SEP IRA

Archive for the ‘Contributions’ Category

Example:

A sole proprietor wishes to contribute 25% to a SEP for himself and his employees. His net earnings from Schedule C for 2004 are $105,000. The employee’s compensation and the SEP Contribution made by the employer on the employee’s behalf have already been reflected in net earnings. Assume a 25% desired Contribution rate. One-half of self-employment tax calculated on Form 1040 schedule SE and shown on line 30 of the Form 1040 is $6,856. Determine the maximum deduction for contributions on behalf of the sole proprietor as follows:

(4) Enter rate determined from the worksheet above (.25/1.25): 20.00%

(5) Net earnings: $105,000 (employee SEP contributions have been factored into this number, but not the sole proprietor’s Contribution).

(6) Enter the deduction for self-employment tax from line 30, Form 1040: $6,856.

(7) Subtract Step 6 from Step 5 and enter the result: $98,144.

(8) Multiply Step 7 by Step 4 and enter the result: $19,628.

(9) Enter the smaller of Step 8 or $41,000 in 2004: $19,628.

This is his maximum deductible Contribution. Enter the deduction on line 32, Form 1040. $19,628 Proof: $19,628/($98,144 -$19,628) = 25%.

To use the worksheet you will need net self-employment earnings (which is generally revenues less expenses including any contributions made to the SEP IRA or profit sharing plan (Keogh) on behalf of employees but not for the business owner), one-half of self-employment tax (shown on line 30 of the Form 1040), and the percentage Contribution desired (up to 25%).

Contribution/Deduction Worksheet

(1) Plan Contribution rate as a decimal up to a maximum of 25% (for example 25% would be .25).

(2) Rate from line 1 plus one (for example, .25 plus one would be 1.25).

(3) Self-employed rate as a decimal (divide line 1 by line 2) .25/1.25 = 20.00%.

(4) Enter Contribution rate as determined from line 3 as a decimal (.20).

(5) Enter earnings. Estimate or use actual amount from line 3, Schedule C-EZ, or line 31, Schedule C, line 36, Schedule F, or line 15a, Schedule K-1 (form 1065).

(6) Estimate or enter amount for “one half self-employment tax” shown on line 30, on IRS Form 1040.

(7) Subtract Step 6 from Step 5.

(8) Multiply Step 7 by Step 4.

(9) Enter the smaller of Step 8 or $42,000 $41,000 in 2004). This is the maximum deductible Contribution. Enter the deduction amount for the self-employed individual as an adjustment to income (AGI adjustment).

How does a self-employed individual calculate his/her SEP or profit sharing plan Contribution amount?

Note: IRS Publication 560 contains a worksheet to calculate a self-employed person’s maximum Contribution.

A sole proprietor’s or general partner’s allowable Contribution to a simplified employee pension (SEP IRA) or profit sharing plan (Keogh) is tax deductible. It is shown as an “adjustment to income” (AGI adjustment) on IRS Form 1040.

The Contribution limit, assuming no other retirement plans (such as a money purchase plan), is limited to the lesser of 25% of net “earnings” from self-employment (after certain adjustments) or $44,000.

If you have net earnings from self-employment before adjustments of $218,510 or more in 2005 ($213,310 for 2004) the maximum Contribution of $44,000.

To get a rough estimate of the Contribution limit at lower earnings levels, multiply net self-employment earnings (revenues less expenses) by 18% (the figure has been reduced by certain adjustments).

SEP IRAs and profit sharing plans are both defined Contribution plans and are subject to combined limits. The contributions to the SEP IRA plan or profit sharing plans or Keogh must be made by the tax filing due date including extensions for the year.

Incorporated Business:

To determine contributions for employees of incorporated businesses, including the salaried business owner, multiply the individual’s W-2 earnings by the Contribution rate of up to 25% (subject to maximum Contribution of $44,000 for 2006.

No special earnings adjustment is required for employees. For a precise calculation of the Contribution limits for unincorporated business owners, use the worksheet below.