By Jeff Pangaro, Pangaro Wealth Management
As the end of 2016 comes into sight, business owners everywhere are thinking of taxes. Which moves can be made to reduce your tax liabilities for the year? One popular option, especially for businesses with few to no employees, is to establish a Simplified Employee Pension (SEP) Plan.
What Is A SEP Plan?
A SEP plan is established by a business as a simple way to make tax-deductible contributions to a retirement plan for its eligible employees, including the business owner. Each eligible employee sets up a traditional IRA to which the employer contributes up to 25% of their pay. The employees do not pay taxes on the contributions, so they pay taxes on the withdrawals (including any earnings).
SEP contributions are used to fund a traditional IRA, so they are subject to many of the same requirements. These include distribution rules, rollover rules and documentation requirements for setting up an IRA. Contribution rules differ, however, and any amount an employer contributes on behalf of an employee does not affect that employee’s ability to contribute to an IRA for themselves.
An employee must be allowed to participate if they meet the following criteria:
- At least age 21
- Earns at least $550 for the year
- Has worked for the employer for at least 3 of the 5 years prior to the year of the contribution, no matter how short the length of employment during the year.
Businesses may establish less restrictive requirements to participate, but they are not allowed to exclude anyone that meets the above eligibility requirements.
An employer is allowed to contribute up to 25% of an employee’s compensation, which is based on W-2 wages. Sole proprietor compensation is based on Schedule C income and partners in a partnership base their compensation on Schedule K-1 income. Only income up to $255,000 may be considered for contributions. Also, employers may not contribute more than $51,000 to an individual employee in a year.
Contributions may be calculated as a percentage of compensation, an equal payment to every employee, or with a more complicated formula that gives a larger percentage to higher-paid employees. Care must be taken to ensure that contribution formulas are done according to IRS regulatory requirements, otherwise, the SEP plan could be disqualified for tax benefits.
SEPs offer many benefits that make them appealing to business owners. These include:
- Contributions are tax-deductible and therefore lower the business’s tax liability.
- A company of any size can establish one, even if the business owner is the sole employee.
- Any type of company may establish one, including a sole proprietorship, partnership, corporation or non-profit organization.
- Start-up and maintenance costs are low compared to other tax qualified plans.
- SEP plans are easy to setup and administer; there is no IRS filing requirement.
- Contributions are discretionary and can change from year to year, or not be made at all, depending on the company’s cash flow.
- Employees may make traditional IRA contributions to the same account as their SEP-IRA.
Contributions must be made by the company’s tax filing deadline, including extensions. Any contributions that you want to reduce your 2016 tax liability must be made by April 17, 2017, or October 16, 2017, if you file an extension. That means that if you filed an extension for 2015, you still have time to reduce your 2015 tax liability by contributing before October 15, 2016.
If you think that a SEP plan might be a good fit for your company, we are here to help. Give us a call at (203) 439-2626 and we will gladly answer any questions you may have regarding SEP plans or get you started establishing one for your company in order to make the October 15 deadline.
About Pangaro Wealth Management
Pangaro Wealth Management is a Registered Investment Advisory firm providing financial planning, risk management, and retirement plan consulting for individuals, families, and business owners. Led by a team of experienced financial professionals with diverse backgrounds, the firm focuses on doing one thing extremely well and with unparalleled dedication and commitment: connecting their clients’ dreams with sound financial strategies. By collaborating as a team, they provide greater depth and more advanced strategizing to clients’ plans and needs. Deeply rooted in their community, they serve clients throughout Connecticut, reaching to Cheshire, Meriden, New Haven, Torrington, Avon, West Hartford, Farmington Valley, Vernon, and beyond. To schedule an appointment, click here. To learn more about their services, visit www.pangarowealthmanagement.com or connect with them on LinkedIn.
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