Inherited IRA Situation - Daughter Dies, Then Dad Dies, Then Mom Dies

Posted by James M. Carlson
Apr 21 2016

Jane Martin was age 37 in 2012 when she died. At the time she had an IRA with ABC Bank with a balance of $70,000. Her IRA account balance was due to a 401(k) rollover made in 2008 plus she had made a number of annual contributions. She had designated her dad, Tom Doe, to receive 50% of her IRA and her mom, Karen Doe, to receive the other 50%. Tom’s date of birth was June 10, 1944 and Karen Doe’s date of birth was December 15, 1950.

ABC Bank established on its computer systems two inherited IRA as follows: (“Tom Doe as beneficiary of Jane Martin’s traditional IRA”) and (“Karen Doe as beneficiary of Jane Martin’s traditional IRA.’)’

Tom designated his wife, Jane, to be the beneficiary of his inherited IRA (“Tom Doe as beneficiary of Jane Martin’s traditional IRA”) and she designated Tom to be the beneficiary of her inherited IRA (“Karen Doe as beneficiary of Jane Martin’s traditional IRA”).

With respect to Tom’s inherited IRA, required distributions were made to him for 2013, 2014 and 2015. Tom recently died on March 13, 2016. He had not taken his 2016 RMD prior to his death.

Since he was age 69 in 2013, the initial divisor for the RMD calculation for his inherited IRA was 17.8 and the schedule to be used was:

2013 17.8

2014 16.8

2015 15.8

2016 Tom died 14.8

2017 13.8

2018 12.8

etc.

With respect to Karen’s inherited IRA, required distributions were made to Karen for 2013, 2014 and 2015. Since she was age 63 in 2013, the initial divisor for the RMD calculation for her inherited IRA was 22.7 and the schedule to be used was:

2013 22.7

2014 21.7

2015 20.7

2016 19.7

2017 18.7

2018 17.7

etc.

With Tom’s passing, Karen now has two inherited IRAs. The one she inherited from her daughter (“Karen Doe as beneficiary of Jane Martin’s traditional IRA”) and the one she inherited from Tom. Although we at CWF have some doubts, the IRS instructions are to title this inherited IRA, “Karen Doe as beneficiary of Tom Doe’s IRA.”

Technically, these two inherited IRAs are not like-kind IRAs for purposes of applying the RMD aggregation rule since the IRAs were inherited from different people.

What RMDs need to be distributed for 2016 to Karen? She needs to be paid Tom’s RMD as calculated for her second inherited IRA as he had not taken it and she will need to take the RMD as calculated for her first inherited IRA (“Karen Doe as beneficiary of Jane Martin’s traditional IRA”)

What about the RMDs for 2017 and subsequent years? The most conservative approach for Karen is to continue to maintain two separate inherited IRAs and to take two required distributions. She would wish to designate a “new” beneficiary for each inherited IRA. As Jane had a brother, Mark Doe, Karen now designates Mark to be the beneficiary of these two inherited IRAs.

From a practical standpoint, Karen may wish to maintain only one inherited IRA. She would combine the two inherited IRAs since both had originated from her daughter’s IRA. The title should be, (“Karen Doe as beneficiary of Tom Doe’s IRA.”) The use of only one of the RMD schedules (the one requiring the larger distribution) would mean she would be withdrawing more than her true RMD amounts, but she may find maintaining only one inherited IRA worthwhile.

Upon Karen’s death, the new inherited IRA would be titled, (“Mark Doe as beneficiary of Karen Doe’s inherited IRA.”) Mark would continue use the divisor schedule being used by Karen. Current rules require the RMD divisor schedule applying to the “first” beneficiary will apply to all subsequent beneficiaries. There is no recalculation for any subsequent beneficiary.

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No Form 1099-R Prepared to Report IRA Funds Moving From the Decedent’s IRA to an Inherited IRA

Posted by James M. Carlson
Apr 21 2016

Some mainframe software vendors just don’t understand the IRS procedures for reporting once an IRA accountholder dies. These mainframe software writers have incorrectly adopted the approach that the Form 1099-R is to be prepared when an inherited IRA is being established.

