How Much Can I Contribute?

The SEP rules permit you to contribute a limited amount of money each year to each employee's SEP-IRA. If you are self-employed, you can contribute to your own SEP-IRA. Contributions must be in the form of money (cash, check, or money order). You cannot contribute property. However, participants may be able to transfer or roll over certain property from one retirement plan to another. See Publication 590 for more information about rollovers.

You do not have to make contributions every year. But if you make contributions, they must be based on a written allocation formula and must not discriminate in favor of highly compensated employees (defined in chapter 1). When you contribute, you must contribute to the SEP-IRAs of all participants who actually performed personal services during the year for which the contributions are made, even employees who die or terminate employment before the contributions are made.

The contributions you make under a SEP are treated as if made to a qualified pension, stock bonus, profit-sharing, or annuity plan. Consequently, contributions are deductible within limits, as discussed later, and generally are not taxable to the plan participants.

A SEP-IRA cannot be designated as a Roth IRA. Employer contributions to a SEP-IRA will not affect the amount an individual can contribute to a Roth IRA.

Time limit for making contributions. To deduct contributions for a year, you must make the contributions by the due date (including extensions) of your tax return for the year.

Contribution Limits

Contributions you make for 2001 to a common-law employee's SEP-IRA cannot exceed the lesser of 15% of the employee's compensation or $35,000 ($40,000 for 2002). Compensation generally does not include your contributions to the SEP. However, if you have a salary reduction arrangement, see Employee compensation under Salary Reduction Simplified Employee Pension (SARSEP), later.

Example. Your employee, Mary Plant, earned $21,000 for 2001. The maximum contribution you can make to her SEP-IRA is $3,150 (15% x $21,000).

Contributions for yourself. The annual limits on your contributions to a common-law employee's SEP-IRA also apply to contributions you make to your own SEP-IRA. However, special rules apply when figuring your maximum deductible contribution. See Deduction Limit for Self-Employed Individuals, later.

Annual compensation limit. You cannot consider the part of an employee's compensation over $170,000 when figuring your contribution limit for that employee. Therefore, $25,500 is the maximum contribution for an eligible employee whose compensation is $170,000 or more. (The annual compensation limit increases to $200,000 for 2002.)

More than one plan. If you contribute to a defined contribution plan (defined in chapter 4), annual additions to an account are limited to the lesser of $35,000 or 25% of the participant's compensation. (For 2002, annual additions are limited to the lesser of $40,000 or 100% of the participant's compensation.) When you figure this limit, you must add your contributions to all defined contribution plans. Because a SEP is considered a defined contribution plan for this limit, your contributions to a SEP must be added to your contributions to other defined contribution plans.

Tax treatment of excess contributions. Excess contributions are your contributions to an employee's SEP-IRA (or to your own SEP-IRA) for 2001 that exceed the lesser of the following amounts.

• 15% of the employee's compensation (or, for you, 13.0435% of your net earnings from self-employment).
• $35,000 ($40,000 for 2002).

Excess contributions are included in the employee's income for the year and are treated as contributions by the employee to his or her SEP-IRA. For more information on employee tax treatment of excess contributions, see chapter 4 in Publication 590.

Reporting on Form W-2. Do not include SEP contributions on your employee's Form W-2 unless contributions were made under a salary reduction arrangement (discussed later).