Is a Simplified Employee Pension (SEP) IRA Tax Deductible?

Payments made to a Simplified Employee Pension (SEP) IRA are tax-deductible for employers, but there is an annual limit on contributions. SEP IRAs are funded solely by the employer using tax-deductible dollars. For 2021, an employer can contribute up to 25% of an employee’s compensation or $58,000, whichever is less, and in 2022 that amount rises to $61,000.

What Is a SEP IRA?

A SEP IRA is a type of traditional IRA available to self-employed individuals, freelancers, and small-business owners. Employees are not able to contribute to a SEP IRA that the company opens on their behalf. Contributions come solely from the employer, and they are not required to contribute every year.

When making SEP IRA contributions, employers are required to contribute an equal percentage of income for every employee. This applies to every employee who performed services during the year, even for employees who die or terminate employment before the contributions are made.

Additionally, business owners who start up a SEP may be eligible for a tax credit of up to $500 per year for the first three years that the SEP account is open.

What Is the Eligibility for an Employer’s SEP?

Once a business owner has set up a SEP IRA, they must include all eligible employees on the plan, which is defined as:

• Employees 21 or older, who
• Have worked for you for at least three of the past five years, and who
• Have earned at least $650 in income from your business for 2021 and 2022

An employer could lower eligibility thresholds, for example, by lowering the age or minimum service requirements. However, the eligibility requirements must apply to everyone equally.

For individuals who are not self-employed, the compensation used to determine SEP IRA contributions includes wages, salaries, fees for professional services, commissions and tips, fringe benefits, and bonuses. Compensation generally includes amounts deferred, at the employee’s election, under benefits plans such as 401(k) plans, 403(b) plans, SIMPLE IRAs, Section 457 plans, and Section 125 cafeteria plans.

Contribution Deadline and Withdrawals

The deadline for establishing a SEP IRA plan and making contributions is the filing deadline for the employer’s tax return, including extensions. Catch-up contributions are not allowed in SEP IRAs as they are made by individuals rather than employers.

SEP IRA contributions and earnings can be withdrawn at any time subject to the general limitations imposed on traditional IRAs. A withdrawal is taxable in the year received. If a participant makes a withdrawal before age 59½, a 10% additional tax generally applies. SEP IRA contributions and earnings may be rolled over tax-free to other IRAs and retirement plans after two years of participation.