A Form 1099-R is prepared only if there is a reportable distribution. Establishing an inherited IRA involves transferring the IRA funds from the decedent’s IRA to one or more inherited IRAs. Such transfers are not to be reported on the Form 1099-R.

Preparing a Form 1099-R which is not required to be prepared is an incorrect form and will result in penalty. The penalty is now $250 (times 2) if an IRA custodian submits an incorrect Form 1099-R

It may not be the best way, but the IRS has the IRA custodian complete the Form 5498 in a special way to inform the IRS that the decedent’s IRA funds have moved to an inherited IRA for one or more beneficiaries. Using the title, “John Doe as beneficiary of Jane Doe,” informs the IRS that funds have been moved from Jane Doe’s IRA into a inherited IRA for John Doe. The Form 1099-R is not used for this purpose.

The software vendor is causing real problems for the individual if it prepares an incorrect Form 1099-R as he or she must explain the distribution on his or her tax return. A non-spouse beneficiary is unable to rollover a distribution from an inherited IRA Putting a 0.00 in box 2a does not make things better.

Categories: Traditional IRAs

IRS Biased Against Inherited Roth IRAs

Posted by James M. Carlson
Apr 20 2016

The IRS should not be biased against inherited Roth IRAs, but the IRS is. Some IRS administrations are more biased against inherited Roth IRAs than others.

The IRS does not like the fact that a person may inherit a Roth IRA and earn tax-free income over the beneficiary’s life expectancy. This will be accomplished if the beneficiary limits his or her distributions to the required amount each year using the life distribution rule. This will not be accomplished if the 5-year rule is used.

The IRS last revised model Form 5305-RA in March of 2002. In Article V it is clearly stated that a beneficiary will use the life distribution rule to comply with the required distribution rules unless he or she elects the 5-year rule. The 5-year rule applies automatically if there is no designated beneficiary (e.g. the estate is the beneficiary).

Article V

1. If the depositor dies before his or her entire interest is distributed to him or her and the depositor’s surviving spouse is not the designated beneficiary, the remaining interest will be distributed in accordance with (a) below or, if elected or there is no designated beneficiary, in accordance

with (b) below:

(a) The remaining interest will be distributed, starting by the end of the calendar year following the year of the depositor’s death, over the designated beneficiary’s remaining life expectancy as determined in the year following the death of the depositor.

(b) The remaining interest will be distributed by the end of the calendar year containing the fifth anniversary of the depositor’s death.

The IRS in Publication 590-B (Distributions from IRAs), page 36, gives murky guidance discussing distributions after the Roth IRA owner’s death. “Generally, the entire interest in the Roth IRA must be distributed by the end of the fifth calendar after the year of the owner’s death unless the interest is payable to a designated beneficiary over the life or life expectancy of the designated beneficiary.” The IRS could and should be informing a Roth IRA beneficiary that if he or she elects to use the 5-year rule that one loses the right to earn tax-free income and therefore most beneficiaries should use the life distribution rule.

In recent years the IRS has adopted rules and procedures to be more fair and transparent. At times the IRS has a great conflict of interest and should make this known. The IRS should revise its discussion of inherited Roth IRAs to not try to induce a beneficiary to use the 5-year rule.

Categories: Roth IRAs

CWF Reminder - 4/30/16 is Deadline to Update Certain Old Keogh and Profit Sharing Plans

Posted by James M. Carlson
Mar 31 2016

Any old Keoghs or old profit sharing plans sitting in any files? Forgotten gems or forgotten liabilities?

Substantial tax benefits are realized by sponsoring businesses and participants of qualified profit sharing plans and 401(k) plans. In order to gain such tax benefits such plans must be amended and restated on a timely basis.

April 30, 2016 is the deadline for most defined contribution plans to be amended and restated. If a plan has been updated within the last 1-20 months, it should be in compliance. If it has not been updated, it should be by April 30th, 2016.

CWF has been a prototype plan submitter since 1984. Contact us if your institution or any of your business clients would benefit by using a CWF document to amend and restate its retirement plan. The consequences of missing this deadline means an employer will have to pay substantially higher fees to bring the plan into compliance. The IRS may argue the plan is no longer qualified and the funds are deemed distributed and taxable.

