Contributed by: CoryF, FreeTaxUSA Agent, Tax Pro
Please consult a Financial Institution for set-up instructions for your business SEP for a discussion on this complex subject. This article will cover the basic concept and example.
Simplified Employee Pension explanation
What options are available to save for my retirement when I am self-employed? The Simplified Employee Pension (SEP) is the easiest to set up and allows you to contribute to your own retirement and to any employees that you hire in your business activities. It is simple to set up and financial institutions can help with the arrangement and maintenance of each account or for yourself. The IRS has provided a simple official form that you can keep with your business records (do not file).
In this article, we will show a basic model and calculations to ensure that you understand the maximum contribution amounts possible based on your business profit.
Contribution Rate
SEP IRAs have contribution rates that are required to keep the benefits standard and applicable to the IRS and taxable deduction amount. More information and examples can be found in Publication 560 with specific worksheets for contribution rates (see page 40).
The IRS limits the maximum amount of contributions that can be invested in a SEP based on the compensation of the employee or, if you are the only owner, the net profit of the business. This example uses business net profit calculated with this basic formula:
Gross Receipts
-Total Expenses
-One half self-employment (SE) tax
= Net Profit used for calculating max contributions allowed
The maximum contribution allowed is 20% of this net profit.
There is another calculation that is based on 25% of the Profit after the one-half SE tax is figured. Both methods of calculation are accepted and produce the same amount of maximum contribution.
Example of basic SEP maximum contribution amount
For Example:
You are a Sole-Proprietor, and you figured out that you have a Profit of $30,000 after all expenses and before you funded your SEP.
30,000 Profit
- 2,119 ½ SE Tax
= 27,881 Amount to calculate the 20% maximum
$5,576 Maximum amount that can be contributed with this profit
You may contribute any amount to the SEP up to a maximum of $5,576 in this example.
Steps to show SEP Contribution in FreeTaxUSA
You enter the contribution by following this menu path:
Deductions/Credits > SEP contributions.
Please note that this page appears after you finish inputting your Schedule C. If you enter more contributions than this maximum, you will get an account level alert that you have entered more contributions than is allowed by the IRS.
Please consult a Financial Institution for any specifics when starting an SEP for the right options for yourself or your business.