Question 52: A member/partner of an LLC for which there are 4 partners wants to set up an SEP plan for just himself at the partner level. My understanding is that the SEP Plan must be set up at the LLC level since the LLC is the employer. However, the taxpayer feels that since he is considered to be a self-employed person he should be eligible to set up a plan for himself.

Answer: I hope the taxpayer listens to you, because you are correct.

Internal Revenue Code Section 401(c)(1)(A) tells us that a self employed individual (as defined in 401(c)) is deemed to be an employee. Without that section, neither sole proprietors nor partners would be eligible to participate in a qualified plan, because they would not be employees and covering them would violate the exclusive benefit fule.

Section 401(c)(1)(B) defines self-employed individual as sole proprietors or partners with earned income from a trade or business in which their services are a material income producing factor. Notice that "self-employed individual" is a defined term. Congress could have called them heffalumps just as well and it would have changed nothing (except possibly made the Internal Revenue Code somewhat more interesting to read).

Section 401(c)(4) then tells us who is the employer of these heffalumps, these self-employed individuals: "An individual who owns the entire interest in an unincorporated trade or business shall be treated as his own employer. A partnership shall be treated as the employer of each partner who is an employee within the meaning of paragraph (1)."

So, the question is not whether the taxpayer is a heffalump. He is, and so he can participate in a plan set up by his employer. But it is the LLC which is the employer, not the taxpayer.

If the taxpayer tries to set up a SEP and names himself as a participant, the SEP will run into problems because the contributions will not be made by his employer, as defined in 408(k).

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