The IRS has always taken the tax position that a distribution in any pension plan is eligible to be rolled over or directly rolled over to any type of IRA or other plan only if the plan is "qualified" at the time of the distribution. To be qualified at the time of distribution the plan document must set forth the current laws. Thus, the need to amend and restate the plan.

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Understanding What Forms Are Needed To Establish a SEP-IRA

Posted by James M. Carlson
Mar 01 2016

Jane Smith wishes to make a SEP-IRA contribution for herself. Jane is a self-employed horse rider/exerciser. She had a good year and so she wants to establish a SEP and then make a $26,000 contribution to her SEP-IRA for tax year 2015.

What forms will she need to prepare?

First, as an employer (a one person busines s), she must establish her Simplified Employee Pension Plan (SEP). She will do so by completing and signing the IRS model form 5035-SEP. Note that she signs the form as the “employer.” The financial institution does not sign this form. Jane will either obtain this form from her accountant, attorney, financial institution or she will find it on-line at the IRS website, www.irs.gov.

Second, as the employer, she will write a business check for the amount of $26,000 and she will contribute it to her SEP-IRA. A SEP- IRA is established by a person establishing a standard traditional IRA (IRS model form 5305) and then making a SEP-IRA contribution to it. For 2015 she is permitted to make a SEP-IRA contribution equal to the lesser of 25% of her adjusted business earnings or $53,000.

We recently had a call from an IRA representative where the IRA software system her bank was using did not make this clear. The system gave the idea that the only form needed was the Form 5305-SEP. The system did not make it clear that the individual either needed to have an existing IRA into which the SEP-IRA contribution would be contributed or a new SEP- IRA must be established. Both forms are needed and so hopefully the vendor wil change its system once it is advised that a clarification is needed.

IRS statistics show that annual SEP-IRA contributions exceed those of annual traditional IRA contributions. A financial institution will benefit by communicating with its business customers about the benefits of SEP-IRAs. The tax laws do not require a person who has an existing traditional IRA to set up a new SEP-IRA. Some financial institutions choose for administrative reasons to require a separate IRA, but the tax laws do not require it. If any employee would fail to have a SEP-IRA so the business did not make a SEP contribution for such employee, there would be no SEP and the expected tax benefits would not apply for the spons oring business and other employees.

In summary, establishing a SEP is easy as long as the two steps above are completed for a one person business and the three steps are completed for a business with employees.

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SEPs The Last-Minute Retirement Plan and Tax Deduction

Posted by James M. Carlson
Mar 01 2016

Definitions

SEP — SEP is the acronym for Simplified Employee Pension plan. In order to have a SEP, two requirements must be met. First, an employer must sign a SEP plan document which may be: (1) the IRS model Form 5305-SEP; (2) a SEP prototype; or (3) a SEP plan as written specifically for that employer by an attorney. The employer may be a gigantic corporation or a self employed person. Second, all eligible employees must establish (or have established for them) a SEP-IRA.

SEP-IRA — A SEP-IRA is a standard, traditional IRA established with a financial institution to which an employer has made a SEP-IRA contribution. The IRA custodian is required to report SEP-IRA contributions in box 8 on Form 5498. In all other respects, the standard, traditional IRA rules will apply to administering SEP-IRAs. Contributions to SEP-IRAs are always owned by the employee, once the funds have been contributed to the employee’s SEP-IRA.

Discussion
SEP plans may be established and funded by the normal tax deadline, plus extensions. A person may come into your institution in July of 2016, and make a SEP contribution of $53,000, for tax year 2015. If an individual has the proper extension(s) a SEP contribution may be made as late as October 15 of 2016, for tax year 2015.

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IRS Increases Filing Fees For Waiver of 60-Day Rollover Rule To $10,000

Posted by James M. Carlson
Feb 16 2016

The IRS has increased the filing fee for a person to request the IRS to waive the 60-day rollover period and grant the person a new 60-day rollover period. Since 2001/2002 the tax law has provided that the IRS may waive the 60-day requirement where the failure to waive such requirement would be against equity or good conscience, including casualty, disaster, or other events beyond the reasonable control of the individual.

The chart below compares the fees for 2015 with those for 2016. Category number #4 for 2016 encompasses the 2015 categories #4-#10 for 2015. The filing fee is $10,000 for any one in category #4.

