S-Corp SEP

[WhiteOleander]

Have an S-Corp with 3 S/H 40%, 40% & 20%

They came in this year with their info. They listed that they contributed to an SEP. They have never done this before. I could not figure out how they knew what to contribute. I asked what the contrib. % was. They said that their financial guy that set up the SEP told them that they could contribute based on the ownership % instead of a %. of wages.

Has anyone ever seen this. Most of my clients do not do SEP's and I don't have alot of experience with them.

Thanks.

[JohnH]

The financial guy

The financial guy is wrong.
If his tax advice is that sorry, I wonder how bad his financial advice might be.

[KJ Judd]

I agree with John. SEP must be a based on taxable wages in Box 1. You may still be okay if their wages match their ownership percentages. They still have time to correct the SEP though. The contribution does not need to be made until the due date of the return.

[WhiteOleander]

I agree with John. SEP must be a based on taxable wages in Box 1. You may still be okay if their wages match their ownership percentages. They still have time to correct the SEP though. The contribution does not need to be made until the due date of the return.

Thanks for the help.

I don't think they match.

WAGES
S/H #1 40% 48695.00
S/H #2 40% 26000.00
S/H #3 20% 42400.00

SEP
#1 2750.83
#2 2750.83
#3 1375.42

S/H #1 & 2 are husband and wife.

[ChEAr$]

One more caveat

It is not "they" who contribute; it is the corporation itself which contributes up to 25% of
W2 taxable pay.

Only then, if they otherwise qualify individually may they contribute to the IRA which is
established for the corporation's funding.

[Bees Knees]

Since you have until the tax return due date plus extensions to make SEP contributions, there is still time to correct it by simply having the corporation contribute more for each so that each has the same percentage of their W-2 wages contributed.

For example, you said:

WAGES
S/H #1 40% 48695.00
S/H #2 40% 26000.00
S/H #3 20% 42400.00

SEP
#1 2750.83
#2 2750.83
#3 1375.42

S/H #2 so far has 10.580115384% of W-2 wage contributed.

In order for S/H #1 to have that same %, total SEP should equal $5,151.99

$5,151.99 - 2,750.83 = $2,401.16, the additional amount to make S/H #1 and #2 have equal SEP percentages.

And so on...

[WhiteOleander]

Update

I have gotten to the bottom of this. The T/P told the financial guy to split the contribution by the S/H ownership. Not based on the same % of wages for each person. And the financial guy didn't know to tell them no.

So, anyway, they are going to base the contribution on the % that has been put in for the 20% S/H. which is approx. 3.4%. So, the other two S/H have too much contibuted to their acct.

Instead of having the excess contr. plus earnings pulled out, can they just designate the money to be a contr for 2008? I know this can be done for a Trad. IRA.

Thanks.

And as an aside question, I was wondering if they had actually done these contributions in the manner they had set up, could that have created a situation that the S-Corp would be terminated? Could the IRS claim the the contributions created a second class of stock because the SEP treated the S/Hs differently? Just curious.

[Bees Knees]

TTB Small Business Edition says the following:

SB6-15:

Excess annual additions. Excess annual additions are the
amounts contributed to a defined contribution plan that are more
than the contribution limits allowed. See Pension Plan Limitations,
page SB6-2. A plan can correct excess annual additions caused by
any of the following actions:
• A reasonable error in estimating a participant’s compensation.
• A reasonable error in determining the elective deferrals
permitted.
• Forfeitures allocated to participants’ accounts.
To correct the excess annual additions:
1) Allocate and reallocate the excess to other participants in the
plan to the extent of their unused limits for the year.
2) If these limits are exceeded, do one of the following:
• Hold the excess in a separate account and allocate (and reallocate)
it to participants’ accounts in the following year (or
years) before making any contributions for that year.
• Return employee after-tax contributions or elective deferrals.
The return of employee after-tax contributions or the distribution
of elective deferrals to correct excess annual additions is considered
a corrective payment rather than a distribution of accrued
benefits. The 10% early distribution penalty and the excess distribution
penalty do not apply. However, the employer may be
subject to an excise tax if the deduction limitation is exceeded.
See Excess contribution penalty, page SB6-16.

SB5-16:

Excess contribution penalty. If an employer contributes more
to a plan than is allowable as a deduction, the excess can be carried
over and deducted in a later year. See contribution limits on
page SB6-2. The combined deduction in a later year is limited to
25% of the participating employees’ compensation for that year.
For purposes of this limit, a SEP is treated as a profit-sharing
(defined contribution) plan. The 25% limit must be reduced for
self-employed individuals. See Deduction limits for self-employed
individuals, page SB6-15.
Excess non-deductible contributions to qualified pension, profit-
sharing, and SEPs are subject to a 10% excise tax. In contrast,
excess non-deductible contributions to IRAs are subject to a 6%
excise tax. See Tab 13, 1040 Edition. The 10% excise tax on nondeductible
contributions is reported on Form 5330, Return of Excise
Taxes Related to Employee Benefit Plans.
Self-employment exception: The 10% excise tax does not apply to
any contribution made to meet the minimum funding requirements
for a self-employed individual in a money purchase pension
plan or a defined benefit plan. Even if that contribution is
more than the self-employed individual’s earned income from
the trade or business for which the plan is set up, the difference
is not subject to this excise tax.

As to the S corporation termination issue, I don’t think you risk having your S corp status terminated when you make excess contributions to retirement plans. That is what the excise tax penalty is for. You also could risk having all pension plan assets treated as being distributed to participants in a fully taxable distribution, if you make no attempt to correct the error.

[WhiteOleander]

Thanks Bees.