Tax Treatment of Deferrals
You can deduct your deferrals that, when added to your other SEP contributions, are not more than the limits under Deducting Contributions, earlier.
Elective deferrals that are not more than the limit discussed earlier are excluded from your employees' wages subject to federal income tax in the year of deferral. However, these deferrals are included in wages for social security, Medicare, and federal unemployment (FUTA) tax.
Excess deferrals. For 2001, excess deferrals are the elective deferrals for the year that are more than the $10,500 limit discussed earlier. The treatment of excess deferrals made under a SARSEP is similar to the treatment of excess deferrals made under a qualified plan. See Treatment of Excess Deferrals under Elective Deferrals (401(k) Plans) in chapter 4.
Excess SEP contributions. Excess SEP contributions are elective deferrals of highly compensated employees that are more than the amount permitted under the SARSEP ADP test. You must notify your highly compensated employees within 2½ months after the end of the plan year of their excess SEP contributions. If you do not notify them within this time period, you must pay a 10% tax on the excess. For an explanation of the notification requirements, see Revenue Procedure 91-44 in Cumulative Bulletin 1991-2. If you adopted a SARSEP using Form 5305A-SEP, the notification requirements are explained in the instructions for that form.
Reporting on Form W-2. Do not include elective deferrals in the Wages, tips, other compensation box of Form W-2. You must, however, include them in the Social security wages and Medicare wages and tips boxes. You must also include them in box 12. Mark the Retirement plan checkbox in box 13. For more information, see the Form W-2 instructions.
Distributions (Withdrawals)
As an employer, you cannot prohibit distributions from a SEP-IRA. Also, you cannot make your contributions on the condition that any part of them must be kept in the account.
Distributions are subject to IRA rules. For information about IRA rules, including the tax treatment of distributions, rollovers, required distributions, and income tax withholding, see Publication 590.
Additional Taxes
The tax advantages of using SEP-IRAs for retirement savings can be offset by additional taxes. There are additional taxes for all the following actions.
- Making excess contributions.
- Making early withdrawals.
- Not making required withdrawals.
For information about these taxes, see chapter 1 in Publication 590. Also, a SEP-IRA may be disqualified, or an excise tax may apply, if the account is involved in a prohibited transaction, discussed next.
Prohibited transaction. If an employee improperly uses his or her SEP-IRA, such as by borrowing money from it, the employee has engaged in a prohibited transaction. In that case, the SEP-IRA will no longer qualify as an IRA. For a list of prohibited transactions, see Prohibited Transactions in chapter 4.
Effects on employee. If a SEP-IRA is disqualified because of a prohibited transaction, the assets in the account will be treated as having been distributed to the employee on the first day of the year in which the transaction occurred. The employee must include in income the fair market value of the assets (on the first day of the year) that is more than any cost basis in the account. Also, the employee may have to pay the additional tax for making early withdrawals.
Reporting and Disclosure Requirements
If you set up a SEP using Form 5305-SEP, you must give your eligible employees certain information about the SEP when you set it up. See Setting Up a SEP, earlier. Also, you must give your eligible employees a statement each year showing any contributions to their SEP-IRAs. You must also give them notice of any excess contributions. For details about other information you must give them, see the instructions for Form 5305-SEP or 5305A-SEP (for a salary reduction SEP).
Even if you did not use Form 5305-SEP or Form 5305A-SEP to set up your SEP, you must give your employees information similar to that described above. For more information, see the instructions for either Form 5305-SEP or Form 5305A-SEP.
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