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SARSEP legality question


Guest Shandi2010
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Guest Shandi2010

My employer in California suddenly reduced my salary 25% per year in July of 2008 and started a salary-reduced SEP program. This was against my wishes and was forced on me. I recently discovered that SARSEPs were outlawed in 1996.

I asked him today what the plan is called since SARSEPs are illegal. He said it doesn't have a name...it's just a SEP, but it's not a salary-reduction plan. He could not/would not answer when I asked him why my salary was being reduced 25% if this wasn't a salary-reduction plan.

In the course of this salary-reduction SEP plan, my salary has also been shorted for the past two years. My boss says that's because my salary is based on the company FISCAL YEAR rather than the calendar year (that it's ALWAYS been based on before). This, of course, benefits the company (by FY, my salary is OVER by 2k, by CY, my salary is SHORTED by 2k). He admitted to me last week that my salary had been shorted, but it seems like he and the accountant ran the numbers in as many ways possible until they got what they wanted. My pay has always been based on the normal CY before, and today was the first time he's said that they're basing it on the FY for ANY reason.

Any advice on how I can get him to stop this salary-reduction!? He refuses to, even though he KNOWS it's illegal (he simply won't use the term salary-reduction SEP). I've been with this company for 9 years, and these are just a couple of many sneaky, evil things this employer has done, but it's tough to change jobs in this rough economy..and I can't afford to with my salary reduced 25%.... (he doubled his salary in the meantime so that he could make the full $49k deposit into his SEP for FY 2010).

Any help/answers/advice appreciated.

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Well...it sounds like your employer has done two separate things: 1) reduced your salary, and 2) made a company contribution to a SEP that just happens to be the amount that your pay was reduced by. It appears that he wants to get a juicy SEP contribution for himself without it costing anything. A SEP is a perfectly legitimate retirement plan, funded entirely by company contributions. It seems that any problems would be associated with item #1 - do you have an employment contract, did he tell you he was reducing your pay, does he have to tell you he is reducing your pay, etc., etc.? Those questions and answers have to do with employment law and I can't help there at all. Good luck.

BTW, SARSEPs weren't outlawed, you just can't establish new ones. But it's not a SARSEP so that's not really relevant. Also, FWIW, it sounds like the calender year/fiscal year thing is just a red herring to confuse the issue.

Ed Snyder

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As Bird notes, this is just a SEP with an employer-paid contribution. This technique is not all that unusual, though typically it is better explained to the affected employees and the adjustment to compensation is calculated to keep the employee whole. for example:

Employee earning $50K per year. Typically would get a 20% cut to $40,000 and receive a 25% SEP contribution of $10,000 to get back to $50K. Employee could withdraw the money from the SEP-IRA right away but would lose 10% in penalty tax (assuming younger than age 59-1/2), and might have a state tax penalty as well. However if the employee had the $10K paid in wages would have lost 7.65% in FICA/Medicare taxes, so the effect is pretty close to a wash.

The employer also is saving 7.65% on the $10K as well. You might ask the employer to give you a raise in the amount of 7.65% of the SEP contribution, pointing out that he saved this when he cut your salary. This would cover the difference between your side of the FICA/Medi tax and the penalty for withdrawing the funds prior to age 59-1/2.

I'm addicted to placebos. I could quit, but it wouldn't matter.

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Good analysis in above two posts.

Technically, the owner did the same for himself.

Your contribution is allocated based on plan year compensation. Your percentage cannot be less than the owner's percentage if an IRS model plan is being used.

The amount excludible from income is 25% of taxable compensation for the limitation year (generally the plan year).

However, the 25 percent employer deduction limit for 2010 is based on the aggregate compensation (including, for this purpose, elective deferrals such as catch-up contributions) of all plan participants. The 25 percent deduction limit is computed using each participant's calendar year compensation. If the employer's 2010 tax year ends prior to December 31, 2010, calendar year compensation for 2009 is used.

It seems that with a contribution of 25%, only a 20% reduction was necessary. [$100 - $20 (20%) = $80. $80 x 25% = $20.]

If a SARSEP, there would be an amount shown in box 12 of your Form W-2.

If a SEP or SARSEP, the "retirement plan" box (13) should also have been checked.

SEPs are pension plans generally subject to the requirements of the Employee Retirement Income Security Act of 1974 (ERISA), including ERISA's reporting and disclosure obligations. Simple annual reporting requirements apply where the employer has adopted the IRS model SEP without modification. In that case, the employer need only have complied as follows:

1. Provided employees with copies of the completed Form 5305-SEP

2. Notified each employee in writing of the amount of employer contribution for the year

3. If the employer selected or otherwise influenced an employee's selection of a particular IRA that restricts the withdrawal of funds, has provided a written explanation of the restrictions and informed the employee of the availability of IRAs that do not restrict withdrawal

An employer must also inform its employees of the SEP's adoption and its terms, including a description of participation requirements and the benefit allocation formula. Such information is to be provided within a reasonable time after an employee becomes employed (or after the SEP is adopted, if later). The instructions to IRS Form 5305-SEP indicate this requirement is satisfied if the employer adopts the IRS model SEP and gives the employee a photocopy of the completed Form 5305-SEP.

Similar requirements apply to a prototype SEP. The sponsor of a prototype SEP will generally provide a “fill in the blanks” disclosure statement designed to satisfy ERISA's annual reporting requirements.

An employer must also provide each employee annually with a statement showing the amount contributed to the IRA on the employee's behalf. This requirement is satisfied if the information is recorded on an employee's Form W-2. If the employer cannot locate an employee, the IRS may require that the employer file reports with the IRS for the employee.

There are serious implications if an employer fails to do so. You might ask for a "Plan Disclosure Statement."

Hope this helps.

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