Publication 560 - Retirement Plans For Small Business

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When To Deduct

Who can have a SARSEP? A SARSEP set

SIMPLE IRA plan.

up before 1997 is available to you and your

Contributions

eligible employees only if all the following re-

Overall limit on SEP contributions. If you

quirements are met.

When you can deduct contributions made for a

also make nonelective contributions to a

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year depends on the tax year on which the SEP

SEP-IRA, the total of the nonelective and elec-

At least 50% of your employees eligible to

is maintained.

tive contributions to that SEP-IRA cannot ex-

participate choose the salary reduction ar-

ceed the lesser of 15% of the employee’s

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rangement.

If the SEP is maintained on a calendar

compensation or $35,000 ($40,000 for 2002).

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year basis, you deduct contributions made

You have 25 or fewer employees who

The same rule applies to contributions you make

for a year on your tax return for the year

were eligible to participate in the SEP (or

to your own SEP-IRA. See Contribution Limits,

with or within which the calendar year

would have been eligible to participate if

earlier.

you had maintained a SEP) at any time

ends.

during the preceding year.

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Employee compensation. For figuring the

If you file your tax return and maintain the

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elective deferral, compensation is generally the

The elective deferrals of your highly com-

SEP using a fiscal year or short tax year,

amount you pay to the employee for the year.

pensated employees meet the SARSEP

you deduct contributions made for a year

Compensation includes the elective deferral and

ADP test.

on your tax return for that year.

other amounts deferred in certain employee

benefit plans. See Compensation in chapter 1.

SARSEP ADP test. Under the SARSEP

Example. You are a fiscal year taxpayer

These amounts are included in figuring your

ADP test, the amount deferred each year by

whose tax year ends June 30. You maintain a

employees’ total contributions even though they

each eligible highly compensated employee as

SEP on a calendar year basis. You deduct SEP

are not included in the income of your employ-

a percentage of pay (the deferral percentage)

contributions made for calendar year 2001 on

ees for income tax purposes.

cannot be more than 125% of the average defer-

your tax return for your tax year ending June 30,

ral percentage (ADP) of all non-highly compen-

You can choose not to treat the defer-

2002.

sated employees eligible to participate. A highly

TIP

ral as compensation, as discussed

compensated employee is defined in chapter 1.

later.

Where To Deduct

Deferral percentage. The deferral percent-

Contributions

To figure the deferral, multiply the

age for an employee for a year is figured as

employee’s compensation by the deferral contri-

follows.

bution rate. However, you must always use the

Deduct contributions for yourself on line 29 of

reduced rate method to determine the maximum

Form 1040. You deduct contributions for your

The elective employer contributions

deductible contribution (13.0435% of unreduced

employees on Schedule C (Form 1040), Profit or

paid to the SEP for the employee

compensation). This is the same method you

Loss From Business, on Schedule F (Form

for the year

use to figure your deduction for contributions

1040), Profit or Loss From Farming, on Form

you make to your own SEP-IRA.

1065, U.S. Return of Partnership Income, on

The employee’s compensation

Form 1120, U.S. Corporation Income Tax Re-

(limited to $170,000)

Example 1. Jim’s SARSEP calls for a defer-

turn, on Form 1120 – A, U.S. Corporation

ral contribution rate of 10% of his salary. Jim’s

Short-Form Income Tax Return, or on Form

The instructions for Form 5305A – SEP

salary for the year is $30,000 (before reduction

1120S, U.S. Income Tax Return for an S Corpo-

TIP

have a worksheet you can use to deter-

for the deferral). You multiply Jim’s salary by

ration, whichever applies to you.

mine whether the elective deferrals of

10% to get his deferral of $3,000. Your maxi-

If you are a partner, the partnership passes

your highly compensated employees meet the

mum deduction for elective deferrals and any

its deduction to you for the contributions it made

SARSEP ADP test.

nonelective contributions would be $3,913.05

for you. The partnership will report these contri-

($30,000 × .130435).

butions on Schedule K – 1 (Form 1065),

On Jim’s Form W – 2, you show his total

Who cannot have a SARSEP? A state or

Partner’s Share of Income, Credits, Deductions,

wages as $27,000 ($30,000 − $3,000). Social

local government, any of its political subdivi-

etc. You deduct the contributions on line 29 of

security wages and Medicare wages will each

sions, agencies, or instrumentalities, or a tax-ex-

Form 1040.

be $30,000. Jim will report $27,000 as wages on

empt organization cannot have a SEP that

his individual income tax return.

includes a salary reduction arrangement.

Choice not to treat deferrals as compensa-

Limit on Elective Deferrals

Salary Reduction

tion. You can choose not to treat elective de-

ferrals (and other amounts deferred in certain

Simplified Employee

The most a participant can choose to defer for

employee benefit plans) for a year as compen-

calendar year 2001 is the lesser of the following

sation under your SARSEP. You can use this

Pension (SARSEP)

amounts.

method for calculating deferral percentages for

the SARSEP ADP test defined earlier.

1) 15% of the participant’s compensation

The deferral and the compensation (minus

A SARSEP is a SEP set up before 1997 that

(limited to $170,000 of the participant’s

the deferral) depend on each other. For this

includes a salary reduction arrangement. (See

compensation).

reason, you figure the deferral indirectly by re-

the Caution, next). Under a SARSEP, your em-

ducing the contribution rate for deferrals called

ployees can choose to have you contribute part

2) $10,500.

for under the salary reduction arrangement. This

of their pay to their SEP-IRAs rather than re-

In 2002, the compensation limit in (1) in-

method is the same one you use to figure your

ceive it in cash. This contribution is called an

creases to $200,000. The amount in (2) in-

deduction for contributions you make to your

“elective deferral” because employees choose

creases to $11,000 and participants who are

own SEP-IRA. You must also use the reduced

(elect) to set aside the money, and they defer

age 50 or over can make a catch-up contribution

rate method to determine the maximum deducti-

the tax on the money until it is distributed to

of up to $1,000.

ble contribution (13.0435% of unreduced com-

them.

The $10,500 limit applies to the total elective

pensation).

deferrals the employee makes for the year to a

You are not allowed to set up a

To figure the deferral, use either the rate

SEP and any of the following.

SARSEP after 1996. However, partici-

table or rate worksheet in chapter 5. Use the rate

pants (including employees hired after

CAUTION

table if the deferral contribution rate called for

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Cash or deferred arrangement (section

1996) in a SARSEP set up before 1997 can

under the SARSEP equals a whole percentage.

401(k) plan).

continue to have you contribute part of their pay

Otherwise, use the rate worksheet. When using

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to the plan. If you are interested in setting up a

Salary reduction arrangement under a

the rate table, first locate the deferral contribu-

retirement plan that includes a salary reduction

tax-sheltered annuity plan (section 403(b)

tion rate in Column A. Then read across to find

arrangement, see chapter 3.

plan).

the reduced rate in Column B. Multiply the re-

Page 8

Chapter 2 Simplified Employee Pension (SEP)

Publication 560 - Retirement Plans For Small Business - 2001 Page 8

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