Allocation limits

[rcline46]

I looked at the 5305-a-Sep and the rules, and a SARSEP document from American Funds. They all seem to say that the allocation to an individual is limited to the LESSER of 25% of pay or $49,000.

I thought this was changed in 2002 with EGTRRA, and in fact 1.408-1(d) says the limits are from 415. This of course is now 100% or $49,000. Is there another reg that limits SARSEP, or is everyone not updating (including the IRS!) because they cannot be established since 1997?

Note this limit is NOT mentioned in the 5305-SIMPLE forms.

[Lou S.]

I think it is probably a deduction issue under 404(h)(1)© which still limits the deduction to 25% of pay.

[rcline46]

I have no problem with the deduction limit. Remember we are speaking of a SARSEP, so we have the $16,500 deferral (which for some strange reason is ALSO capped at 25% of pay!). So if pay is in the right range, one could have $15,600 plus 25% of pay er contribution.

For example, someone making $80,000 defers $16,500 or 21% of pay. Company wants to deposit 25% of pay or another $20,000. The document limits the whole shooting match to $20,000! I can't find justification for this in the regs, but we also can't violate the documents.

THe IRS 5305 series even says to combine with other SEP plans for the 25% limit.

[Guest Sieve]

Look at IRC Section 402(h)(2).

[rcline46]

What a weird place to find it! Actually 402(h)(1)(B) is the real killer - the way I read this section, elective deferrals are NOT treated as ee contributions to a SEP! Since they are not ee contributions, they must be ER contributions, and then 402(h)(2) limits the total to 25%

Double bummer - time to get a qualified plan!

[Guest Sieve]

Actually, IRC Section 402(h)(1)(B) is a positive--it permits employee deferrals into a SARSEP not to be considered distributions (as IRC Section 402(e)(3) does for qualified plans). Without it, those deferrals would be taxable as distributions under the constructive receipt doctrine (which says that it's income if you have a choice to turn taxable income into a non-taxable item).

Notice that IRC Section 402(e)(3) treats employee deferrals as employer contributions. Deferrals ARE employer contributions from the IRS perspective, and always have been, meaning that their basis is $0 for tax purposes (just like a non-elective employer contribution), while a true employee contribution--i.e., after-tax--has a basis. And, employer contributions (including deferrals) are decutible by the employer, but not so for emplyoee contributions.

The deduction provisions recently were amended to exclude employee deferrals from the qualified plan's 25% deduction limitation (with EGTRRA, effective 1/1/2002--see IRC Section 404(n)), but before that amendment employee deferrals were included when calculating the overall 25% of compensation deduction limitation. As you point out, that 25% deduction limitation still includes SARSEP elective deferrals (i.e., there is no provision comparable to 404(n) for SARSEPs).