Excess contributions have been discovered for an SEP plan. There has been no Form 5329 completed for any prior years. The questions I have are:
1. Are there any penalties that will exist?
2. How should I correct this?
3. How many years must I go back to adjust?
Full Version: Excess contributions to SEP
1. Are there any penalties that will exist?
10% excise tax on employer.
6% excise tax on emploee.
Both are cumulative.
File amended corporate returns with Form 5330 attached (wait for notice of interest and penalties).
If SASEP, there may be additional penalties (and possible loss of tax santioned status) for failure to provide notices depending upon the type(s) of excesses.
2. How should I correct this?
Report excesses on amended W-2s (as "wages").
Employees contact sponsor to remove "excesses" (with gain for 2007 contributions returned before due date).
Letter from employer will be helpful to employees in getting excesses removed from IRA.
Employees may have to file amended returns.
3. How many years must I go back to adjust?
The employer should fix all years (because amounts must be removed). In general, S of L not expired because form 5329 reporting these excesses never filed.
Other methods that would allow excesses to remain in plan are available under the EPCRS. The 10% charge under the EPCRS for retaining excess does not generally apply. Both approaches must be analyzed (carefully) to determine which fix (Code or EPCRS) is better (and for which employees) and whether current year (2007) should be part of an EPCRS submission. See Rev.Proc. 2006-27, Section 6.10(5).
SEPs are very unforgiving!
Hope this helps.
10% excise tax on employer.
6% excise tax on emploee.
Both are cumulative.
File amended corporate returns with Form 5330 attached (wait for notice of interest and penalties).
If SASEP, there may be additional penalties (and possible loss of tax santioned status) for failure to provide notices depending upon the type(s) of excesses.
2. How should I correct this?
Report excesses on amended W-2s (as "wages").
Employees contact sponsor to remove "excesses" (with gain for 2007 contributions returned before due date).
Letter from employer will be helpful to employees in getting excesses removed from IRA.
Employees may have to file amended returns.
3. How many years must I go back to adjust?
The employer should fix all years (because amounts must be removed). In general, S of L not expired because form 5329 reporting these excesses never filed.
Other methods that would allow excesses to remain in plan are available under the EPCRS. The 10% charge under the EPCRS for retaining excess does not generally apply. Both approaches must be analyzed (carefully) to determine which fix (Code or EPCRS) is better (and for which employees) and whether current year (2007) should be part of an EPCRS submission. See Rev.Proc. 2006-27, Section 6.10(5).
SEPs are very unforgiving!
Hope this helps.
I'm trying to help a client out with a similar issue. Are the rules any different if the employer is a sole proprietor?
Thanks Gary!
Thanks Gary!
No. The rules are what they are. The only difference with the entity being a sole proprietor is how the 'earned income' of the owner is determined. Instead of W-2, you are using Schedule C (after it has been reduced by 1/2 the SE tax). In addition to this, the owner's 'earned income' if further reduced by the actual contributions made into the SEP (for the owner).
For simplicity, we will assume 1 owner and no employees. Schedule C (after reduction for SE tax) is $230,000. The owner makes a contributon to the SEP of $46,000. His earned income is reduced from $230,000 to $184,000. That $46,000 contribution is actually 25% of the $184,000 in earned income of the owner. He is at his limit.
Had the owner been incorporated with $230,000 of W-2, then the $46,000 contribution would amount to only 20% of his salary.
Everything else for the SEP remains consistent, regardless of how the entity is taxed.
Hope this helps address your question.
For simplicity, we will assume 1 owner and no employees. Schedule C (after reduction for SE tax) is $230,000. The owner makes a contributon to the SEP of $46,000. His earned income is reduced from $230,000 to $184,000. That $46,000 contribution is actually 25% of the $184,000 in earned income of the owner. He is at his limit.
Had the owner been incorporated with $230,000 of W-2, then the $46,000 contribution would amount to only 20% of his salary.
Everything else for the SEP remains consistent, regardless of how the entity is taxed.
Hope this helps address your question.
QUOTE (Gary Lesser @ Mar 17 2008, 09:31 AM) 
1. Are there any penalties that will exist?
10% excise tax on employer.
6% excise tax on emploee.
Both are cumulative.
File amended corporate returns with Form 5330 attached (wait for notice of interest and penalties).
If SASEP, there may be additional penalties (and possible loss of tax santioned status) for failure to provide notices depending upon the type(s) of excesses.
2. How should I correct this?
Report excesses on amended W-2s (as "wages").
Employees contact sponsor to remove "excesses" (with gain for 2007 contributions returned before due date).
