integrated SEP for sole prop

[Guest Bob Monte]

It appears that it is permissible to have a SEP that is integrated with SS and that has a flexible yearly contribution. However, for a sole proprietor it seems that calculating the allowable contributions set ups a circular reference (in addition to the normal one that limits the deduction to 13.04%). With a set, required %, the calc seems pretty straight forward, but with a non-required, flexible contribution, I seem to run into a deadend. It seems to require that the gross contribution amount be selected first and then the employee allocations calculated in a multi-step process that does not allow for the self-employed limitation. Or am I just confusing myself on something simple?

[Calculation shown below based on facts in later posts - GSL]

[Gary Lesser]

Yes, contributions for non owners reduce the pre-plan EI amount, and affects the 1/2 reduction for Self-Employemnt Tax. And the owners contribution (generally an unknown) must also be considered to arrive at plan compensation. W-2 income (if any is earned by the SE) must also be considered, as well as any SE g/l from unrelated entities. The math is circular and interdependant, but inexpensive software is available. You might wish to check out "QP-SEP Illustrator" in the software section of BenefitsLink.

[Guest Bob Monte]

Ok, I'll check it out.

I'm not sure I asked the question properly as your answer didn't really address it.

I checked with a custodian and was yold that you cannot use an SEP with SS integration unless it is a SARSEP. Is this right? I amunder the impression that you can start a new SEP with SS integration either on a fixed % basis (which to me sounds very similar to a money purchase plan) or a flexible % that can vary yearly and this calcs on this method is what I asked about.

Can you indeed integrate with SS with a new SEP?

[Appleby]

You can integrate a SEP with social secuity. However, this cannot be done with the IRS Form 5305-SEP.

Most custodians who adopt a prototype SEP, includes the SARSEP provision on the prototype form. However, the SARSEP provision has nothing to do with SSI, it ( the SARSEP provision) just happens to be on the SEP form that alos allows for SSI.

[Guest Bob Monte]

That's how I read it all, too. You are absolutely right about the form. There are sections that are specifically labeled for the SARSEP and the other areas must then be for any SEP and those sections allow for integration as in my previous post. So when I try to understand their allocation method for a flexible %, I get lost wen trying to apply it to a self- employed.

Obvioulsy, trying to have them explain that will be useless when they are telling me that you can't have SS integration period.

Maybe this is just their prototype method. If there is some IRS method, what is it or can you direct me to it.

Again.....the main question deals with the actual calcs for allocation of SEP contribution for a self-employed when integrating with SS and having a flexible yearly contribution %,

Maybe I should cut and paste the actual rules as in the prototype.

[Gary Lesser]

Since the calculations are iterative, software is required when the non-owner contribution rate/amount is not known. This is generally the case, since the percentage needed for the owner can't be determined until after the non-owner percentage determined. See QP-SEP Illustrator in the software area of BenefitsLink.

GO TO http://www.BenefitsLink.com/GSL/index.html

[Gary Lesser]

Bob,

If you only need one set of numbers run, please provide me with the 2001 pre-plan EI of each owners and the W-2 wages of each non-owner. I'll also need to know in respect to owners whether there is any self-employment g/l from unrelated entities and any W-2 income for that owner. Also please indicate how much is desired to be spent or if your looking for a 15% contribution. If integrated, please specify the integration level.

[Guest Bob Monte]

Ok Gary, let's try these numbers.

There is one owner/employee (with $40,000 of W-2 income from another source) who has Schedule C income of 132,000 which already accounts for other employees' wages but not any contribution for retirement since this is not yet known.

There is a SEP plan with SS integration at the base wage level. There are two other employees both earning $25,000 in W-2 wages. I want to maximize the contribution for the owner.

Is there more you need to know?

[Gary Lesser]

The calculation you requested follows:

A SEP contribution of $22,609.39 would give the owner (who also has $40k of W-2 income from a nonadopting nonrelated entity) a maximum 15% contribution (integrated at the 2001 TWB of $80,400).

Owner (15%) $15,781.45 (1/2 SE Tax $4,180.95

E/ees $3,413.97 each.

Proof: (assuming SS tax is correct!):

.15 X ($132,000 - $6,827.94 - $4,180.95 - $15,781.45) = $15,781.45

[sET tax calculations shown in later message - see below)

If the integration level is changed to 20% of the TWB ($16,080 for 2001) a smaller contribution ($21,975.03) would yield more dollars to the owner, as follows:

Owner (15%) $15,875.14 (1/2 SE Tax is $4,190.70)

E/ees $3,049.95 each

The integration level can be changed by amendment (and notice of amendment and its effect to employees). IMO, the amendment must be made on or before the date contributions for the year are actually made (others think by 12/31 and before contribution is made).

Hope this helps. Are all eligible employees of related entities (if any) reflected in your information?

[Guest Bob Monte]

If I understand the rules right, I have no related entities.

Thanx for the help. Just two more points.

One, I assume that I need the software to come up with those results...??? since it seems impossible to do otherwise.

Two, are the results reliable and does it provide some sort of documentation or printout to show the ee and er calcs in case of IRS audit??

[Bill Berke]

I noticed that documents have been barely mentioned in this discussion. I, personally, have never seen an integrated prototype. I have been told that some insurance companies sponsor an integated SEP document. Whether or not the document contains SARSEP language, it must contain, at least, an integrated allocation formula. I suggest you read the entire document, not just the adoption agreement.

[Gary Lesser]

There is a 6 page printout that has all of the numbers and limits. The program (QP-SEP Illustrator) has been in existance for over 10 years and provides acccurate answers. The software can be ordered on BenefitsLink or by calling me at 317-254-0385 (during business hours). It also handles SARSEPs.

