SEP IRA Questions
[quote]Contributions for an employee can be up to 25% of the [b]employee’s eligible compensation[/b], providing the contribution amount does not exceed $45,000. For SEP IRAs, the compensation cap applies, which means that no more than $225,000 in compensation can be taken into consideration for purposes of determining SEP contributions for an employee.[/quote]
What is considered “Employee’s eligible compensation”? I have a client who is a realtor that owns an S-Corp. He is the sole share holder. He takes a “salary” from his payroll company, but also takes a draw in which they do not handle. When he get’s his W-2 it shows just the salary, but not the draw as the payroll department did not handle that.
There are some issues now with the amount of money he has contributed to his SEP IRA. He’s is being told by his new CPA that according to his W-2 in 2005 & 2006 he made excess conributions to his SEP IRA. Is this accurate?
Also is there such a thing as making non-deductible contributions to a SEP IRA? Thanks for any help.
Permalink Submitted by Denise Appleby on Wed, 2007-10-03 19:21
For a S-Corporation, ‘eligible compensation’ is W-2 wages.
Nondeductible contributions would be any amount in excess of the limits quoted above.
Permalink Submitted by Jim Giles on Wed, 2007-10-03 19:37
So you can make a non-deductible contribution to a SEP IRA?
Permalink Submitted by Denise Appleby on Thu, 2007-10-04 08:58
Yes. But – in effect, a non -deductible SEP contribution would be an excess contribution, subject to an excise tax of 10% unless corrected .
See page 7 of http://www.irs.gov/pub/irs-pdf/p560.pdf
And http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00004972—-0…
Permalink Submitted by Jim Giles on Thu, 2007-10-04 13:28
Denise is there ever any reason you would recommend a “non-deductible” contribution ot a SEP? Seems like the penalty is there to prohibit this practice altogether. By the way, thanks for helping me with these questions.
Permalink Submitted by BruceM on Thu, 2007-10-04 17:46
For corporations, the maximum contribution is 25% of payroll. Unless there is some exception to this based on the employee % ownership of company stock, I don’t see why an S-Corp would not also have this limit.
But for an S-Corp with little or no profit, or revenue for that matter, does the IRS have a problem with making a 25% of payroll deductible SEP contribution (on the 1120S)? I don’t see any reason why it would, but clearly the tax character of the contribution would be pretax. I have never read anywhere that a corp can designate SEP contributions as after tax, and I’m not sure why the corporation would want to, as the deduction would offset taxable income or result in a loss that could be carried forward or back. The only way I’m aware that an after tax contribution could be made is by an employee elective deferral as outlined under section 401(m).
BruceM
Permalink Submitted by Jim Giles on Thu, 2007-10-04 18:08
Here is the situation, client has S-Corp and is only shareholder. He has a payroll company pay him $52,000/year. His S-Corporation however retains much more then that and through out the year he takes the equivalent of a draw or bonuses that are not tracked by the payroll company, thus they do not show up on his W-2. His contributions to his SEP IRA are not deducted by his payroll company either.
He has for the past 2 years been putting money, $40,000 per year, into this SEP. His CPA is now saying he did not make enough money to put that much into his SEP IRA, in essence the S-Corp. made “non-deductible” contributions on his behalf.
Is his draw or bonus money not part of his “employee compensation”? What is the easiest way to handle a “non-deductible” contribution to a SEP IRA? I’m thinking he should have the over funded portion refunded to the S-Corp. and have his returns amended to show the additional income.
Permalink Submitted by Denise Appleby on Fri, 2007-10-05 14:55
[quote=”[email protected]“]For corporations, the maximum contribution is 25% of payroll. Unless there is some exception to this based on the employee % ownership of company stock, I don’t see why an S-Corp would not also have this limit.
BruceM[/quote]
But in this case, he is 100% shareholder…so he can only rely on W-2 ages.
The following is from IRS Publication 560
[quote]Net earnings include a partner’s distributive share of partnership income or loss (other than separately stated items, such as capital gains and losses). It does not include income passed through to shareholders of S corporations.[/quote] Another Cite [Durando v. United States, 70 F.3d 548 (9th Cir. 1995)]
Permalink Submitted by Denise Appleby on Fri, 2007-10-05 15:01
[quote=”[email protected]“]Denise is there ever any reason you would recommend a “non-deductible” contribution ot a SEP? Seems like the penalty is there to prohibit this practice altogether. By the way, thanks for helping me with these questions.[/quote]
You are most welcome.
I would not feel comfortable making such a recommendation under any circumstances. If the client wants to do that on his/her own, then the most you can do is explain the ramifications…
Would an individual-K be more suitable for this client? It allows the 25% of compensation, plus salary deferral of $15,500 + catch-up. This could be a good choice if 25% of his wages does not get him up to the $45,000
Individual-k Defined here http://www.retirementdictionary.com/SBO-401k.htm
Permalink Submitted by Denise Appleby on Fri, 2007-10-05 15:14
[quote=”[email protected]“]Here is the situation, client has S-Corp and is only shareholder. He has a payroll company pay him $52,000/year. His S-Corporation however retains much more then that and through out the year he takes the equivalent of a draw or bonuses that are not tracked by the payroll company, thus they do not show up on his W-2. His contributions to his SEP IRA are not deducted by his payroll company either.
He has for the past 2 years been putting money, $40,000 per year, into this SEP. His CPA is now saying he did not make enough money to put that much into his SEP IRA, in essence the S-Corp. made “non-deductible” contributions on his behalf.
Is his draw or bonus money not part of his “employee compensation”? What is the easiest way to handle a “non-deductible” contribution to a SEP IRA? I’m thinking he should have the over funded portion refunded to the S-Corp. and have his returns amended to show the additional income.[/quote]
Seems the CPA is right.
The IRS’s recommendation for handling the excess is to treat it as wages for the year, and for it to be removed from the IRA as a ‘return of excess contribution’. This is subject to a 6% excise tax for each year it remains in the IRA. The only way to about the 6% tax is to remove the excess by tax filing deadline, including extensions- along with NIA. ( NIA defined here http://www.retirementdictionary.com/nia.htm )
Excuse my piecemeal responses…just trying to make sure it is easier to follow the points and posts to which the responses apply
Permalink Submitted by Jim Giles on Fri, 2007-10-05 16:02
I think the SEP is definitely better then the Personal 401k as he wants to fund it to it’s maximum. The problem of course is his old tax preparer never caught or cared that he was only taking so much in W-2 income and was putting so much into a SEP IRA. Does he have any kind of recourse agaisnt the person or compant aht prepared his taxes in 2005? He is in the process of completing 2006 returns now.