Publication 590
Individual Retirement Arrangements (IRAs)

For use in preparing 2002 Returns

3. Simplified Employee Pension (SEP)

Important Changes for 2002

Increase in limits on elective deferrals under a SEP-IRA.   In general, the limit on elective deferrals made on your behalf for 2002 that represent a reduction in your salary under a SEP-IRA cannot be more than $11,000 (up from $10,500 for 2001). For more information, see What Is a Salary Reduction Arrangement, in this chapter.

Increase in overall limits on SEP-IRA contributions.   For 2002, your employer can contribute to your SEP-IRA up to the lesser of 25% of your compensation or $40,000 (up from $30,000 in 2001). For more information, see What Is a Salary Reduction Arrangement, in this chapter.

Additional elective deferrals under a SEP-IRA for persons 50 and older.   For contributions made after 2001, additional elective deferrals can be contributed to your salary reduction arrangement SEP-IRA if:

• You reached age 50 by the end of 2002, and
• No other elective deferrals can be made for you to the plan for the year because of limits or restrictions, such as the regular annual limit.

See What Is a Salary Reduction Arrangement, in this chapter.

Credit for salary reduction contributions.   For tax years beginning after 2001, if you are an eligible individual, you may be able to claim a credit for a percentage of your qualified retirement savings contributions, such as salary reduction contributions to your SEP. To be eligible, you must be at least 18 years old as of the end of the year, and you cannot be a student or an individual for whom someone else claims a personal exemption. Also, your adjusted gross income (AGI) must be below a certain amount.

For more information, see chapter 5.

Important Changes for 2003

Increase in limits on elective deferrals under a SEP-IRA.   In general, the limit on elective deferrals made on your behalf for 2003 that represent a reduction in your salary under a SEP-IRA cannot be more than $12,000 (up from $11,000 for 2002). For more information, see What Is a Salary Reduction Arrangement? in this chapter.

Additional elective deferrals under a SEP-IRA for persons 50 and older.   For 2003, additional elective deferrals can be contributed to your salary reduction arrangement SEP-IRA if:

• You will be 50 or older in 2003, and
• No other elective deferrals can be made for you to the plan for the year because of limits or restrictions, such as the regular annual limit.

For 2003, the additional amount is the lesser of the following two amounts.

1. $2,000 (up from $1,000 for 2002), or
2. Your compensation for the year reduced by your other elective deferrals for the year.

For more information, see What Is a Salary Reduction Arrangement? in this chapter.

Introduction

Employers, including self-employed individuals, can set up simplified employee pension (SEP) plans. A SEP plan allows an employer to make contributions toward employees' retirement, and, if the employer is self-employed, his or her own retirement, without becoming involved in more complex retirement plans.

A self-employed individual is an employee for SEP purposes. He or she is also the employer. Even if the self-employed individual is the only qualifying employee, he or she can have an IRA under a SEP plan (SEP-IRA).

This chapter focuses on the rules affecting employees. For information on the rules affecting employers, see Publication 560.

What Is a SEP?

A simplified employee pension (SEP) is a written arrangement (a plan) that allows an employer to make deductible contributions for the benefit of participating employees. The contributions are made to individual retirement arrangements (IRAs) set up for participants in the plan. Traditional IRAs set up under a SEP plan are referred to in this publication as SEP-IRAs. For more information, see Publication 560, Retirement Plans for Small Business.

How Much Can Be Contributed on My Behalf?

The SEP rules permit an employer to contribute to each participating employee's SEP-IRA up to 25% of the employee's compensation or $40,000, whichever is less. These contributions are funded by the employer.

An employer who signs a SEP agreement does not have to make any contribution to the SEP-IRAs that are set up. But, if the employer does make contributions, the contributions must be based on a written allocation formula and must not discriminate in favor of highly compensated employees (defined in Publication 560).

Figuring the 25% Limit

For purposes of determining the 25% limit, compensation is generally limited to $200,000 for 2002, not including your employer's contribution to your SEP-IRA.

Example.   Barry's nonunion employer has a SEP for its employees. Barry's compensation for 2002, before his employer's contribution to his SEP-IRA, was $120,000. Because the 25% limit is less than the $40,000 limit, Barry's employer can contribute up to $30,000 (25% × $120,000) to Barry's SEP-IRA.

Deduction Limit for a Self-Employed Person

If you are self-employed and contribute to your own SEP-IRA, special rules apply when figuring your maximum deduction for these contributions.

Determining your compensation.   For purposes of the 25% limit on contributions, discussed above, your compensation is your net earnings from self-employment, defined later. Note that, for SEP purposes, your net earnings (compensation) must take into account your deduction for contributions to your own SEP-IRA. Because your deduction amount and your net earnings amount are each dependent on the other, this adjustment presents a problem. To solve this problem, you must use a reduced contribution rate to figure your maximum deduction. Make no reduction to the contribution rate for any common-law employees.

First, use either the rate table or rate worksheet to find your reduced contribution rate. Then complete the deduction worksheet to figure your deduction for contributions.

The table and the worksheets that follow apply only to self-employed individuals who have only one defined contribution plan, such as a profit-sharing plan. A SEP plan is treated as a profit-sharing plan.

Rate table for the self-employed.   If your plan's contribution rate is a whole percentage (for example, 12% rather than 12½%), you can use Table 3-1 to find your reduced contribution rate. Otherwise, use Worksheet 3-1 provided later.

First, find your plan contribution rate (the contribution rate stated in your plan) in Column A of the table. Then read across to the rate under Column B. Enter the rate from Column B in step 4 of Worksheet 3-2, Deduction Worksheet for Self-Employed.

Example.   You are a sole proprietor with no employees. If your plan's contribution rate is 10% of a participant's compensation, your rate is 0.090909. Enter this rate in step 4 of Worksheet 3-2.

Rate worksheet for the self-employed.   If your plan's contribution rate is not a whole percentage (for example, 10½%), you cannot use Table 3-1. Use Worksheet 3-1, Rate Worksheet for the Self-Employed, instead.

Figuring your deduction.   Now that you have your self-employed rate from either the rate table or rate worksheet, you can figure your maximum deduction for contributions for yourself by completing Worksheet 3-2, Deduction Worksheet for the Self-Employed.

Community property laws.   If you reside in a community property state and you are married and filing a separate return, disregard community property laws for step 1 of Worksheet 3-2. Enter on step 1 the total net profit you actually earned.

Example.   You are a sole proprietor with no employees. The terms of your plan provide that you contribute 8½% (.085) of your compensation to your plan. Your net profit from line 31, Schedule C (Form 1040) is $200,000. You have no elective deferrals or catch-up contribuitons. Your self-employment tax deduction on line 29 of Form 1040 is $7,942. You figure your reduced contribution rate and maximum deductible contributions as shown on Filled-in Worksheet 3-1 and Filled-in Worksheet 3-2.