SEP IRA Contribution Percentage for Employee

Submitted by Christopher Currie on Tue, 2019-02-26 19:48

I have a self-employed sole proprietor whose net earnings from self-employment (after adjusting for 1/2 SE tax, etc.) is above the annual maximum compensation limit; therefore, they intend to fund the maximum SEP contribution for 2018 of $55,000. The sole proprietor has one eligible employee who is due an employer contribution, and my question is how to calculate the SEP contribution for this W-2 employee.

Because the owner’s compensation exceeds the maximum limit, their contribution works out to be 20% of $275,000, but I’m unsure if I should be using 20% or 25% for the W-2 employee. Any assistance the forum can provide would be greatly appreciated!



Submitted by William Tuttle on Tue, 2019-02-26 20:36

  • The employee’s comepensation = their W-2 Box 1 with any Box 12 deductions added back in. Their maximum SEP IRA contribution with a plan 25% contribution rate with be 25% of their compensation
  • A sole proprietor’s SEP IRA contribution is also 25% of compensation, but because their employer contribution is not compensation. It is calculated as the lessor of earned income or the compensation limit * 20%. 

Submitted by Christopher Currie on Wed, 2019-02-27 14:51

Thanks for your comment.  This is more for my own information than an actual client situation, but let us change the facts from above to state that instead of the owner being a sole proprietor, they are organized as an S-Corporation, and their only source of compensation for purposes of the SEP is their W-2 wages.Owner’s Gross W-2 = $275,000Employee’s Gross W-2 = $31,000 For owner to max, they take 20% of their eligible compensation ($275,000) to arrive at $55,000 for 2018. In this scenario, when there is no special calculation for the owner due to self-employment income, is the answer still the other employee receives 25% of their gross W-2 compensation for their contribution or is it 20%?  

Submitted by William Tuttle on Wed, 2019-02-27 22:31

  • The maximum contribtion rate is 25% of compensation. However, if the owner can reach the $55K annual addition limit with a 20% plan contribution rate, because they are an S-Corp W-2 employee. He can set that % of compensation for all employees.
  • However, he will be increasing his salary from $220K -> $275K. He will have to pay an additonal 2.9% FICA  = $1,595 + (0.9% MC * $55K =  if single = $495 or $25K * 0.9% MC = $225 if MFJ). So he will end up paying $1,820 -> $2,090 in additional employment taxes to save $31K * 5% = $1,550.
  • Also, if the owner is eligible for the qualfied business income QBI deduction (possibly subject to specified service trade or business and associated taxable income phaseout). That additional $55K in W-2 wages + 1/2 ($1,820 -> 2,090) ~= $1K will reduce his QBI deduction by = ~$56K * 20% =  $11,200.
  • However, his QBI may be limited to 1/2 the total S-Corp W-2 wages. So more wages may be more advantageous.
  • In other words, There is no possible way for me to tell what is best for you. The only way you can determine this is run two tax software simulations of a salary of $220K with a 25% contribution rate and a salary of $275K with a 20% contribution rate.
  • That extra $1500 in employer contribution to that employee is the least of your worries. And as my mother always said, share the wealth. With at least an order of magnatude greater income that this one employee should you really be trying to begrudge them a measly $1500. It would be a totally different story if you have many employees.

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