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SEP Noncompliance corrections


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We are a CPA firm & a new client provided a copy of her business' SEP prototype document. We discovered the plan has the following noncompliance issues:

  1. The document was adopted by the business when it was a sole proprietorship & wasn't restated when the business converted to an S-corp. SEP contributions continued to be taken after becoming an S-corp. All SEP contributions were made on behalf of the owner only.
  2. The document indicated "no age or service" requirement, however, the client applied the 3 out of 5 year statutory eligibility requirement. There were 3 eligible employees that were excluded.

To correct the document failure, we would file under the IRS VCP.

We would also correct the excluded employees under the VCP, however, regarding the method to correct; can the deductions for the excluded years be allocated prorata among the owner & the employees & have the employees' shares transferred from the owner's SEP-IRA to newly created SEP-IRA for the employees? I know the regulations forbid reducing an employee's original SEP allocation as a means to correct, but does it matter if the employee is an owner?

Any advise would be appreciated.

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  • 1 month later...

Yes, VCP, but not SCP.

An egregious error (which this is) can only be fixed with Service approval (submission of application under EPCRS required). There are competing approaches (disqualification under Code; or fix as excess* or making restoration under the EPCRS) that could be used (considered) depending upon how long this has been going on for. I do not think the Service would entertain the idea of a simple distribution to fix this (see EPCRS 6.11)

Absent some sort of scrivener's error (doubtful), for earlier years I can not see using any age or service requirement. All employees are eligible!

The Service could also impose additional fees because of the egregious error.

See EPCRS Sections 4.11 and 12.06.

A reallocation is not a sanctioned method; and would only make matters worse. SEPs are very unforgiving.

Hope this helps.

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