I have a small consulting business and I am the only employee'I have
opened a Simplified Employee Pension plan'I am somewhat confused however as to
the amount I can deduct as contributions to the plan, and who is doing the
deducting'Several sources have not lessened that confusion'Specifically, can I
as an employer contribute to the plan and deduct that amount on Schedule C as a
business expense? Also, can I as an employee contribute to the plan and deduct
that amount on line 29 of Form 1040? Finally, of course, how much can be
contributed to the plan by each entity?
Simplified Employee Pension plans (SEPs) are retirement plans whereby self-employed individuals make contributions to a special type of IRA for themselves and their qualified employees.
People making a contribution to an SEP for the first time have some nice flexibility in setting up the plan 'the deadline for formally setting up an SEP is the due date of the tax return in which you take the deduction, including extensions'So, a first-time contributor to an SEP who has extended the due date of his 1998 tax return to 6/15/99, has until 6/15/99 to set up the SEP.
The stated rule is that the amount of contribution you can deduct is the lesser of $30,000 or 15% of your net earnings'Sounds easy, doesn't it? Actually, the computation is a bit complicated, and the bottom line is that the most you can contribute is the lesser of $24,000 (calculated by taking that 15% mentioned previously times $160,000, the maximum compensation limit for 1998) or 13.0435% of your net earnings from your business, reduced by 50% of your self-employment tax'Huh?
Let's see how this works'If your net earnings from your business total $100,000, the self-employment tax for 1998 will be 12.4% times $68,400 ($8,482) plus 2.9% times $100,000 ($2,900), or $11,382'So the amount on which you figure your SEP contribution is $100,000 less $5,691 (1/2 of your self-employment tax), or $94,309'The maximum contribution would then be 13.0435% times $94,309, or $12,301.
If your net earnings from your business total $200,000, the SE tax is $14,282'Ignoring that amount, your SE contribution will be figured on $160,000 (the maximum allowed), and at 13.0435%, the contribution can be as high as $20,870.
For those readers who need to see some logic in these computations (not that logic has ever played a very big part in tax laws), the 13.0435% is determined by incorporating your SEP contribution into the contribution calculation.
The deduction for your company's SEP contribution made on your behalf does not go on your Schedule C, but instead goes on page one of your 1040, line 29.
Should you acquire employees who qualify to participate in this plan, you don't need to mess with this complicated SE tax computation'The contribution for your employees will be the lesser of $24,000 or 15% of their net income, up to $160,000'Note that that $160,000 maximum income may change in the future'Note also that any amount you contribute on behalf of your employees reduces your business net income for purposes of calculating your own SEP contribution.
As an employee yourself, you are entitled to make a personal contribution to your SEP by following the same rules that would entitle you to make a contribution to an IRA'The maximum allowable annual contribution is $2,000'Your contribution may be deductible, in addition to the amount contributed by your business, but is subject to certain income limitations for participants in employer retirement plans as set out in the IRA rules.
Please note: In last week's column, in my zeal to congratulate the Illinois taxing authorities on their liberal rules regarding zero taxation of retirement income, I made reference to Indiana's comparatively stringent rules for taxing retirement income, including Social Security income'Please note that Indiana does not tax Social Security income, nor does it tax Railroad Retirement Benefits'However, to take advantage of this tax benefit, you must file Indiana Schedule 1 with your Indiana Income Tax return and reduce your federal adjusted gross income by the amount of federally taxable Social Security or Railroad Retirement income'All other retirement income is taxed in Indiana.