Most prototype SEPs permit integration. Some provide for SARSEP contributions.

[Guest Bob Monte]

Ok thanx Gary. You've been a big help. The software will be useful whatever I do, I think.

Bill, I have a prototype but it doesn't really have a formula but a procedure. But because of the circular references it doesn't make much sense for a self-employed. I called the sponsor and unbelievably I was told you could not have a SEp with SS integration. So I didn't bother asking them any more questions. This person knew less than I did and knew nothing about all the changes enacted this year. A real pro!!!!!

Without this board I would never have been able to sort thru all this.

[Bill Berke]

Bob, your experience is quite common. Vendors' staff are not technical, they are only trained to answer common, simple questions to enable the money to come under management. What a surprise!! Gary is the all time pro in this area and I repeat that I have never seen an integrated SEP prototype. But, the few SEPs I've been a consultant to were all with various stockbrokers (Schwab etc.) and maybe the insurance industry has integrated plan documents. Still, what bothers me is the whole purpose of the SEP is to let an employer easily understand how the plan works, and self operate by being able to figure out eligibility and allocation (non-integrated). An integrated SEP must be calculated by someone with some pension knowledge - not the case at an employer or even at most vendors. And I have a very healthy skepticism regarding insurance companies back office competentcy and servicing.

One other thing, especially with small business owners (almost all my clients) 401(a)(10), via a reference to 401(d), limits compensation that can be considered to the business that has adopted the plan. So, if your client has two (or more) sources of earned income, then each of his/her unincorporated businesses must adopt the plan to use that business's earned income for SEP purposes

[Guest Bob Monte]

I agree 100%, but what kind of assets will you gather when you can provide no answers. This is all probably why the small business retirement area is so underdeveloped and what amonut of business is done is a lot of annuities thru an insurance company. See even if they have the same "no answer" problem. whatever assets already gathered by the time the client gets tired if getting run around probably won't be lost. But the really worst part is getting wrong answers and people not being able to take full advantage of the law or getting in a big mess with the IRS.

I better get off ny soapbox.

[Gary Lesser]

Just an added note: The four-step integration leval assures that all employees get up to 3 percent (of compensation). Thus, the employer will always satisfy the top-heavy test (without having to test). After that, the remaining contribution is allocated (and maximum spreads reduced to take into account the 3 percent already allocated (5.7% reduced to 2.7%)). BOTH methods produce EXACTLY the same results PROVIDED at least 3 percent is contributed. [That is, a base percentage of at least 3 percent when the formula method is used.]

[Guest sabecker]

Can an IRA owner convert parts of a traditional IRA to a Roth at different times? For example, if the IRA holds several stocks could one particular stock be converted now and another stock converted at some time in the future?

[Gary Lesser]

In general, yes. Conversions are not limited to thee "one in 12-month" rule and are treated as distributions to the IRA owner regardless of how transferred. If eligible to make a conversion, and no part is a required minimum distribution nor a periodic payment excepted under Code Section 72 from the 10% penalty, a step conversion is possible. Keep good records in the event you need to make a withdrawal (of a converted amount) and/or are under age 59 1/2.

[Gary Lesser]

If 72(t) applies, then the entire amount in that IRA would have to be converted. Otherwise a "modification" would be deemed to occur.

[Guest sabecker]

If 72(t) applies it means that the IRA must be making at least annual distributions (substantially equal). And the IRA distributing under 72(t) may not be modified at all. So wouldn't any conversion, regardless of one stock or the entire balance, be a modification of the IRA? This raises one other question, though. Can the 72(t) distribution itself be converted to the Roth? I would think not, that it would need to be treated as a regular Roth contribution, but I have no cite for that reasoning.

[Gary Lesser]

The conversion of the entire IRA to a Roth IRA is permitted so long as the substantially equal payment stream continues from the Roth IRA. [Treas Reg Sec 1.408A-4, Q&A 12]

[LIBERTYKID]

A SEP contribution of $22,609.39 would give the owner (who also has $40k of W-2 income from a nonadopting nonrelated entity) a maximum 15% contribution (integrated at the 2001 TWB of $80,400).

Owner (15%) $15,781.45 (1/2 SE Tax $4,180.95

E/ees $3,413.97 each.

Proof: (assuming SS tax is correct!):

.15 X ($132,000 - $6,827.94 - $4,180.95 - $15,781.45) = $15,781.45

Hi Gary.

Just wondering how you got the social security tax in the above example. I assume you take (80400-40,000) * .124 and then

net self employed comp. x .029 but I don't total up to $4,180.95.

[Gary Lesser]

The method used by the IRS (see page 2 of Schedule SE (Form 1040)), is used below, to yield $4,180.94 (1/2 of the IRC 164(f) deduction)---

SEP plan formula: $22,609.39 contributed OR 13.65587 percent of compensation up to $80,400 plus 19.35587 percent on compensation in excess of $80,400 (up to $170,000 for 2001)

Pre-plan: $132,000 owner

2 employees earning $25,000 each

Allocations: (A) $15,781.45, (B) $3,413.97, © $3,413.97.

$132,000.00

- $6,827.94 (non-owner contribution - 100%)

=$125,172.07

x .9235

=$115,596.41 (line 6)

$80,400 (twb)

-$40,000 (credit for W-2)

=$40,400 (line 9)

x .124 (6.2% x 2)

=$5009.60 (line 10)(lesser of line 6 or line 9 x 12.4%)

lesser of line 6 or line 9 x .029 = $3,352.29 (line 11)

line 10 + line 11 = $8,361.89/2 = $4,180.94