Simplified Employee Pensions (SEPs) are stripped-down retirement plans intended for self-employed individuals and small businesses. If you don’t already have a tax-favored retirement plan set up for your business, consider establishing a SEP — plus, if you act quickly enough, you can claim a deduction for your initial SEP contribution on your 2016 tax return.
Putting SEPs to Work for You
Beware of Requirements to Cover Employees
Establishing a SEP is more complicated if your business has employees. Specifically, contributions may be required for any employee who:
1. Is age 21 or older,
2. Has worked for your business during at least three of the past five years, and
3. Receives at least $600 of compensation.
Your business can deduct any contributions made for employees. Because SEP contributions made for employees vest immediately, a covered employee can leave your company at any time without losing any of his or her SEP money. For this reason, SEPs generally aren’t preferred by businesses with more than a few trusted employees.
Because SEPs are relatively easy to set up and can allow large annual deductible contributions, they’re often the preferred retirement plan option for self-employed individuals and small business owners — unless they have employees. (See “Beware of Requirements to Cover Employees” at right.)
The term “self-employed” generally refers to:
- A sole proprietor,
- A member (owner) of a single-member limited liability company (LLC) that’s treated as a sole proprietorship for tax purposes,
- A member of a multimember LLC that’s treated as a partnership for tax purposes, or
- A partner.
If you’re in one of these categories, your annual deductible SEP contributions can be up to 20% of your self-employment income. For a sole proprietor or single-member LLC owner, self-employment income for purposes of calculating annual deductible SEP contributions equals the net profit shown on their Schedule C, less the deduction for 50% of self-employment tax. For a member of a multimember LLC or a partner, self-employment income equals the amount reported on their Schedule K-1, less the deduction for 50% of self-employment tax claimed on their personal income tax return.
If you’re an employee of your own corporation, it can establish a SEP and make an annual deductible contribution of up to 25% of your salary. The contribution is a tax-free fringe benefit and is, therefore, excluded from your taxable income.
For 2016, the maximum contribution to a SEP account is $53,000. For 2017, the maximum contribution is $54,000. However, there’s no requirement to contribute anything for a particular year. So when cash is tight, a small amount can be contributed or nothing at all.
As with most other tax-advantaged retirement plans, assets in a SEP can grow tax-deferred, with no tax liability until withdrawals are made. Early withdrawals (before age 59½) are generally subject to a 10% penalty, in addition to income tax. Certain minimum distributions are generally required beginning after age 70½.
Setting Up Your Plan
A SEP is fairly simple to set up, especially for a one-person business. Your financial advisors can help you complete the required paperwork in just a few minutes. A key benefit of SEPs is that you can establish your plan as late as the extended due date of the return for the year in which you claim a deduction for your initial SEP contribution.
For example, say your business is a sole proprietorship or a single-member LLC that’s treated as a sole proprietorship for tax purposes. If you establish a SEP and make your initial SEP contribution by April 18, 2017 — the deadline for filing your 2016 federal income tax return — you can deduct the contribution on your 2016 tax return.
Important note: If you extend your 2016 return, you have until October 16, 2017, to set up the plan and make a deductible 2016 contribution.
SEPs can be a smart way for many small businesses to save tax. You still have time to retroactively set up a SEP for the 2016 tax year and make a contribution that can be deducted on your 2016 return. If you have questions or want more information about SEPs and other small-business retirement plan options, contact your tax or financial advisor.
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Brought to you by: McClanathan, Burg & Associates, LLC