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SEP IRA with Multiple Businesses

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Client has operated as a sole proprietor and contributes to his SEP based on the net earnings from the business every year. Client and his spouse open a new business in which they materially participate (husband /wife partnership filed 1065). This business will also have employees separate from the husband/wife. In year 1, the new business reports a loss for self-employment purposes. Would the client be able to exclude the net earnings from the partnership and determine his SEP contribution based on his sole proprietor business or would the net earnings from both businesses have to be aggregated for purposes of determining net earnings from SE for contribution purposes? Would this SEP now be subject to controlled group rules as well and potentially make the employees eligible in future years?

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Yes, the SEP would be subject to controlled group rules and potentially make the employees eligible in future years.

The Loss. A self-employment loss from a separate unincorporated business that is unrelated to the employer adopting the SEP but is owned in part by the same individual does not directly offset the earned income of the employer adopting the SEP. There is no such thing as negative compensation. Nevertheless, the loss will affect the calculation of the individual's self-employment tax, and the amount of that tax will have an effect on the calculation of earned income that can be considered for the plan. Similarly, a loss from an unincorporated business owned by one spouse would not reduce the earned income of an unincorporated business owned by the other spouse.

More than one entity may have to be considered in designing a SEP, testing for various limits, and avoiding discrimination initially or in operation. The employers may be related or unrelated, or they may be considered related for some purposes but not all.

Many complexities may arise when an individual has an interest in more than one business. For instance, if a sole proprietor has an interest in multiple related or controlled employers, in most cases those employers will all adopt the plan. What if one of the entities was unrelated and did not adopt the plan? Would the deduction for half of the owner's self-employment tax have to be prorated? Possibly, says one commentator. [Lawrence C. Starr, American Society of Pension Professionals and Actuaries (ASPPA), p. 4, ―Compensation Issues: Earned Income, Sole Proprietors, Partners, LLCs, LLPs‖ (2016), available at https://www.asppa.org/sites/asppa.org/files/PDFs/2016AnnualHandouts/WS28 part 1 of 2.pdf (visited on May 5, 2022)]
Further, knowing the total amount of all the outside earned income subject to self-employment tax presupposes that the formulas and contributions for each separate employer's nonowner participants are known. That is unlikely (see Q 7:2).

When the ―ultra net (after all adjustments) earned income (see Q 7:26) is less than the $305,000 maximum for 2022, the proration of the self-employment tax deduction among multiple entities (to increase the amount of earned income that is considered for plan purposes) would seem preferable to allocating all of the earned income to the entity that adopted the plan. [See Ann. 94-101, §684, Ex. I, 1994-35 I.R.B. 53] At the same time, it should be noted that allocating all of the self-employment tax to a nonadopting entity (to maximize the amount of earned income that is considered for plan purposes) might be considered aggressive.

[See Simple, SEP, and SARSEP Answer Book, Q 7:5 (regarding the loss) and Q 7:27, Wolters-Kluwer (2022).]

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