Integrated SEP Plan maximums

[Guest rffahey]

I read Gary's comments about how it is not possible to maximize a business owner with maximum compensation at $40,000 if his SEP plan is integrated with Social security. Can you elaborate on this in detail ? This is not the rule with profit sharing plans.

Does it also apply to SAR SEP plans ?

[Gary Lesser]

It is possible that the $40,000 limit under Code Section 415 will be reached because of the application of the annual compensation limit and the 25 percent limit on allocations. Code Section 402(h)(2)(B) states that the maximum dollar amount that can be allocated each year to an HCE’s SEP IRA ($40,000 for 2003) is “reduced . . . by the amount taken into account with respect to such employee under section 408(k)(3)(D).” Code Section 408(k)(3)(D) does not provide a concrete amount, but instead refers to “the rules of 401(l)(2),” which are the integration rules. For the reasons that follow, it appears that the language of Code Section 402(h)(2)(B) means that the $40,000 amount is reduced by the product of the disparity rate (generally 5.7%, 5.4%, or 4.3%) and the compensation of the HCE up to the plan’s integration level.

Under the law applicable to taxable years beginning before 1983, Code Section 219(b)(7) provided that the dollar limit (then $7,500) was to be reduced by “the amount of tax taken into account with respect to such employee under . . . 408(k)(3).” Also under prior law, FICA (Social Security) taxes were treated as employer contributions for purposes of complying with the SEP requirement in Code Section 408(k)(3) that contributions be a uniform percentage of compensation. Senate Report No. 1263 [95th Cong, 2d Sess 93 (1978)] suggested that integration could be accomplished as follows: the employer’s contribution will be an amount equal to x percent of compensation, up to a maximum of the lesser of $7,500 or 15 percent of compensation offset by the employer’s share of Social Security taxes paid on behalf of the employee. [see pre-ERISA Treas Reg § 1.401-12(h)(3)(i), 1.401-12(h)(3)(ii).]

According to the way SEP integration used to work, it appears that the language in Code Section 402(h)(2)(B) means that the $40,000 amount is reduced by the disparity rate multiplied by the compensation of the HCE (not in excess of the plan’s integration level). The disparity rate is the excess contribution percentage reduced by the base contribution percentage.

Informally, the IRS has indicated that the Section 402(h) reduction does apply. Representatives of the American Society of Pension Actuaries (ASPA) met with James E. Holland, Jr., Chief, Actuarial Branch 1, and Richard Wickersham, Chief, Projects Branch 2, of the IRS, on September 25, 2001, in Arlington, Virginia. The meeting served as the basis for discussions at ASPA’s 2001 National Conference, IRS Q&A, No. 65(v). The statements of these IRS representatives do not represent official positions of the IRS; nor were they reviewed or approved by the IRS or the Treasury Department. See, too, page 6 of IRS prepared chart (attached) or click link to IRS.gov.

http://www.irs.gov/pub/irs-tege/cd_comp_chart.pdf

When the intent is to place a $40,000 limit on total retirement contributions, the foregoing interpretation seems to make sense as a policy matter—it puts the amount deemed to be contributed by the employer under Social Security into the same category as the SEP contributions. Notwithstanding that the IRS has approved SEP arrangements that provide for a nondiscriminatory contribution of a flat dollar amount per hour for each participant [Ltr Ruls 8824019, 8441067], the interpretation presented above is also in keeping with the structure of Code Section 408(k)(3), which, while calling for a uniform percentage to be contributed under the SEP arrangement, in effect allows the employer to consider FICA contributions to be SEP contributions.

For 2003, the maximum offset produces an exclusion limit of $35,041 ($40,000 - ($87,000 x 5.7%)) ($37,041 with catch-up). Prior years' limit of 15 percent and a lower compensation limit made this a moot issue for the last several years. [iRC Sec 402(h)(2)(B)] If the plan were integrated at $1, the 2003 maximum elcludable contribution for an HCE is $39,999.94 (plus catch-up contributions).

CHARTIRS.pdf