Sarsep

[Guest cypress]

I participate in a SARSEP plan. I have been doing some research and discussing this with Fidelity but believe they are not confident in the answer they have given me. My questions is this, for 2002, does the maximum contribution to the SARSEP increase from 15% to 25%. This is the only retirement plan we have and I would like to make sure all employees get the maximum benefit available to them. Thanks.

[Gary Lesser]

Although the overall SARSEP deduction limit was increased by EGTRRA to 25%, the amount that can be excluded from income remains 15% of TAXABLE compensation. A technical correction is likely, but the law still reads 15%--so that is the answer.

[Guest Michael Burns]

This is just to say that it would seem reasonable for the IRS to come out with some sort of guidance, but as of Dec. 31, I don't see any. This is a really tough problem for people with SARSEP clients.

Let me know if you hear anything - even if it is a mere rumor on how this is to be resolved!!

[Gary Lesser]

IN GENERAL AND UNLESS CHANGED BY A TECHNICAL CORRECTION:

Note: How the section(s) is/are changed is important, see discussion later.

1) SEP Deduction Limit - The employer may claim a deduction for contributions (including elective deferrals) to the extent contributions do not exceed 25 percent of all participant's aggregate compensation (determined without reduction for elective contributions). But see item 3.

2) The IRC 415 limits of 100 percent and $40,000 apply, but rarely so, unless there is second SEP or or qualified plan maintained by the employer. Employers will not generally contribute more than they can deduct (item 1) and, unless corrected, even less -- that is, more than can be excluded from a participants income (item 3)

3) SEP Exclusion Limit - Amounts allocated to a participant's account are included in income (treated as W-2 wages, or not deducted if self employed) to the extent that the contribution (including elective deferrals) exceeds the lesser of:

a. 15 percent of compensation includible in gross income, or

b. $40,000 (reduced if the plan is integrated by the spread percentage (max 5.7%) times the plan's integration level (max $84,900)). Thus, the maximum that could be contributed in a SEP plan that is fully integrated at the taxable wage base would be $35,160 (40,000 - ($84,900 x .057)).

Note: Under EGTRRA, elective deferrals are not seperately deductible (25% limit), nor excludible (15% limit), and are included in determining the $40,000/100% limit

DISCUSSION: Although the EGTRRA did not make any changes to the rules regarding the participant's exclusion of SEP and SARSEP contributions under Code Section 402(h), technical corrections are likely to be forthcoming. It is unclear to what extent Code Sections 402(h) will be changed, if at all. The practitioner will need to examine any change by taking into account the following:

1. Whether the "percentage limit" (currently 15 percent) on the exclusion of contributions from a participant's income, is increased (i.e., to 25 percent). [iRC § 402(h)(2)(A)]

2. Whether elective contributions (within appropriate limits) are excluded from a participant's income in addition to the percentage limit (up to the $40,000 aggregate limit under Code Section 415).

3. Whether elective contributions continue to be excluded for the purpose of applying the percentage limit, thus requiring that only "includible" (taxable) compensation be considered [iRC § 402(h)(2)(A)]

4. Whether the reduction to the $40,000 (for 2002) limit should continue to apply when the plan is integrated. [iRC § 402(h)(2)(B)] With a projected taxable wage base (TWB) of $84,900 for 2002, the maximum SEP contribution for 2002 would be $35,160.70 ($40,000 - ($84,900 x .057)) in a plan fully integrated at the projected TWB amount. The language of Code Section 402(h)(2)(B) would appear antiquated and inconsistent with current legislative intent.

5. Whether the compensation cap of $200,000 under Code Section 401(a)(17) for 2002 will apply for the purpose of the percentage limit, which in the authors opinion, it has never been subject to, although it does apply to Code Section 415.

6. Whether elective contributions (within appropriate limits) are deductible by the employer in addition to the 25 percent of aggregate compensation deduction limit (but not in excess of the $40,000 per participant limit under Code Section 415). [iRC § 404(n)].

I submitted a comment to Treasury and Senate officials on July 18, 2001, proposing the following changes be made to address these issues:

(I) Advocating the use of a NEW form (Form 5500-S) for SEP reporting and compliance. Esentially this form would cover coverage, contribution, and (although seldom needed) bonding requirements. The one page form would be easy to complete.

(II) Amend Code Section 402(h)(2) (dealing with the exclusion from income) as follows:

"Limitations on Employer Contributions. - Contributions made by an employer (other than elective deferral contributions made pursuant to an arrangement under section 408(k)(6)) to a simplified employee pension with respect to an employee for any year shall be treated as distributed or made available to such employee and as contributions made by the employee to the extent such contributions exceed the lesser of -

(A) 25 percent of the compensation [Authors Note: Or "includible compensation," see item 3 above] (within the meaning of section 414(s)) from such employer for the year (determined without regard to the employer contributions to the simplified employee pension), or (B) The limitation in effect under section 415©(1)(A). "

(III) Strike the remainder of Code Section 402(h)(2)(B).

(IV) Amend new Code Section 404(n) (dealing with the 100 percent deduction rules for elective deferrals) as follows:

"Elective deferrals (as defined in section 402(g)(3)) shall not be subject to any limitation contained in paragraph (3), (7), or (9) of subsection (a), or subparagraph © of subsection (h)(1), and such elective deferrals shall not be taken into account in applying any such limitation to any other contributions."

Amounts (including elective contributions) that exceed the exclusion limit (currently 15%) should be reported as "wages" on an Employee's Form W-2. In most likelyhood, this will eliminate the 10 percent nondeductible contribution penalty tax under Code Section 4972.