Simplified Employee Pension (SEP) A simplified employee pension (SEP) is a written plan that allowsyou to make deductible contributions toward your own and youremployees' retirement without getting involved in more complexretirement plans. A corporation also can have a SEP and makedeductible contributions toward its employees' retirement. But someadvantages available to qualified plans, such as the special taxtreatment that may apply to lump-sum distributions, do not apply toSEPs. Under a SEP, you make the contributions to a traditional individualretirement arrangement (called a SEP-IRA). SEP-IRAs are set up for, at a minimum, each eligible employee.A SEP-IRA may have to be set up for a leased employee,but need not be set up for an excludable employee.For more information, see Publication 560. Form 5305-SEP. You may be able to use Form5305-SEPin setting up your SEP. Contribution Limits Contributions you make for a year to a common-law employee'sSEP-IRA are limited to the lesser of $30,000 or 15% of the employee'scompensation. Compensation generally does not include yourcontributions to the SEP, but does include certain elective deferralsunless you choose not to include them. Annual compensation limit.You generally cannot consider the part of compensation of anemployee that is over $160,000 when you figure your contribution limitfor that employee. More than one plan.If you also contribute to a defined contribution retirement plan(defined later), annual additions to an account are limited to thelesser of $30,000 or 25% of the participant's compensation. When youfigure this limit, your contributions to all of the plans must beadded. Because a SEP is considered a defined contribution plan forpurposes of this limit, your contributions to a SEP must be added toyour contributions to defined contribution plans. Reporting on Form W-2.Do not include SEP contributions on Form W-2 unless there arecontributions under a salary reduction arrangement. Contributions for yourself.The annual limits on your contributions to a common-law employee'sSEP-IRA also apply to contributions you make to your own SEP-IRA.However, special rules apply when you figure your maximum deductiblecontribution. See Deduction of contributions for yourself,later. Deduction Limits The most you can deduct for employer contributions for common-lawemployees is 15% of the compensation paid to them during the year fromthe business that has the plan. Deduction of contributions for yourself.When figuring the deduction for employer contributions made to yourown SEP-IRA, compensation is your net earnings from self-employmentminus the following amounts. The deduction for one-half of your self-employmenttax. The deduction for contributions to your own SEP-IRA. The deduction for contributions to your own SEP-IRA and your netearnings depend on each other. For this reason, you determine thededuction for contributions to your own SEP-IRA indirectly by reducingthe contribution rate called for in your plan. Use the RateWorksheet for Self-Employed shown under Qualified Planto figure the rate. SEP and profit-sharing plans.If you also contributed to a qualified profit-sharing plan, youmust reduce the 15% deduction limit for that plan by the allowablededuction for contributions to the SEP-IRAs of those participating inboth the SEP plan and the profit-sharing plan. SEP and other qualified plans.If you also contributed to any other type of qualified plan, treatthe SEP as a separate profit-sharing plan when applying the overall25% deduction limit described in section 404(h)(3) of the InternalRevenue Code. Employee contributions.Employees can also make contributions of up to $2,000 to theirSEP-IRAs independent of the employer's SEP contributions. However, theemployee's deduction for IRA contributions may be reduced oreliminated because the employee is covered by an employer retirementplan (the SEP plan). See Publication 590for details. Salary ReductionSimplified EmployeePension (SARSEP) Caution: An employer is no longer allowed to set up a SARSEP. However,participants in a SARSEP set up before 1997 (including employees hiredafter 1996) can continue to have their employer contribute part oftheir pay to the plan. A SEP can include a salary reduction (elective deferral)arrangement. Under the arrangement, employees can choose to have youcontribute part of their pay to their SEP-IRAs. The income tax on thecontribution is deferred. This choice is called an elective deferral,which remains tax free until distributed (withdrawn). This choice is available only if all the following requirements aremet. At least 50% of your eligible employees choose the salaryreduction arrangement. You had 25 or fewer eligible employees (or employees whowould have been eligible if you had maintained a SEP) at any timeduring the preceding year. Each eligible highly compensated employee'sdeferral percentage each year is no more than 125% of theaverage deferral percentage (ADP) of all nonhighly compensatedemployees eligible to participate (the ADP test). SeePublication 560for the definition of a highly compensated employeeand information on how to figure the deferral percentage. Limit on elective deferrals.In general, the total income an employee can defer under a salaryreduction arrangement included in a SEP and certain other electivedeferral arrangements for 1999 is limited to the lesser of $10,000 or15% of the participant's compensation (as defined in Publication 560).This limit applies only to amounts that reduce the employee's pay, notto any contributions from employer funds. Employment taxes.Elective deferrals that meet the ADP test are not subject to incometax in the year of deferral, but they are included in wages for socialsecurity, Medicare, and unemployment (FUTA) tax purposes. Reporting SEP Contributions on Form W-2 Your contributions to an employee's SEP-IRA are excluded from theemployee's income. Unless there are contributions under a salaryreduction arrangement, do not include these contributions in youremployee's wages on Form W-2 for income, social security, orMedicare tax purposes. Your SEP contributions under a salary reductionarrangement are included in your employee's Form W-2 for socialsecurity and Medicare tax purposes only. Example.Jim's salary reduction arrangement calls for a deferralcontribution rate of 10% of his salary to be contributed by hisemployer as an elective deferral to Jim's SEP-IRA. Jim's salary forthe year is $30,000 (before reduction for the deferral). The employerdid not choose to treat deferrals as compensation under thearrangement. To figure the deferral amount, the employer multipliesJim's salary of $30,000 by 9.0909%, the reduced rate equivalentof 10%, to get the deferral amount of $2,727.27. (This methodis the same one that you, as a self-employed person, use to figure thecontributions you make on your own behalf.) See Rate Worksheetfor Self-Employed under Qualified Plan. On Jim's Form W-2, his employer shows total wages of$27,272.73 ($30,000 minus $2,727.27), social security wages of$30,000, and Medicare wages of $30,000. Jim reports $27,272.73 aswages on his individual income tax return. If his employer chooses to treat deferrals as compensation underthe salary reduction arrangement, Jim's deferral amount would be$3,000 ($30,000 x 10%). In this case, the employer uses therate called for under the arrangement (not the reduced rate) to figurethe deferral and the ADP test. On Jim's Form W-2, the employershows total wages of $27,000 ($30,000 - $3,000), social securitywages of $30,000, and Medicare wages of $30,000. Jim reports $27,000as wages on his return. In either case, the maximum deductible contribution would be$3,913.05 ($30,000 x 13.0435%). For more information on employer withholding requirements, seePublication 15. For more information on SEPs, see Publication 560.