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Excess SEP contributions - recharacterize?


Guest amfam2
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Guest amfam2

Have client who made excess SEP contribution. Can they recharacterize as Trad IRA contribution?

I thought they could as long as they notify ee (who also happens to be owner) of excess & include in W-2 wages. Then the ee elects to treat excess contribution as a Trad IRA contribution, then follow the deductibility rules of that contribution.

According to page 55 of IRS Publication 590, one cannot recharacterize employer contributions under a SEP as contributions into another IRA.

But if an ee has the amount included as W-2 wages, why wouldn't the IRS allow the ee to recharacterize?

Any ideas?

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You are right.

There are two recharacterizations that are being done here.

1. The recharacterization of employer contribution to employee contribution.

2. The IRA participant then has the option to recharacterize the now IRA participant contribution, to a Roth IRA contribution.

For option 2, it is not an employer contribution that is being recharacterized, but an IRA participant contributions, since the contribution has since lost the employer flavor.

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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Employer contributions (including elective deferrals) under a SEP IRA or a SIMPLE IRA may NOT be recharacterized to another IRA. Amounts held in a SEP IRA or a SIMPLE IRA (after the two-year holding period has expired with respect to the SIMPLE IRA) may, however, be converted to a Roth IRA. [see, IRC Sec 408A Treas Reg § 1.408A-5, Q&A 5]. An amount converted from a SEP (to an IRA) can be recharaterized.

[Appleby-- You are most certainly correct (next message). And I was wrong. I deleted a message and changed a few things so no one gets confused.--Thanks.]

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Gary,

I see you point of reasoning.

I read Pub 590 as you suggested, and agree which the statement. However, what 590 fail to do (typical ) is take the issue beyond the employer contribution, to when it is excess and then becomes an IRA contribution. The recharacterization then would not be of an employer contribution, but of an actual IRA participant contribution.

I have read several books, which states that the SEP excess contribution becomes an IRA contribution, and that upon notification, the IRA custodian must adjust the 5498 reporting to reflect such. The following is the general steps that are followed:

1. Employer notifies the employee

2. Employer amends employee’s W-2 to reflect excess as wages

3. Employee notifies IRA custodian of excess

4. IRA custodian then adjusts SEP contribution to an IRA participant contribution and adjust 5498 reporting to reflect excess an IRA contribution.

The following was taken from the SIMPLE, SEP and SARSEP Answer Book

Ques: What should an employee do upon receiving notification of an excess SEP contribution?

Ans: The excess SEP contributions (and allocable income) should be withdrawn by the employee from the IRA by April 15 following the calendar year in which he or she was notified by the employer of the excess elective SEP contributions. (Excess elective SEP contributions not withdrawn by April 15 will be subject to the IRA contribution limits of Code Sections 219 and 408 and may be considered excess IRA contributions; see Q 5:58.)…

Also Revenue procedure 91-44 states that “In the event that the 50% requirement of section 2.1a is not satisfied as of the end of any plan year, then all elective deferrals made by employees for that plan year shall be considered “disallowed deferrals”, i.e., IRA contributions that are not SEP-IRA contributions.”

I know this particular question may lead one to believe that only deferrals may be treated as IRA participant contributions, but other literature I have read suggests that any SEP excess contribution, such as Excess nondeductible SEP contributions (IRC Sec. 4972); SEP allocation excesses (Prop. Treas. Reg. Sec. 1.408-7(f)); An excess deferral (IRC Sec. 402(g)); A salary deferral SEP excess contribution (IRC Sec. 4979) which occurs when a highly compensated employee defers more as a percentage of income than is permitted by the deferral percentage rules.

If this is true, then wouldn’t the recharacterization be of an employer contribution, not of an actual IRA participant contribution?

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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