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Correcting a SEP with Excess Contributions


Guest bpsep
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Hi everyone,

I am a small business owner and operate a SEP plan for myself and an employee. I recently switched accountants and my new accountant has discovered a problem with how my SEP has been operating for the past 8 years. The problems include:

  • The previous accountant was using both my W-2 wages and my K-1 passthrough in determining my SEP contribution when he should have only been using W-2 wages. Thus my allowed SEP contributions have been computed much to high (a total of about $185K excess over 8 years).
  • The previous accountant was not taking the deduction for the SEP contributions on the corp return - the deductions were being placed on my personal return line 28.

My new accountant is suggesting that we can self correct this problem by:

  • Amending my tax returns (both corp and personal) for the past 8 years to take the deduction correctly on the corp return.
  • Paying the 6% penalties for the past 8 years (compounded) on the execess contributions (and any investment income realized on those contributions).
  • Not distributing the excess contributions from the plan - but continuing to pay the 6% penalty going forward until my allowed contributions "catch up" to the excess contributions that we previously made.

While this proposed remediation seems logical to me I am somewhat concerned after reading the EPCRS procedures. I am concerned that given the dollar amounts involved and the length of time this has been occurring that this is not something that can be self corrected and that going with the VCP is both necessary and prudent. I don't want to go through the lengthy process that the new accountant is proposing without some reasonable level of assurance that I will end up with a SEP plan that is in compliance.

Does anyone have thoughts on this? Thanks!

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Before you can determine whether you have a plan or a reporting issue you must first determine WHY WERE amounts paid on a K-1 to an owner and employee of this corporation?

Once realizing that the amounts reported on the K-1 were probably subject to FICA and FUTA and that the "disquised dividends" were in fact compensation, most of the plan problems would be resolved. Unlike the 6% penalty, social security taxes are only paid once. Perhaps, reissuing the reporting forms will be far less costly and more effective. Of course I could be wrong, but this fact pattern comes up all too frequently. Generally, the payment (of compensation) on the K-1 is treated as a dividend and made to avoid social security taxes (and without a valid reason).

[see Simple, SEP, and SARSEP Answer Book Q 2:63, and discussion in Q 6:14]

Yes, the SEP plan contribution deductions should be claimed on the corportate return.

The proposed fix you mentioned would also work, but may be overkill and rather expensive. I would estimate between 35-50% (actually more) would be given away in taxes, penalties, and interest Also, there is a 10% tax for making a nondeductible contribution. The 10% penalty is also cummulative. Oops (at 16%) there is nothing left.

Clearly there may be (or is) a better ways to handle this issue. I don't see using the EPCRS when there are comparable (if not better) Code fixes.

Hope this helps.

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Gary, - Presumably it's an S-Corp, so W-2 and K-1 is SOP. But bpsep is correct, K-1 income is not plan compensation.

8 years? Can you even amend returns that far back? Statute of limitations is 3 years.

Continuing to pay 6% per year doesn't seem like a good idea. Why not take out the excess and stop the bleeding? I mean as a U.S. taxpayer, I'll thank you for your voluntary contribution to reduce the national debt if that's what you want to do.

I carry stuff uphill for others who get all the glory.

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Thank you for the response and insight!

Before you can determine whether you have a plan or a reporting issue you must first determine WHY WERE amounts paid on a K-1 to an owner and employee of this corporation?

Once realizing that the amounts reported on the K-1 were probably subject to FICA and FUTA and that the "disquised dividends" were in fact compensation, most of the plan problems would be resolved. Unlike the 6% penalty, social security taxes are only paid once. Perhaps, reissuing the reporting forms will be far less costly and more effective. Of course I could be wrong, but this fact pattern comes up all too frequently. Generally, the payment (of compensation) on the K-1 is treated as a dividend and made to avoid social security taxes (and without a valid reason).

[see Simple, SEP, and SARSEP Answer Book Q 2:63, and discussion in Q 6:14]

Yes, the SEP plan contribution deductions should be claimed on the corportate return.

The proposed fix you mentioned would also work, but may be overkill and rather expensive. I would estimate between 35-50% (actually more) would be given away in taxes, penalties, and interest Also, there is a 10% tax for making a nondeductible contribution. The 10% penalty is also cummulative. Oops (at 16%) there is nothing left.

Clearly there may be (or is) a better ways to handle this issue. I don't see using the EPCRS when there are comparable (if not better) Code fixes.

Hope this helps.

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shERPA - thanks for the insight and thoughts.

Gary, - Presumably it's an S-Corp, so W-2 and K-1 is SOP. But bpsep is correct, K-1 income is not plan compensation.

8 years? Can you even amend returns that far back? Statute of limitations is 3 years.

Continuing to pay 6% per year doesn't seem like a good idea. Why not take out the excess and stop the bleeding? I mean as a U.S. taxpayer, I'll thank you for your voluntary contribution to reduce the national debt if that's what you want to do.

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