Maximum contribution to EE's SARSEP

[Guest ERISA_kid]

Participant earns $65,000/year from a plan sponsor. Participant makes elective deferrals of $12,000 into his SARSEP plus an additional $2,000 in catch-up deferrals since he is over age 50. For purposes of determining the ER's maximum deductible contribution, I'm hopelessly confused between IRC Sections 402, 404, 414, and 415. For purposes of the 25% limit under 402(h), is the EE's compensation based on $65,000, $53,000, or $51,000 and are the elective deferrals (including the catch-ups) excluded from the 25% limit? Any insight would be greatly appreciated.

[Appleby]

IRS Form 5305-A SEP states…

The maximum amount that you may defer to a SEP for a calendar year is limited to the smaller of 25% of compensation or the section 402(g) limit. The 25% limit is reduced if your employer makes nonelective contributions on your behalf to this or another SEP for the year. In that case, the total contributions on your behalf to all such SEPs may not exceed the smaller of $40,000* or 25% of compensation.

5305-A SEP also states that

Compensation does not include any employer SEP contributions, including elective deferrals.

-- in your example, for purposes of the 25 % limit, compensation would be based on $53,000

Catch-up contributions are not subject to the 25% limit. See http://www.irs.gov/pub/irs-pdf/f5305ase.pdf

[Gary Lesser]

Agreed. It should also be noted that unlike the normal elective contribution, the catch-up amount does not reduce the compensation upon which the 25% exclusion limit is computed. It would appear that the $14,000 is deductible, excludable, and does not violate 415. Compensation differs depending upon the limitation being applied.

Regarding the sections you mentioned, in general:

402(h) -- the 25 percent exclusion limit (one of two limits under this section) is based on compensation (within the meaning of section 414(s)) but excludes normal elective contributions only (see section 414v) . [$12,000] The sum of nonelective and normal elective contributions are subject to this limit. [$53,000] The catch-up amount [$2,000] is separately excludible. [(.25 x $53,000) plus $2,000]. The $40,000 limit under THIS section is reduced if the plan is integrated (model plan's are not integrated). When an employer makes nonelective contributions that would cause this limit to be exceeded, elective contributions are reduced as necessary (and the ADP test may have to be rerun).

Note: This limit is not contained in the plan (it is not a required plan provision). Compensation, as defined in the plan, has nothing to do with this limit. It a limit that applies to each participant. Designing a plan around this limit is often most productive (since it is equal to or less than the deduction limit). The allocation limit in the model SARSEP plan, prevents this limit from being exceeded.

Note: Compensation for allocation purposes, generally include elective contributions. An employer may elect to exclude elective amounts for this purpose. See IRS Pub 560, Section 1, definition of compensation.

Note: Compensation for ADP testing, however, includes elective deferrals.

If self-employed earning $65,000 (after reduction for 1/2 SE tax deduction and nonowner contributions), then this limit would be based on $53,000 (further reduced by any employer nonelective contributions). The catch-up amount [$2,000] is separately excludible.

404(h) & (n) -- The 25 percent deduction limit (which may be higher than the amount that can be excluded from a participant's gross income under section 402(h)) is based on $65,000. The normal elective and catch up elective contributions are separately deductible. [(.25 x $65,000) plus $14,000]

If self-employed earning $65,000 (after reduction for 1/2 SE tax deduction and nonowner contributions), then this limit would be based on $65,000 (further reduced by any employer nonelective contributions).

415 -- The $40,000/$42,000 limit applies. The 100 percent limit is based on $65,000. Both limits apply to a SEP/SARSEP.

If self-employed earning $65,000 (after reduction for 1/2 SE tax deduction and nonowner contributions), then this limit would be based on $65,000 (reduced by any employer nonelective contributions).

414 -- This section (controlled, related, and affiliated employers, and other definitions) generally applies to a SEP/SARSEP which is a defined contribution plan.