Letter from employer will be helpful to employees in getting excesses removed from IRA.
Employees may have to file amended returns.
3. How many years must I go back to adjust?
The employer should fix all years (because amounts must be removed). In general, S of L not expired because form 5329 reporting these excesses never filed.
Other methods that would allow excesses to remain in plan are available under the EPCRS. The 10% charge under the EPCRS for retaining excess does not generally apply. Both approaches must be analyzed (carefully) to determine which fix (Code or EPCRS) is better (and for which employees) and whether current year (2007) should be part of an EPCRS submission. See Rev.Proc. 2006-27, Section 6.10(5).
SEPs are very unforgiving!
Hope this helps.
10% excise tax on employer.
6% excise tax on emploee.
Both are cumulative.
File amended corporate returns with Form 5330 attached (wait for notice of interest and penalties).
If SASEP, there may be additional penalties (and possible loss of tax santioned status) for failure to provide notices depending upon the type(s) of excesses.
2. How should I correct this?
Report excesses on amended W-2s (as "wages").
Employees contact sponsor to remove "excesses" (with gain for 2007 contributions returned before due date).
Letter from employer will be helpful to employees in getting excesses removed from IRA.
Employees may have to file amended returns.
3. How many years must I go back to adjust?
The employer should fix all years (because amounts must be removed). In general, S of L not expired because form 5329 reporting these excesses never filed.
Other methods that would allow excesses to remain in plan are available under the EPCRS. The 10% charge under the EPCRS for retaining excess does not generally apply. Both approaches must be analyzed (carefully) to determine which fix (Code or EPCRS) is better (and for which employees) and whether current year (2007) should be part of an EPCRS submission. See Rev.Proc. 2006-27, Section 6.10(5).
SEPs are very unforgiving!
Hope this helps.
Gary
Thanks for the enlightening reply. A couple of other questions.
1. Doesn't the employer have until Oct 15 of the year following the year for which excess contributions have been made to make a corrective withdrawal and avoid the penalty (although this amount would be includable as ordinary income to the employee and a possible 10% penalty on the earnings to the employee if < 59.5?
2. If not a SARSEP, why would the employee be subject to a 6% penalty? The employee didn't have anything to do with the making of the contribution.
3. We're only talking about the excess....correct? This would not impact the contribution that are within the contribution maximums, wouldn't it?
3. Somewhat unrelated, but may an employer ever designate SEP contributions as after-tax?
Thanks
BruceM
1. Doesn't the employer have until Oct 15 of the year following the year for which excess contributions have been made to make a corrective withdrawal and avoid the penalty (although this amount would be includable as ordinary income to the employee and a possible 10% penalty on the earnings to the employee if < 59.5?
The trustee or custodian will not allow an employer to unilaterally remove funds from an IRA. Other rules apply under the EPCRS. By showing the exess on the W-2, the employer has done all it can do as far as a "correction" is and (arguably) is not subject to the 10% penalty on nondeductible contributions. A notice from the employer would help (see BruceC's response). If the "correction" is not made (generally amended W-2) by the due date for filing the return, the 10% penalty would seem to apply for that year.
2. If not a SARSEP, why would the employee be subject to a 6% penalty? The employee didn't have anything to do with the making of the contribution.
The excess is in the IRA. The penalt can be waived or reduced.
3. We're only talking about the excess....correct? This would not impact the contribution that are within the contribution maximums, wouldn't it?
Correct. However, special disqualification rules may apply if the 100%/$46,000 (for 2008) limits are exceeded.
3. Somewhat unrelated, but may an employer ever designate SEP contributions as after-tax?
No, all nonelective SEP contributions are pre-tax.
The trustee or custodian will not allow an employer to unilaterally remove funds from an IRA. Other rules apply under the EPCRS. By showing the exess on the W-2, the employer has done all it can do as far as a "correction" is and (arguably) is not subject to the 10% penalty on nondeductible contributions. A notice from the employer would help (see BruceC's response). If the "correction" is not made (generally amended W-2) by the due date for filing the return, the 10% penalty would seem to apply for that year.
2. If not a SARSEP, why would the employee be subject to a 6% penalty? The employee didn't have anything to do with the making of the contribution.
The excess is in the IRA. The penalt can be waived or reduced.
3. We're only talking about the excess....correct? This would not impact the contribution that are within the contribution maximums, wouldn't it?
Correct. However, special disqualification rules may apply if the 100%/$46,000 (for 2008) limits are exceeded.
3. Somewhat unrelated, but may an employer ever designate SEP contributions as after-tax?
No, all nonelective SEP contributions are pre-tax.
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