Find the Mistake
Fix the Mistake
Avoid the Mistake
|4) Contributions to participants’ SEP-IRAs were miscalculated because the wrong definition of compensation was used||Review the SEP plan document to determine if you're using the proper compensation for allocations||Correction is based upon the terms of the SEP plan document at the time of the mistake||Review the SEP plan document terms to ensure that you're considering the correct amount of compensation when calculating contributions|
A SEP plan’s definition of employee compensation must satisfy rules for determining the amount of contributions. The amount of compensation taken into account under the plan is limited.
You must follow the definition of compensation stated in the plan document in the operation of the plan. Compensation generally includes the pay an employee received from you for personal services for a year including:
- Wages and salaries
- Fees for professional services
- Other amounts received (cash or non-cash) for personal services actually rendered by an employee, including, but not limited to, the following items:
- Commissions and tips
- Fringe benefits
You may use an alternative definition of compensation, permitted under Internal Revenue Code Section 414(s) that excludes some of the above listed items. Any exclusions of compensation must be specified in your plan document and be nondiscriminatory.
If you are a self-employed person sponsoring a SEP, the compensation on which you calculate your maximum contribution is your net earnings from self-employment. Publication 560 provides a worksheet for this calculation.
How to find the mistake:
To determine if you're using the proper compensation for allocations, you’ll need to review your SEP plan document.
Spot-check allocations to see if you’re using the correct employee compensation as defined in your SEP plan document. If you’re using the Form 5305-SEP, make sure you’re basing allocations on total compensation. If you have a plan with a complicated definition of compensation, develop a worksheet to calculate the correct amounts. Some of these definitions can get very complicated with expense reimbursements, car allowances, bonuses, commissions and overtime pay that may or may not be included in the definition of compensation.
How to fix the mistake:
You would make a corrective contribution, including earnings through the date of correction, to each affected employee’s SEP IRA.
Employer G operates a restaurant with 15 employees. Under the terms of the SEP document, compensation for determining allocations of the employer contribution is total wages earned including bonuses, tips and other income reported on the Form W-2. Since the inception of the plan, it was determined that Employer G considered bonuses and other income for the contribution allocation, but tips hadn’t been included.
Recalculate the contribution amounts based on the correct definition of compensation. If compensation was understated, make corrective contributions to the SEP-IRAs of affected employees, adjusted for earnings through the date of correction. 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.
Correction programs available:
The example illustrates an operational problem, because Employer G failed to follow the SEP plan terms by not including tips in compensation used to determine allocations under the plan. If the other eligibility requirements of SCP are satisfied, Employer G might be able to use SCP to correct the mistake. Employer G would have to determine whether:
- Practices and procedures were originally in place to facilitate compliance with requirements regarding employee compensation and allocations under the plan.
- The failure is insignificant
Voluntary Correction Program:
If the plan is not under audit, Employer G may make a VCP submission to the IRS under Revenue Procedure 2018-52 identifying the failure, using Form 14568, Model VCP Compliance Statement, including Form 14568-C, Model VCP Compliance Statement - Schedule 3: SEPs and SARSEPs. The user fee for VCP submissions is 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 G 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. 2018-52.
How to avoid the mistake:
When calculating allocations, it is important for you to review the plan terms to ensure that you are using the correct amounts of compensation. If necessary, you may wish to include in your payroll program an account that accumulates the proper compensation figures for all employees.