A simplified employee pension is a type of individual retirement arrangement for self-employed individuals and small businesses. If you are covered by an SEP and your employer contributes too much to your account, you must withdraw the unwanted amount to avoid taxation and penalties. You should return the excess amount to your employer, but it’s not required.
A business owner can create SEP accounts for herself and for each eligible employee. Only the employer can contribute to an SEP IRA. The contributions are tax-deductible to the employer and tax-deferred for the employees, up to the annual limits. In 2013, those limits are 25 percent of the employee’s compensation or $51,000, whichever is less. If your employer makes an excess contribution, you can correct it by filling out a form with your custodian and withdrawing the money. However, different procedures apply if you don’t correct the problem before the tax filing deadline, including extensions. The IRS will slap you with a 6 percent excise tax if you don’t withdraw the money before the filing deadline.
Corrections Before Filing
Your custodian can provide you with a form to remove excess contributions from your SEP IRA. Your employer can initiate the process under the Employee Pension Compliance Resolution System Voluntary Compliance Program. If you and your employer complete the form before the filing deadline plus extensions, you must also remove the earnings on the excess contribution. The form allows you to instruct the custodian on how to distribute the excess. If you return it to your employer, the Internal Revenue Service will not tax or penalize you. Your copy of 1099-R, in which your custodian reports annual distributions from your SEP IRA, will show a nontaxable distribution for the excess amount you return to your employer.
Corrections After Filing
If you discover an unwanted contribution after the final tax-filing deadline, you might have to pay the 6 percent excise tax, which you report on Forms 5329 and 5330. If you are younger than 59 1/2, you might also have to pay the 10 percent penalty for an early withdrawal. You can choose to return the excess contribution to your employer or to contribute it to your own IRA. You can carry forward in your IRA the portion of your excess contribution that is greater than the IRA annual contribution limits. You will have to pay 6 percent excise tax each year on the remaining balance until you use up the excess amount.
If you are an employer or are self-employed, you’ll owe a 10 percent excise tax on the excess contribution. Remove the unwanted contribution using the custodian’s form and have your employee sign it. Report the tax on Form 5330. You can’t deduct the excess contribution, but you can carry over and deduct it in later tax years. If the excess amount is small and the mistake is not recurring, you might be able to report it under the Self-Correction Program. If the problem is more severe, you can report it under the Voluntary Correction Program. You’ll have to pay fees and submit Forms 8950 and 8951. If the IRS discovers the error during an audit, you’ll have to pay sanctions.
- Internal Revenue Service: Publication 560 Retirement Plans for Small Business
- Internal Revenue Service: SEP Contribution Limits
- Oppenheimer Funds: SEP IRA Removal of Excess Form Information
- Internal Revenue Service: SEP Plan Fix-It Guide - Contributions to the SEP-IRA Exceeded the Maximum Legal Limits
- Internal Revenue Service: Instructions for Form 5330
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