In 2015 the filing fee to request a 60 rollover waiver was $500, $1,500 or $3,000. If it is now $10,000, there will be very few taxpayers where it will make financial sense to seek a waiver. An individual who has a good reason they missed the 60-day period will need to consider hiring a tax attorney to sue the IRS in U.S. Tax Court. This IRS change is going to create real dilemmas for IRA custodians as much more work will be involved in getting the IRS to waive the initial 60-day period.

One would think it was near impossible that the IRS would increase the filing fees with respect to a person’s request of the IRS to waive the 60-day rollover rule to $10,000 form $500, $1,500 or $3000 for an equity waiver situation, but the IRS is warring with the Republican controlled Congress and the new $10,000 filing fee is correct. The IRS has adopted this policy to spite the U.S. Congress.

Note that the IRS chart contains good news for those non-bank financial entities wishing to qualify as a non-bank trustee. The fee decreases from $20,000 to $10,000.

Also note the fee for requesting special treatment on a missed Roth IRA recharacterization increases from $4,000 to $10,000.

 

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Obama Administration Again Proposes Taxing Some Roth IRA Distributions And Other Law Changes

Posted by James M. Carlson
Feb 01 2016

Below is a summary of the President’s fiscal year 2017 budget proposal for IRA and pension law changes. Unsurprisingly, the proposals seek to reduce the tax benefits realized by individuals with higher incomes.

