SEP Excess Amount

[Guest jrob]

Just took on a new client for 2010 filing year and, as always, reviewing prior 3 years returns. Big problem in 2007, s-corp with 2 owners each contributed $45,000 ($90,000 total) to SEP on $50,000 each of W-2. They claim fidelity, the broker who established SEP plan, told them they could include income reported on K-1 from s-corp in determination of compensation for contributing maximum amount. I disagree. I think each has $28,500 excess amount in SEP ($45K less SEP of $50K*.25 plus $4,000 IRA) .

I've already advised them of the issue and necessity to correct ASAP. If we follow SCP procedures, I know contribution is not deductible by corporation...but which year.? Do we amend 2007 1120S or recognize income in 2011 when we remove excess contribution from plan?

What about VCP, if we use this procedure and leave money in plan paying the 10% penalty, does corporation lose deduction. If so, which year? Or does corporation keep deduction under VCP? If so, 10% penalty might be cheapest way to clear this up. Another question comes to mind on this (sorry, I ramble) regarding interim years. If owners were taking salary in 08, 09 & 10 but made no SEP contributions, could these reduce the excess amount as of today and hence the balance on which the 10% penalty is paid for the VCP agreement. Am I thinking of this correctly? I know there is an excise tax of 10% cumulative each year the excess is left in. Isn't the purpose of the VCP suppose to be in lieu of that excise tax...akin to getting a slap on the wrist for bringing the problem to their attention vs. waiting for an audit. I haven't run the numbers but they may have even used up all excess in these three years, in which case maybe excess amount is extinquished and the only cost of VCP is the $250 flat fee. But then, deduction then becomes an issue if they lose that.

Also, I'm looking into adopting solo 401(K) for 2011 whereby returned excess amount from 2007 can be recontributed into a solo 401(k), thereby creating a net-zero impact if SEP income and deduction for 401(k) contribution both hit in this year. This, of course, will only work if SEP excess comes into current year, not into prior year (2007) requiring amended returns & penalties and so forth. Seems I read somewhere that correction procedures did not require amending prior years returns in order to correct an excess amount in a retirement plant, that everything was accounted for in current year.

Client asked me this question, and of course my answer was that they need to correct the issue and pay any taxes or penalties, but they were wondering what the chances of getting audited or reviewed were at this point (2007 return 1120s was filed under extension on 9/15/08). I agree that there is no statue running as has been discussed on this board ad nauseum. However, given the amount of time so far, how likely is this to get inquiries or audits from the IRS. Wouldn't something have happened by now if it were going to?

[Gary Lesser]

...the broker who established SEP plan, told them they could include income reported on K-1 from s-corp in determination of compensation for contributing maximum amount. I disagree. I think each has $28,500 excess amount in SEP ($45K less SEP of $50K*.25 plus $4,000 IRA) .I've already advised them of the issue and necessity to correct ASAP. If we follow SCP procedures, I know contribution is not deductible by corporation...but which year.? Do we amend 2007 1120S or recognize income in 2011 when we remove excess contribution from plan?

You are correct, it is a dividend (and not plan compensation). Arguably, it could be changed into W-2 income (especially since it probably shouldn't have been on a K-1. The year is the year the excess w3as made. Excesses are subject to a 10% per year employer penalty until coreected.

Was broker's advice in writing? !!!

What about VCP, if we use this procedure and leave money in plan paying the 10% penalty, does corporation lose deduction.

Yes, RP 2008-50, Section 6.10(5)(b)

If owners were taking salary in 08, 09 & 10 but made no SEP contributions, could these reduce the excess amount as of today and hence the balance on which the 10% penalty is paid for the VCP agreement.

No.

Also, I'm looking into adopting solo 401(K) for 2011 whereby returned excess amount from 2007 can be recontributed into a solo 401(k), thereby creating a net-zero impact if SEP income and deduction for 401(k) contribution both hit in this year. This, of course, will only work if SEP excess comes into current year, not into prior year (2007) requiring amended returns & penalties and so forth. Seems I read somewhere that correction procedures did not require amending prior years returns in order to correct an excess amount in a retirement plant, that everything was accounted for in current year.

The 1099 is issued to employer (for employer contributions) for year in which excess returned. [see section 6.10(5)(a)]

Client asked me this question, and of course my answer was that they need to correct the issue and pay any taxes or penalties, but they were wondering what the chances of getting audited or reviewed were at this point (2007 return 1120s was filed under extension on 9/15/08).

There is no "sleep with one eye open" or "take a chance" section of the Code. The excess penalties are cumulative (6% and 10%) and the statute of limitations hasn't even started yet!! It could be a very costly mistake.

this to get inquiries or audits from the IRS. Wouldn't something have happened by now if it were going to?

Not likely!

Hope this helps.