Is a Simplified Employee Pension (SEP) right for your Maine small business? SEPs are stripped-down retirement plans intended for self-employed individuals and small businesses. Consider establishing a SEP if you don’t already have a tax-favored retirement plan set up for your business, and if you act quickly, you may be able to claim a deduction for your initial SEP contribution on your 2016 tax return.
Putting SEPs to Work for You
SEP are often the preferred retirement plan option for self-employed individuals and small business owners because they are relatively easy to set up and can allow large annual deductible contributions. However, if the business has employees, that may add some complications. (See “Beware of Requirements to Cover Employees” below)
The term “self-employed” generally refers to:
- A sole proprietor,
- A member (owner) of a single-member limited liability company (LLC) that’s treated as a sole proprietorship for tax purposes,
- A member of a multimember LLC that’s treated as a partnership for tax purposes, or
- A partner.
Your annual deductible SEP contributions can be up to 20% of your self-employment income if you’re in one of these categories. For a sole proprietor or single-member LLC owner, self-employment income for purposes of calculating annual deductible SEP contributions equals the net profit shown on their Schedule C, less the deduction for 50% of self-employment tax. For a member of a multimember LLC or a partner, self-employment income equals the amount reported on their Schedule K-1, less the deduction for 50% of self-employment tax claimed on their personal income tax return.
If you’re an employee of your own corporation, it can establish a SEP and make an annual deductible contribution of up to 25% of your salary. The contribution is considered a tax-free fringe benefit and is, therefore, excluded from your taxable income.
The maximum contribution to a SEP account for 2016 is $53,000. For 2017, the maximum contribution is $54,000. However, there’s no requirement to contribute anything for a particular year, so a small amount can be contributed or nothing at all when cash is tight.
Assets in a SEP, like most other tax-advantaged retirement plans, can grow tax-deferred, with no tax liability until withdrawals are made. Early withdrawals (before age 59½) are generally subject to a 10% penalty in addition to income tax. Certain minimum distributions are generally required beginning after age 70½.
Beware of Requirements to Cover Employees
Establishing a SEP is more complicated if your business has employees. Specifically, contributions may be required for any employee who:
- Is age 21 or older,
- Has worked for your business during at least three of the past five years, and
- Receives at least $600 of compensation.
Your business can deduct any contributions made for employees. Because SEP contributions made for employees vest immediately, a covered employee can leave your company at any time without losing any of his or her SEP money. For this reason, SEPs generally aren’t preferred by businesses with more than a few trusted employees.
Setting Up Your Plan
A key benefit of SEPs is that you can establish your plan as late as the extended due date of the return for the year in which you claim a deduction for your initial SEP contribution. Your financial advisors can help you complete the required paperwork to set up a SEP. It is a fairly simple process, especially for a one-person business.
For example, say your business is a sole proprietorship or a single-member LLC that’s treated as a sole proprietorship for tax purposes. If you establish a SEP and make your initial SEP contribution by April 18, 2017, the deadline for filing your 2016 federal income tax return, you can deduct the contribution on your 2016 tax return.
Important note: You have until October 16, 2017 to set up the plan and make a deductible 2016 contribution, if you extend your 2016 return.
If you have questions or want more information about SEPs and other small-business retirement plan options, contact your tax or financial advisor. You still have time to retroactively set up a SEP for the 2016 tax year and make a contribution that can be deducted on your 2016 return. SEPs can be a smart way for many small businesses to save tax.