SEP-IRA for self-employed taxpayers and small business owners
By Cora M. Barnhart and Luis I. Ingles III, CPA • Bankrate.com

June 24, 1999 -- When you started your own business, establishing a retirement plan for you and your employees probably wasn't as urgent as surviving. Yet, once you reach a point where your business shows signs of stability and longevity, you may want to look for ways to reward your loyal employees. Establishing a retirement plan renews your commitment to the business and acknowledges the contributions of your employees.

Choosing a retirement plan can be an overwhelming chore. This tax tip discusses details of the simplest retirement plan for self-employed taxpayers and their employees: an simplified employee pension that is set up as an individual retirement account and known as a SEP-IRA. An example specifies the steps involved in calculating contributions.

Future tax tips will review other plans suitable for self-employed taxpayers and small business owners. These tips will help self-employed taxpayers and small business owners select the retirement plan most appropriate for their situation.

Ease of use is major advantage of the SEP
The SEP-IRA is the easiest plan to set up and maintain. You can establish a SEP-IRA if you earn self-employment income, regardless of whether you have employees. If you do have employees, you aren't required to offer them a SEP-IRA, even if you have one. Once you decide to offer your employees a SEP-IRA, any employee meeting the basic eligibility requirements can join. If maintained for more than one person, the pension plan becomes a group of IRAs. Contributions for any participant are deposited into a SEP-IRA in the name of that participant.

As in a standard IRA, the plan's earnings aren't taxed until withdrawn at retirement. All of the funds contributed to a participant's account immediately belong to that person. This means there is no mandatory minimum vesting period. In addition, the participant "guides" the investment. For example, if the contributions are invested in mutual funds, he can choose the fund(s) in which to invest his contribution.

A major appeal of a SEP-IRA is the lack of paperwork. If you are a self-employed taxpayer with no employees and wish to establish a plan for yourself, apply for an IRA account and designate it as a SEP-IRA. There is no annual reporting requirement for this type of IRA. If you are establishing a SEP-IRA for your employees, you must fill out Form 5305-SEP. While the plan for the employees doesn't require an annual tax return, each participant must receive a copy of the plan agreement and an annual report of contributions made to their account for the year.

Flexibility and timing of contributions
Another benefit of the SEP-IRA is the flexibility of contributions. You don't have to make annual contributions. But any contributions made must be based on a written formula and can't discriminate in favor of highly compensated employees. When you contribute, you must contribute to the SEP-IRAs of all participants who actually performed personal services during the year for which the contributions are made.

You are also allowed, unlike IRAs, to continue to contribute to your SEP-IRA after you reach age 70 ½, provided you still have earned income. Finally, the deadline for making contributions, as well as setting up the plan, is your tax return filing deadline, including extensions. This is a critical difference from the deadline for standard IRA contributions, which is fixed at April 15.

You can take advantage of the extended deadline to receive your tax refund before your contribution is due and use your refund to fund your SEP-IRA. Suppose you wish to fund your plan for 1999 but are experiencing cash flow problems. You know that you will receive a refund on your 1999 taxes. File an extension for your 1999 taxes so that you have until Aug. 15, 2000 to file. Filing an extension also means you have until Aug. 15, 2000 to fund your SEP-IRA for 1999. Now file your tax return on April 16, or as soon as possible after April 15. Unless a major snafu occurs with your return at the IRS processing center, you will receive your refund well before Aug. 15 and have this additional cash to fund your SEP.

The maximum contributions on behalf of each participant are:

1. For employees: 15 percent of an employee's wages, up to a maximum of $24,000
2. For self-employed taxpayers: 13.0435 percent of self-employment income, up to a maximum of $24,000

Contributions on behalf of your employees are deductible on your business tax form or schedule. Contributions on your behalf are deductible as an adjustment to gross income on your individual income tax return. Before computing contributions as a self-employed business owner, make sure you compute any self-employment tax due on the net earnings of your business because they will be reportable as personal earnings.

Computation of SEP contributions
Say that, in 1999, your business has a net profit, before computing and deducting any SEP-IRA contributions, of $75,000. You are reporting $50,000 in wages paid for the year. You decide that you would like to set up a SEP-IRA for 1999 and offer it to your employees. Assume that all of your employees are eligible to participate. You elect the maximum contribution for all employees as well as yourself. Your deductible contributions are $7,500 for your employees and $8,182 for you, computed as follows:

Your employees' contributions are 15 percent of $50,000, or $7,500.

Your contribution for yourself is calculate in four steps:
(This example assumes that all profit from your company is reportable as your personal income.)

Represent the figures above on Form 1040, the Individual Income Tax Return, as follows:

• Line 12: Business income or loss (Schedule C net income): $67,500
• Line 27: One-half of the self-employment tax: $4,769
• Line 29: SEP contribution: $8,182
• Line 50: Self-employment tax: $ 9,537

Conclusion
This tax tip introduces self-employed taxpayers to Simplified Employee Pension plans. The SEP-IRA is the easiest retirement plan for the self-employed taxpayer to maintain. It should appeal especially to small business owners who don't have a staff to handle the extra paperwork and record keeping required by other, more complex retirement plans. Are you an owner of a small business wishing to develop a retirement plan for yourself and your employees? Get your feet wet with a SEP-IRA before diving into one of the more complicated plans.

-- Posted June 24, 1999