Errant SEP contribution

[Guest pmetallic]

Last year the rank and file received a 10% SEP contribution. Due to miscalculations of partners' income, the partners received a bit more than 10%. What are the ramifications and what are the options for correction?

[Gary Lesser]

Treat the amount above 10 percent (as computed below) as "wages" on Form W-2 for 2003. The amounts are now treated as IRA contribution by employee to traditional IRA (trustee will recode if requested). Individual's must remove any excess (over traditional IRA limits 100%/$3,000/$3,500) by Federal tax return due date (with gain) to avoid penalties on exess contribution. Gain may be subject to penalty if under age 59-1/2 unless another exception applies.

See, Prop Treas Reg Section 1.408-7(e) and example in (f). Under the proposed regulations the amount contributed not in accordance with the formula is treated as not contributed under the SEP. [The example omits details for the second employee "B"; they are: $11,500, $10,000, $1,500, and 15%.]

Calculation: .10 X ((Pre-plan compensation + allocation) / 1.10) = deemed contribution (the excess amout treated as wages, subj to FICA and FUTA). In essence, the excess amount is added to pre-plan compensation, then allocated, here 10 percent. So, employees that should have gotten 10 percent originally will wind up with slightly more than 10 percent (of their original compensation) in the end.

Although not required, a notice to employees would be helpfull in removing the excess properly and explain why their W-2 is higher, and that they have "made" deemed traditional IRA contributions because of the error.

Hope this helps.