax-exempt entity), did not have more than 25 employees eligible to participate in the year preceding the year under exam, and had at least 50 percent of employees electing to make deferrals to the SEP in the year under exam.
Verify that the plan satisfies the deferral percentage test. Each HCE's elective contributions for a year, measured as a percentage of his or her compensation, cannot exceed 1.25 times the average of such percentages for all eligible NHCEs for the year.
Confirm that the applicable IRC 402(g) limit was met.
Determine if the plan is top-heavy or is treated as top-heavy and if so, confirm that top-heavy minimum contributions were made. If a the plan is a SARSEP verify that elective contributions made by non-key employees were not used to satisfy top-heavy minimums, but that elective contributions made by key employees (other than catch-up contributions) were used to determine the minimum that non-key employees should receive.
Verify that notice and reporting requirements were met.
Verify that proper disclosure was given to employees. See IRM 184.108.40.206.1, Disclosure to Employees and IRM 220.127.116.11.2, Annual Statements.
Verify that annual statements were filed. Determine if Forms 1099-R were correctly prepared and filed by reviewing third party documentation.
Follow the procedures in IRM 18.104.22.168, EPCRS and DO 8-3 Closing Agreements, when you discover issues that cause the SEP or SARSEP to be non-compliant.
The table below contains the annual dollar limits applicable to SEPs.
Year IRC 402(g) IRC 414(v) IRC 408(k)(2)(C) IRC 401(a)(17) IRC 414(q) IRC 415(c) Taxable Wage Base 2017 $18,000 $6,000 $600 $270,000 $120,000 $54,000 $127,200 2016 $18,000 $6,000 $600 $265,000 $120,000 $53,000 $118,500 2015 $18,000 $6,000 $600 $265,000 $120,000 $53,000 $118,500 2014 $17,500 $5,500 $550 $260,000 $115,000 $52,000 $117,000 2013 $17,500 $5,500 $550 $255,000 $115,000 $51,000 $113,700 2012 $17,000 $5,500 $550 $250,000 $115,000 $50,000 $110,100 2011 $16,500 $5,500 $550 $245,000 $110,000 $49,000 $106,800 2010 $16,500 $5,500 $550 $245,000 $110,000 $49,000 $106,800 2009 $16,500 $5,500 $550 $245,000 $110,000 $49,000 $106,800 2008 $15,500 $5,000 $500 $230,000 $105,000 $46,000 $102,000 2007 $15,500 $5,000 $500 $225,000 $100,000 $45,000 $97,500 2006 $15,000 $5,000 $450 $220,000 $100,000 $44,000 $94,200