  1. The law will “cap” the tax benefit (exclusion or tax deduction) that a person may receive from an IRA, 401(k) or other tax preferred plan at the 28% bracket. That is, those individuals in a higher tax bracket (33%, 35%, 39.6%, etc) would not be able to claim a tax deduction for the full amount or claim a full tax exclusion. This is the first proposal or discussion making some Roth IRA distributions taxable. New for 2016
  2. The standard RMD rules would apply to a person who had funds within a Roth IRA in the same manner as they know apply to funds within a traditional IRA, SEP-IRA and SIMPLE IRA. This change does not generate any additional tax revenues, but is being made to lower the amounts in Roth IRAs earning tax free income. Proposed in 2015. This change would only apply to those Roth IRA accountholders who attain age 70½ in 2016 or later
  3. Required distributions would no longer apply to individuals who had an aggregated balance of less than $100,000 in IRAS, 401(k)’s and other retirement accounts. A special rule would apply in the case of certain defined benefit plans. Proposed in 2015
  4. A person who has after-tax dollars in an IRA or pension plan would lose the right to convert such dollars into a Roth IRA. That is, a person will be eligible to convert only “taxable” funds, he or she could not convert after-tax funds. New for 2016.
  5. Require most non-spouse beneficiaries to take required distributions using the 5-year Rule. The life distribution rule no longer could be used. This is a large revenue raiser and it raises greatly the taxes to be paid by non-spouse beneficiaries. This change would only apply if the IRA accountholder died on or after January 1, 2017
  6. The proposed law will “cap” the amount of funds a person may accumulate within tax preferred plans. This was also proposed in the 2015 budget proposal. The person would be required to aggregate the balance he or she has within personal IRAs with the balance within all employer sponsored retirement plans. Once a certain limit is reached, then no additional contributions could be made by the individual or by the individual’s employer on his or her behalf. The account balance could grow if due to earnings, but not on account of new contributions. The law would permit a person to accumulate an initial balance of $3,400,000 as that is the actuarial equivalent of a joint and 100% survivor annuity of $210,000 per year. The $210,000 limit would be adjusted for cost of living increases.CWF Observation. This proposal would greatly complicate the administration of IRAs and pension plans. There would be a tremendous increase in the need for actuarial and accounting services. It may well be an employee would need to inform his/her current employer what he/she has accumulated in his/her IRAs and other pension plans.
  7. The proposed law would allow certain non-spouse beneficiaries who mistakenly are paid a distribution from an inherited to roll over such distribution if certain rules are met. This was also proposed in the 2015 proposal
  8. The 401(k) plan rules would be changed so that an employer would have to let those employees working 500-999 hours per year for three consecutive years to be able to make elective deferral contributions. Under current law, an employer is not required allow employees who work less than 1,000 hours to participate in the plan. Although the employer would have to let such employees make elective deferral, the employer would not be required to make any contributions, matching or profit sharing, on behalf of such employees
  9. The IRS and the DOL are big fans of automatic enrollment pension plans. Under current law an employer’s decision to sponsor a pension or profit sharing plan is totally voluntary. Many small and moderate size employers choose to not offer a plan due to the regulatory complexity. The IRS and the DOL don’t seem to accept why so many employers choose to not offer such plans. Their solution, change the law so an employer must offer a simplified retirement plan. An employer with more than 10 employees which has been in business for at least two years would be required to offer a payroll deduction IRA program. Employees would automatically be enrolled to have 3% of compensation withheld unless they expressly waived coverage. An employee could have a larger percentage withheld. Funds could go into either a traditional IRA or a Roth IRA. To offset some of the cost for maintaining this plan there would various tax credits extended to the small employers
  10. The current tax rules applying to the taxation of net unrealized appreciation would be repealed. The general tax rule is, when a person takes a distribution from his or her IRA or 401(k) plan, such amount is combined with other wage or ordinary income for such year and taxed at the applicable marginal income tax bracket. Many times a person will move into a higher tax bracket on account of the IRA/401(k) distribution. Current law allows an employee who has been distributed employer stock to be taxed differently. He or she will include the cost basis of the stock in his or her income for the year of distribution, but is able to defer further taxation to when the stock is subsequently sold. There is no time limit by when the individual must sell the stock. It may be the government won’t see any tax revenues for 20-50 years. Example. Jane works for ABC, Inc from ages 22-38. Her employer has a profit sharing which invests in employer stock. The corporation has been very successful. The corporation contributes stock which at the time contributed had a cost basis of $45,000, but has a value of $450,000 when distributed to her. Although she has various options, she elects to have the stock distributed to her inkind. Under this method she includes the $45,000 in her income and pays tax on such amount. Now assume the stock appreciates to $600,000 and she then decides to sell the stock. She would have $555,000 of long term gain and it would be taxed at a rate of 28% under current law. That is, she will not pay any tax on the stock appreciation until she sells the stock. And at that time she will most likely qualify to pay tax at then existing capital gain rates on the stock gain. The current tax rate is 28% but there were times during 2009-2012 when the tax rate was 10%, 15% or 20%. This change would not apply to a person who was age 50 or older as of 12/31/15.
  11. The current tax laws allowing a publicly traded company to claim a tax deduction for dividends paid with respect to stock held in an ESOP would be repealed. Most of the above proposals have little chance of being enacted as the Republicans for the time being control Congress. The purpose of this article is, the politicians will certainly be discussing many of these same IRA and pension topics with some modifications. CWF believes it is only a matter of time before the law is changed to reduce the distribution period applying to an inheriting IRA beneficiary. The reason, the life expectancy approach means there is too long of a time of tax deferral and the government is waiting too long time to receive the tax payments associated with these tax-deferred funds. Tax laws should be reasonable, but what one person thinks is reasonable another person does not. Compromises will be made.

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New SIMPLE-IRA Rollover and Transfer Rules

Posted by James M. Carlson
Jan 26 2016

The tax laws for rolling over or transferring funds into a SIMPLE-IRA changed as of December 18, 2015. A person who is a SIMPLE-IRA participant, whose employer first made a SIMPLE-IRA contribution more than 2 years ago and who is eligible for a 401(k) distribution is now authorized to take a distribution from the 401(k) plan and directly rollover or rollover such funds into the SIMPLE-IRA.

The tax rules now also authorize an individual to take a distribution from his or her traditional IRA or SEP-IRA and to transfer or rollover such funds into his or her SIMPLE-IRA. The individual must have met the 2 year rule applying to the SIMPLE-IRA plan. Presently you may have some customers who have both a traditional IRA and a SIMPLE-IRA because the tax laws required this prior to December 18, 2015. No longer, if the individual has met the two year rule, then the traditional IRA funds may be merged into the SIMPLE-IRA.

This law change means an IRA custodian should be using updated rollover, transfer, and SIMPLE-IRA plan agreement forms. SIMPLE-IRA amendments should be furnished. We expect (and hope) the IRS will soon be revising its model SIMPLE-IRA Forms (5305-S and 5305-SA) as these forms expressly provide that it is impermissible to contribute funds to a SIMPLE-IRA arising from a traditional IRA or a 401(k) plan. Until then, an amendment should be added to such forms authorizing such rollover, direct rollover and transfer contributions.

