SEP contribution - sole proprietor's spouse

[Lori Friedman]

A sole proprietor employs his wife. She's the business's only employee. The sole proprietor recently adopted a SEP, and he wants to make a contribution for himself, but not for his wife.

I've never heard or read about any family exception to SEP participation. But, the FUTA exception for a family employee keeps popping up in my head, so I thought I'd post this issue just to be sure.

Could someone confirm that there are no special SEP rules for a family member, and that the owner's wife is covered by the same rules that affect any employee?

[Appleby]

Hi Lori,

I recall researching the same question for a client- I looked high and low, and could find no such provision.

Let’s see if Gary chimes in. If there any are exception/s, he would know of it/them.

[Gary Lesser]

Confirmed.

Regadless of whether the SEP is an ERISA plan or wife's wages are exempt from FUTA, the SEP is subject to the stringent participation rules of Code Section 408(k)(2). [iRC 408(k)(1)] SEP contributions, when made, must be allocated to "each [eligible] employee" in accordance with the plan's allocation formula.

Assuming the wife is an "employee" she must be treated as an employee for plan purposes. There are no provisions under the SEP rules that permit an individual to "opt out."

Perhaps the business could unionize its shop and thereby exclude the wife in accordance with plan provisions.

The "opting out" issue is covered in Q 2:40, and more exlicitly in Q 5:4 of the SIMPLE, SEP, and SARSEP Answer Book (11th ed).

[Guest mjb]

This is a case of counter intutive logic basing an answer on a distinction without a difference. Has anyone considered that there is no difference in contribution amount if the owner includes the spouse because the deductible contribution will be same. If the spouse in entitled to a contribution of X then the owner can reduce his contribution by some formula taking X into account and exclude the spouse's contribution from w-2 income. The employee deducts his contribution from his taxable income on the 1040 and deducts the spouse's contribution from his taxable income on the sked C. The amount deducted for H & W will be the same amount that would have been deducted by the employee for his own contribution.

[Lori Friedman]

This is a case of counter intutive logic basing an answer on a distinction without a difference.

Wrong. The sole proprietor wasn't asking for bottom-line income and deduction reasons. He had a subjective purpose -- he wanted to maximize the contribution to his own SEP account while denying a contribution to his wife.

[Guest mjb]

What is the difference if the deduction is the same? The only reason to deny a contribution to his wife is because he is planning to divorce her.

[saabraa]

What is the difference if the deduction is the same?

The difference is that the plan fails to be a kosher SEP under 408k, if the wife isn't covered.

Other than that, I'm not seeing how bottom line deduction is the same. For example, assume H's self employment net income is $80,000 and W's w-2 income is $20,000. Contribution rate is 25%. The 80,000 takes W's 20,000 wage and W's SEP contribution into account.

H's contribution is: ($80,000 less 1/2 the SE tax, 6,120) times .2 = $14,768 (deduct on 1040)

W's contribution is $20,000 x 25% = 5,000

If we now assume it's okay to deny contribution to wife, then:

H's contribution is: ($85,000 less 1/2 SE tax of $6,503) times .2 = $15,699.

Using the no contribution for wife scenario, the change to taxable income on Form 1040 is + $3,686:

1040 Husband's SEP deduction is higher - $931

Schedule C net self employment income +5,000

Deduction for 1/2 SE tax is higher -383

Assuming 28% bracket, income tax is $1,032 higher, plus paying higher SE tax in the amount of 15.3% times $5,000.

[Lori Friedman]

The only reason to deny a contribution to his wife is because he is planning to divorce her.

Could be. I don't know the personal and intimidate details of this marriage, and I certainly won't be asking.