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SEP Plan Fix-It Guide - Contributions to each participant’s SEP-IRA weren't a uniform percentage of the participant’s compensation

Mistake

Find the Mistake

Fix the Mistake 

Avoid the Mistake

5) Contributions to each participant’s SEP-IRA weren't a uniform percentage of the participant’s compensation Divide contributions by compensation for each employee Corrective contribution that would place affected employees in the position they would've been in if there were no operational plan mistakes After the initial calculation of allocations based on the SEP plan document terms, verify that all proposed contributions are based on a uniform percentage of participants’ compensation

Unless the SEP plan has an allocation formula that involves permitted disparity (and most SEP documents, including Form 5305-SEP, don't allow for permitted disparity), employer contributions to participants’ SEP-IRAs must be equal to the same percentage of compensation (as limited - see Mistake 4) of each participant.

How to find the mistake:
 
Divide contributions made to each employee’s SEP-IRA by the employee's compensation for the year. The resulting percentage should be the same for all participating employees.

How to fix the mistake:  

Corrective action:
Generally, if you didn’t provide an employee the correct contribution in your SEP plan, you must make a contribution to the employee's SEP-IRA that places the employee in the position he would’ve been in if you hadn’t made the mistake. Make a contribution to the SEP-IRA equal to the same percentage of compensation received by other employees. Increase the amount contributed to reflect missed earnings through the date of correction. Don’t reduce other employees’ SEP-IRAs.

Example:
Employer Q maintains a SEP plan for its 20 employees. The plan provides that the contributions are allocated to participants’ SEP-IRAs in the ratio that each eligible employee's compensation for the year bears to the compensation of all eligible employees for the year. For 2015, Employer Q made a contribution to the plan of a fixed dollar amount. All of the employees except Jim received a contribution in the amount of 8% of compensation. Jim’s contribution was in the amount of 5% of his compensation.

Reasonable correction:
Employer Q should make an additional contribution to Jim’s SEP-IRA of 3% (8% allocation to other employees less 5% already made to Jim’s SEP-IRA) of his compensation plus earnings through the date of correction. No adjustments are made to the SEP-IRAs of employees who shared in the prior allocation, even though their allocations would’ve been different had Employer Q not made the mistake. If it isn’t feasible to determine what the actual investment results would’ve been, Q 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.

Correction programs available:

Self-Correction Program:
The example illustrates an operational problem because Employer Q failed to follow the SEP plan terms by not giving one employee the proper allocation of the employer contribution. If the other eligibility requirements of SCP are satisfied, Employer Q might be able to use SCP to correct the failure. Employer Q would have to determine whether:

  • Practices and procedures were originally in place to facilitate compliance with requirements regarding the accuracy of employee compensation and allocations under the plan.
  • The failure is insignificant.

Voluntary Correction Program:
If the plan isn’t under audit, Employer Q may make a VCP submission o the IRS under Revenue Procedure 2016-51 identifying the failure, using Form 14568, Model VCP Compliance Statement, including Form 14568-C, Model VCP Compliance Statement - Schedule 3: SEPs and SARSEPs, and Forms 8950 and 8951. Beginning in 2018, the user fee for VCP submissions is generally based upon the current value of all IRAs that are associated with the SEP plan. For example, if the value is between $0 and $500,000, the user fee is $1,500. If the value of all IRAs exceeds $500,000, the user fee will be higher.

Audit Closing Agreement Program:
Under Audit CAP, correction is the same as described above under “Corrective action.” Employer Q and the IRS enter into a Closing Agreement outlining the corrective action and negotiate a sanction that is not excessive, considers facts and circumstances, and bears a reasonable relationship to the nature, extent and severity of the failures, based upon all relevant factors described in section 14 of Rev. Proc. 2016-51.

How to avoid the mistake:

After the initial calculation of allocations based on the terms of the plan, you should check to make sure all of the proposed allocations are in an equal percentage of compensation. If there's a problem, you can adjust it before you transfer the money into the SEP-IRAs.

SEP Fix-It Guide
SEP Overview
EPCRS Overview
SEP Checklist
IRA-Based Plans Additional Resources

IRS.gov / Retirement Plans / Correcting Plan Errors / Fix-It Guides / SEP Fix-It Guide / Potential Mistake