Wednesday, March 25, 2015
SEPs - The Last Minute Retirement Plan and Tax DeductionDefinitions
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 maybe 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.
SEP plans may be established and funded by the normal tax deadline, plus extensions. A person may come into your institution in July of 2015, and make a SEP contribution of $52,000, for tax year 2014. If an individual has the proper extension(s) a SEP contribution may be made as late as October 15 of 2015, for tax year 2014.
The Contribution Rules Applying to SEPs are Very Favorable
1. The maximum contribution for 2014 is the lesser of $52,000, or 25% of a person’s compensation. The limit for 2015 is $53,000.
2. The age 70½ eligibility rule that applies to traditional IRAs does not apply to SEP-IRAs. A farmer, age 74 and still farming and has net income, may still make contributions to their SEP-IRA. A corporation (and any other employer) is required to make a contribution for any employee age 70½ or older, as long as the employee has met the eligibility requirements. The age discrimination laws prohibit an employer from not making such contributions. An employee may not waive the contribution.
3. All contributions made to a SEP-IRA by an employer are employer contributions, and are reported in box8 of Form 5498. However, an individual is permitted to make his or her annual traditional IRA contribution to the same IRA to which a SEP contribution is made. Annual contributions are reported in box 1 on Form 5498. Such annual contributions mayor may not be deductible.
4. An employer is not required to make SEP IRA contributions each year. Contributions are also discretionary as to amount.
5. The contributions that an employer makes for its employees are deductible by the business entity on its tax return. A corporation will claim the deduction on Form 1120. A partnership will claim the deduction on Form 1065, and partners will be informed of their respective shares on Schedule K-1. A sole proprietor may deduct SEP contributions on his or her Schedule C for Form 1040.
6. Contributions by the employer to a person’s SEP-IRA are not taxed for income tax purposes, withholding purposes, social security income tax purposes, Medicare tax purposes, or federal unemployment income tax purposes.
7. There are special contribution rules for self-employed individuals. A self-employed individual does “deduct” his or her contribution amount to a SEP-IRA on Form 1040. That is, the amount contributed to the SEP-IRA is not excluded from income, as occurs for corporate employers. Since the maximum contribution is the lesser of 25% of compensation, or $51,000 for 2013, one must calculate the “compensation” for a self-employed individual. Compensation for a self-employed person is his or her net earnings from self-employment, as decreased by (1) the amount contributed to their SEP-IRA, and (2) 50% of his or her self-employment tax (the IRS has a special chart and formula to be used for this calculation).
8. An employer is required to provide each employee with an annual statement indicating the amount contributed to the employee’s SEP-IRA for the year. A self-employed person is not required to prepare a statement for himself.
Establishing a SEP for 2014
As with any tax procedure, there are certain actions that must be taken in order for any business, including a one person business, to establish a Simplified Employee Pension Plan (SEP). If not properly established, the expected tax benefits will not be realized.
What must be done by the business? First, there must be written plan agreement. Most businesses will choose to complete and execute the IRA model Form 5305-SEP, Simplified Employee Pension–Individual Retirement Accounts contribution Agreement.
A business may set up its SEP for a year (e.g. 2014) as late as the due date including extensions for the tax year. So, a business may establish a SEP for 2014 on October 15, 2015, if it has an extension for its 2014 tax return.
The maximum contribution for 2014 is the lesser of: 25% of a person’s qualifying compensation or $52,000.
The business must provide certain information to each employee, if any. If no employees, then this information is not furnished. If there are employees, in general, they will be furnished a copy of the Form 5305-SEP and its instructions.
What must be done by each individual?
Each eligible employee, including the individual who is the sole proprietor or sole shareholder, must establish a SEP-IRA. A SEP-IRA is a standard traditional IRA to which a SEP contribution has been or will be made. 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.
Seeking IRA Contributions by April 15, 2015
U.S. taxpayers are not taking advantage of IRAs as one would expect and hope. Many younger individuals have not grown up with IRAs being common. Many individuals do not understand that a person is able to contribute to both a traditional IRA and the 401(k) plan at work.
The IRS has recently released their tax data for tax year 2012. April 15th and the end of the 2014 tax year is close at hand. This is the deadline for contributions to a traditional IRA and a Roth IRA for 2014.The deadline for SEP-IRAs and SIMPLE-IRAs may be extended if a tax extension is in effect.