The IRS has revised its IRA Rollover Chart showing the new rollovers applying to SIMPLE-IRAs.

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New SIMPLE-IRA Rollover and Transfer Rules

Roth IRA funds are only eligible to be rolled over to another Roth IRA. They are ineligible to be rolled over to any other type of IRA or any qualified plan, 403(b) plan or governmental 457(b) plan, including a Designated Roth account.

  1. The once per year rollover rule applies when there is a distribution from a traditional IRA, SEP-IRA, SIMPLE-IRA or Roth IRA distribution which is rolled over to a traditional, SEP IRA, SIMPLE-IRA or Roth IRA. It does not apply to distributions from any non-IRA plan. It does not apply to distributions from a traditional IRA, SEP IRA or SIMPLE-IRA which is rolled over to a qualified plan, 403(b) plan or governmental 457(b) plan
  2. Funds within any non-SIMPLE-IRA or any plan are now eligible to be rolled over into a SIMPLE-IRA if the 2-year requirement has been met
  3. SIMPLE-IRA funds may be distributed and rolled over into any other type of plan only if such rollover occurs after the 2-year holding requirement has been satisfied.
  4. Funds within any of the 4 types of IRAs are ineligible to be rolled over in a Designated Roth account within a 401 (k) , 403 (b) or 457 (b) plan.
  5. Funds within a qualified plan, 403(b) plan or governmental 457 plan may be rolled into a Designated Roth account within a 401(k), 403b) or section 457b only if done as an in-plan rollover. Such distribution amount is includible in income.
  6. Designated Roth funds may be distributed and rolled over into a Roth IRA or they may be transferred into a Designated Roth account within a different plan. That is, Designated Roth funds cannot be withdrawn and then rolled over by the participant. Observe that there are some special rollovers not discussed by the IRS chart.

    a. IRA to HSA direct rollovers
    b. Direct rollovers by both spouse beneficiaries and non-spouse beneficiaries.

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Understanding What Forms Are Needed To Establish a SEP-IRA

Posted by James M. Carlson
Jan 14 2016

Jane Smith wishes to make a SEP-IRA contribution for herself. Jane is a self-employed horse rider/exerciser. She had a good year and so she wants to establish a SEP and then make a $26,000 contribution to her SEP-IRA for tax year 2015.

What forms will she need to prepare?

First, as an employer (a one person business), she must establish her Simplified Employee Pension Plan (SEP). She will do so by completing and signing the IRS model form 5035-SEP. Note that she signs the form as the “employer.” The financial institution does not sign this form. Jane will either obtain this form from her accountant, attorney, financial institution or she will find it on-line at the IRS website, www.irs.gov.

Second, as the employer, she will write a business check for the amount of $26,000 and she will contribute it to her SEP-IRA. A SEP- IRA is established by a person establishing a standard traditional IRA (IRS model form 5305) and then making a SEP-IRA contribution to it. For 2015 she is permitted to make a SEP-IRA contribution equal to the lesser of 25% of her adjusted business earnings or $53,000.

We recently had a call from an IRA representative where the IRA software system her bank was using did not make this clear. The system gave the idea that the only form needed was the Form 5305-SEP. The system did not make it clear that the individual either needed to have an existing IRA into which the SEP-IRA contribution would be contributed or a new SEP-IRA must be established. Both forms are needed and so hopefully the vendor will change its system once it is advised that a clarification is needed.

IRS statistics show that annual SEP-IRA contributions exceed those of annual traditional IRA contributions. A financial institution will benefit by communicating with its business customers about the benefits of SEP-IRAs. The tax laws do not require a person who has an existing traditional IRA to set up a new SEP-IRA. Some financial institutions choose for administrative reasons to require a separate IRA, but the tax laws do not require it. If any employee would fail to have a SEP-IRA so the business did not make a SEP contribution for such employee, there would be no SEP and the expected tax benefits would not apply for the sponsoring business and other employees.

In summary, establishing a SEP is easy as long as the two steps above are completed for a one person business and the three steps are completed for a business with employees.

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