SEP Plan fix-it guide - Eligible employees were excluded from participating



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3) Eligible employees were excluded from participating Review plan sections on eligibility and participation and check when employees are entering the plan Corrective contribution that would place affected employees in the position they would've been in if there were no operational plan mistakes Review the participation status of all employees at least once a year

You must allow all eligible employees to participate in the SEP, including part-time employees, seasonal employees and employees who die or terminate employment during the year. An eligible employee is an employee who:

  1. is at least 21 years of age,
  2. has performed service for you in at least three of the immediately preceding five years, and
  3. received at least $750 in compensation from your business in 2023 ($650 in 2021 and in 2022, $600 in each year from 2016 to 2020).

The term “employee” includes both a self-employed individual who has earned income and a working business owner.

You must treat certain leased employees as “employees.”

Your SEP document can provide for less (but not more) restrictive eligibility requirements. “Service” means any work performed for you for any period of time, however short. A SEP may not impose an hours-of-service requirement.

Excludable employees: You don't need to cover the following employees under a SEP:

  • Employees covered by a union agreement whose retirement benefits were bargained for in good faith by you and their union.
  • Nonresident alien employees who didn't earn U.S. source income from you.
  • Employees who received less than $750 in 2023; $650 in 2021 and 2022; $600 in 2015 - 2020 ($550 in 2009 - 2014) in compensation during the year. This amount is subject to cost-of-living adjustments.

You may not exclude employees simply because they’re classified as “part-time” or “seasonal.” When determining who’s an eligible employee, you must include all employees of controlled groups of corporations that include your business, trades or businesses under common control with your business and affiliated service groups that include your business. This means, for example, that if you and/or your family members own a controlling interest in another business, employees of that other business are “employees” for purposes of determining who is eligible to participate in your SEP.

Example 1: Employer X maintains a calendar year SEP. The eligibility requirements under the SEP are an employee must perform service in at least three of the immediately preceding five years, reach age 21 and earn the minimum amount of compensation during the current year. Andy worked for Employer X during his summer breaks from school in 2017, 2018 and 2019, but never earned more than $600 in any year. In July 2020, Andy turned 21. In August 2020, Andy began working full-time for Employer X, earning $12,000 in 2020. Andy is an eligible employee in 2020, because he met the minimum age requirement, worked for Employer X in three of the five preceding years and met the 2020 minimum compensation requirement.

Example 2: Employer Y designs its SEP to provide for immediate participation regardless of age, service or compensation. Bill is age 18 and began working part-time for Employer Y in 2018. Bill is an eligible employee for 2018.

How to find the mistake:

Review the section of your plan document concerning eligibility and participation. Check when employees are entering the plan.

  • Make a list of all employees who received a W-2.
  • Compare the employees' dates of hire and annual compensation against the eligibility and participation requirements in the plan document.
  • Determine the date that each employee is entitled to become a participant in the plan according to the plan document.
  • Inspect plan records to make sure the employees timely entered the plan.

How to fix the mistake:

Corrective action:

Generally, if you didn’t provide an employee the opportunity to participate in your SEP plan, you must make a contribution to the plan for the employee that makes up for the missed contribution. The corrective contribution is an employer contribution that’s intended to place the employee in the same position had the employee participated in the plan timely. Open a SEP-IRA for the excluded employee and make contributions to the SEP-IRA equal to the same percentage of compensation received by other employees for each year the employee was excluded. Increase the amount contributed to reflect missed earnings through the date of correction. Do not reduce other employees’ SEP-IRAs. 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.

Example: Employer D maintains a SEP plan for its 20 employees. The total amount of IRA assets associated with the plan exceed $500,000 but is less than ten million dollars. The plan provides that contributions are allocated to the 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 2020, Employer D contributed to the plan. However, Employer D inadvertently excluded one part-time employee who met the eligibility requirements, but terminated during the 2020 plan year. The contribution resulted in an allocation for each of the eligible employees, other than the excluded employee, equal to 10% of compensation. If the excluded employee had shared in the original allocation, the allocation made for each employee would’ve equaled 9% of compensation.

Reasonable correction:

Revenue Procedure 2021-30 provides different methods for correcting eligible employees who’ve been improperly excluded from participating. The contribution method requires the employer to make a corrective contribution to the SEP-IRA of each improperly excluded employee. The corrective contribution is determined taking into account the excluded employee's compensation and must be adjusted for earnings through the date of corrections. No adjustments are made to the SEP-IRAs of employees who shared in the prior allocation, even though their allocations would have been different had the excluded employee not been excluded. For the above example, Employer D would contribute an amount equal to 10% of the excluded employee’s compensation for the 2020 year (adjusted for earnings) and doesn’t reduce the 10% allocations made to the other employees.

Correction programs available:

Self-Correction Program:

The example illustrates an operational problem because the employer failed to follow the terms of the SEP plan by failing to give one employee an allocation of the employer contribution. If the other eligibility requirements of SCP are satisfied, Employer D might be able to use SCP to correct the failure. Employer D would have to determine whether:

  • Practices and procedures were originally in place to facilitate compliance with requirements regarding participant eligibility
  • The failure is insignificant

Voluntary Correction Program:

If the plan is not under audit, Employer D may make a VCP submission to the IRS under Revenue Procedure 2021-30 via the website following the procedures in Section 11. Employer D, use Form 14568, Model VCP Compliance StatementPDF, including Form 14568-C, Model VCP Compliance Statement - Schedule 3: SEPs and SARSEPsPDF to identify the failure and describe how it’s being fixed. User fees for VCP submissions are generally based upon the current value of all IRAs that are associated with the SEP plan.

Audit Closing Agreement Program:

Under Audit CAP, correction is the same as described above under “Corrective action.” Employer D 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. 2021-30.

How to avoid the mistake:

Review the participation status of all employees at least once a year. The person assigned the task should have a good understanding of the eligibility requirements and have access to the employment and payroll records necessary to make eligibility decisions for all employees.

SEP fix-it guide

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EPCRS overview

SEP checklistPDF

IRA-based plans additional resources