Publication 560 - Retirement Plans For Small Business

duced rate by your employee’s compensation to

more than the $10,500 limit discussed earlier.

Effects on employee. If a SEP-IRA is dis-

get the deferral.

The treatment of excess deferrals made under a

qualified because of a prohibited transaction,

SARSEP is similar to the treatment of excess

the assets in the account will be treated as

Example 2. The facts are the same as in

deferrals made under a qualified plan. See

having been distributed to the employee on the

Example 1 except you chose not to treat defer-

Treatment of Excess Deferrals under Elective

first day of the year in which the transaction

rals as compensation under the arrangement.

Deferrals (401(k) Plans) in chapter 4.

occurred. The employee must include in income

To figure the deferral, you multiply Jim’s salary

the fair market value of the assets (on the first

Excess SEP contributions. Excess SEP

of $30,000 by 0.090909 (the reduced rate

day of the year) that is more than any cost basis

contributions are elective deferrals of highly

equivalent of 10%) to get the deferral of

in the account. Also, the employee may have to

compensated employees that are more than the

$2,727.27. Your maximum deduction for elec-

pay the additional tax for making early withdraw-

amount permitted under the SARSEP ADP test.

tive deferrals and any nonelective contributions

als.

would be $3,913.05 ($30,000 × .130435).

You must notify your highly compensated em-

ployees within 2

months after the end of the

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

wages as $27,272.73 ($30,000 − $2,727.27).

plan year of their excess SEP contributions. If

you do not notify them within this time period,

Social security wages and Medicare wages will

Reporting and

you must pay a 10% tax on the excess. For an

each be $30,000. Jim will report $27,272.73 as

explanation of the notification requirements, see

wages on his individual income tax return.

Disclosure

Revenue Procedure 91 – 44 in Cumulative Bulle-

Alternative definitions of compensation.

tin 1991 – 2. If you adopted a SARSEP using

Requirements

In addition to the general definition of compen-

Form 5305A – SEP, the notification require-

sation in chapter 1 and the choice described in

ments are explained in the instructions for that

the preceding paragraphs, you can use any defi-

If you set up a SEP using Form 5305 – SEP, you

form.

nition of compensation that meets all the follow-

must give your eligible employees certain infor-

ing conditions.

mation about the SEP when you set it up. See

Reporting on Form W – 2. Do not include

•

Setting Up a SEP, earlier. Also, you must give

elective deferrals in the “Wages, tips, other com-

It is reasonable.

your eligible employees a statement each year

pensation” box of Form W – 2. You must, how-

•

It is not designed to favor highly compen-

ever, include them in the “Social security wages”

showing any contributions to their SEP-IRAs.

sated employees.

and “Medicare wages and tips” boxes. You must

You must also give them notice of any excess

•

also include them in box 12. Mark the “Retire-

It provides that the average percentage of

contributions. For details about other informa-

ment plan” checkbox in box 13. For more infor-

total compensation used for highly com-

tion you must give them, see the instructions for

mation, see the Form W – 2 instructions.

pensated employees as a group for the

Form 5305 – SEP or 5305A – SEP (for a salary

year is not more than minimally higher

reduction SEP).

than the average percentage of total com-

Even if you did not use Form 5305 – SEP or

pensation used for all other employees as

Form 5305A – SEP to set up your SEP, you must

Distributions

a group.

give your employees information similar to that

described above. For more information, see the

(Withdrawals)

C o m p e n s a t i o n

o f

s e l f - e m p l o y e d

instructions for either Form 5305 – SEP or Form

individuals. If you are self-employed, com-

5305A – SEP.

pensation is your net earnings from self-employ-

As an employer, you cannot prohibit distribu-

ment as defined in chapter 1.

tions from a SEP-IRA. Also, you cannot make

To figure the deferral, you must use a re-

your contributions on the condition that any part

duced rate instead of the deferral contribution

of them must be kept in the account.

rate called for under the SARSEP. Use either

Distributions are subject to IRA rules. For

the rate table or rate worksheet in chapter 5 to

information about IRA rules, including the tax

get the reduced rate. Then use the deduction

treatment of distributions, rollovers, required

worksheet to figure the deferral.

distributions, and income tax withholding, see

Compensation does not include tax-free

Publication 590.

items (or deductions related to them) other than

SIMPLE Plans

foreign earned income and housing cost

amounts.

Additional Taxes

Compensation of disabled participant.

You may be able to choose to use special rules

Topics

to determine compensation for a participant who

The tax advantages of using SEP-IRAs for re-

This chapter discusses:

is permanently and totally disabled. Under these

tirement savings can be offset by additional

rules, compensation means the compensation

•

taxes. There are additional taxes for all the fol-

SIMPLE IRA plan

the participant would have received if paid at the

lowing actions.

•

rate paid immediately before becoming perma-

SIMPLE 401(k) plan

•

Making excess contributions.

nently and totally disabled. See Internal Reve-

nue Code section 415(c)(3)(C) for details.

•

Making early withdrawals.

Useful Items

•

You may want to see:

Not making required withdrawals.

Tax Treatment of Deferrals

Forms (and instructions)

For information about these taxes, see chap-

You can deduct your deferrals that, when added

ter 1 in Publication 590. Also, a SEP-IRA may be

to your other SEP contributions, are not more

W – 2 Wage and Tax Statement

disqualified, or an excise tax may apply, if the

than the limits under Deducting Contributions,

account is involved in a prohibited transaction,

earlier.

5304 – SIMPLE Savings Incentive Match

discussed next.

Elective deferrals that are not more than the

Plan for Employees of Small

limit discussed earlier are excluded from your

Employers (SIMPLE) (Not Subject

Prohibited transaction. If an employee im-

employees’ wages subject to federal income tax

to the Designated Financial

properly uses his or her SEP-IRA, such as by

in the year of deferral. However, these deferrals

Institution Rules)

borrowing money from it, the employee has en-

are included in wages for social security, Medi-

5305 – SIMPLE Savings Incentive Match

gaged in a prohibited transaction. In that case,

care, and federal unemployment (FUTA) tax.

Plan for Employees of Small

the SEP-IRA will no longer qualify as an IRA. For

Excess deferrals. For 2001, excess deferrals

a list of prohibited transactions, see Prohibited

Employers (SIMPLE) (for Use With

are the elective deferrals for the year that are

Transactions in chapter 4.

a Designated Financial Institution)

Chapter 3 SIMPLE Plans

Page 9

Publication 560 - Retirement Plans For Small Business - 2001 Page 9

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