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SEP excess contribution - How to handle this error.


Guest Bette N
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Guest Bette N

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Last fall I advised a client to pay himself (president of an S corporation with a calendar year-end) a salary and to open a SEP. He opened and funded a SEP; however, he did not pay himself a salary all year. Therefore, the SEP has an excess contribution. If the contribution is withdrawn before June XX, 2001, there is a $140 bank penalty. Can we (1) extend his personal and corporation returns, (2) withdraw the excess funds in June, (3) pay the excise tax on the earnings only (4) redeposit all the money back into the corporation to reverse the transaction (in effect) and declare interest earnings? (5) If so, is the excise tax 6% or 10% and (6) is it reported on the corporate return? My interpretation is that the excess must be withdrawn by the due date of the corporate return, plus extensions, and that only the earnings will be subject to the excise tax. Thanks for your help.

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Bette N

Bette N

Joined Feb 2001

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Such an excess contribution to a SEP IRA is corrected as follows.

1. The employer amends the employees W-2 to include (or treat) the contribution amount as wages

2. The participant- employee must notify the IRA custodian to re-designate the excess contribution as an IRA participant contribution for the year the contribution was made.

3. The participant-employee had tax-filing deadline, plus any IRS granted extension to remove the excess. The deadline is for the INDIVIDUAL NOT THE COMPANY/EMPLOYER

If the excess is removed timely, the attributable income (EARNINGS) will be treated as income and be subjected to ordinary income tax and 10% early withdrawal penalty if the individual is under the age of 59 1/2

If the excess is not removed by the above stated deadline, it will be removed by a "return of excess after the deadline" If the amount is $2000 or under, it will be reported as a non-taxable distribution. The individual must ensure that the custodian reports it as such. It is more than $2000, then it will be subjected to early withdrawal penalties (10%) is applicable and ordinary income tax. Also, the earnings do not accompany the excess at this point.

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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