These 2012 IRA statistics show there is a substantial balance in IRAs (5.4 trillion dollars), with 86% of it (4.6 trillion) with-in traditional IRAs. This is primarily due to rollovers from 401(k) and other pension plans. These statistics also shows there should be larger "annual" IRA contributions. There were 198.6 million taxpayers for tax year 2012. 65.8 million individuals were covered by a pension plan and so they were active participants for IRA deduction purposes. There were 146.2 million taxpayers who were eligible to make either a traditional and/or Roth IRA contribution. Some individuals were only eligible to make non-deductible contributors. 80.4 million taxpayers were eligible to make deductible contributions as they had compensation and they were not covered by an employer sponsored pension plan. 11.3 million taxpayers made contributions to the four types of IRA assets set forth in Chart #1. $50.7 billion was contributed with 17.6 billion to Roth IRAs, 14.1 billion to traditional IRAs, 11.4 billion to SEP IRAs and 7.5 billion to SIMPLE IRAs. 135 million taxpayers were eligible to make an IRA contribution, but they chose not to do so. This number is much larger than it should be. The tax benefits of IRAs are substantial, but not so substantial that a large percentage of individuals make an IRA contribution.
As you would expect, the percentage of those individuals with higher incomes who make an IRA contribution is higher than the percentage applying to those with lesser incomes. But it is not as high as one would expect. For individuals who have adjusted gross incomes of $1 million or more, 413,157 out of a total of 718,895 are eligible to make a IRA contribution. Only 99,076 or 24% do so. In this day and age of financial planners one does wonder why the other 76% do not see the benefit to make an IRA contribution. For individuals who have adjusted gross incomes of $100,000 - $200,000, 21.7 million out of a total of 28.5 million are eligible to make a IRA contribution. Only 3.3 million or 15% do so. For individuals who have adjusted gross incomes of $50,000 - $75,000, 21.4 million out of a total of 28.7million are eligible to make a IRA contribution. Only 1.9million or 9% do so. It is 7.6% for those individuals with incomes between $40,000 - $50,000. It is 5.7% for those individuals with incomes between $30,000-$40,000. For individuals who have adjusted gross incomes of less than $30,000, 56.0 million out of a total of 78.0 million are eligible to make a IRA contribution. Only 1.3 million or 0.2% do so. Of the 11.3 million taxpayers who had IRA contributions, only 3.5 million were made by individuals who claimed a tax deduction on their personal tax return. Remember that the 5.5 million Roth IRA contributions are unable to claim a tax deduction for their contributions. A total of 1.6 million taxpayers had a SIMPLE IRA contribution. Only 97,000 taxpayers claimed a deduction on their tax returns. This means that 1.5 million contributions are made by a business on behalf of its employees. A total of .98 million taxpayers had a SEP-IRA contribution. 383.6 thousand taxpayers did claim a deduction on their tax return. This indicates that many one-person businesses have a SEP. However, small employers also will sponsor a SEP for their employees as the statistics show contributions being made for 600,000 employees. All IRA custodians want to service those individuals rolling over funds from 401(k) plans and other IRAs. Rollover contributions totaled 300 billion in 2012. The average rollover was $74,800. The average rollover into a Roth IRA was $18,000. Only 1.4% of rollovers went into a Roth IRA. This will certainly increase dramatically in future years as the law now permits individuals to rollover 401(k) funds directly into a Roth IRA. See the newsletter for an article discussing new IRS rules making it easier to rolling over basis into a Roth IRA. And individuals are increasing their Roth IRA conversions as 415,243 did a conversion which averaged $38,344. Under existing tax laws a person wants to maximize the amount he or she has in a Roth IRA. More people should be making IRA contributions than do. An excellent planning tool is not be used to the degree it should be. It is never too late to start making IRA contributions. Individuals should be making 401(k) contributions and IRA contributions and not just 401(k) contributions. During the next 45-75 days a financial institution should be seeking IRA/SEP/SIMPLE-IRA contributions and Roth IRA contributions.
The maximum IRA contribution limits for 2014 and 2015 is $5,500 if under age 50 and $6,500 if age 50 or older. The maximum SEP contribution for 2014 is $52,000 and $53,000 for 2015.