Are you a business owner whose business was profitable in 2015? Great, that’s a good thing. Of course, you may hear your accountant say, “you need a tax deduction for 2015.” If you find that you need a tax deduction for the 2015 calendar year, there is an option you may want to consider: a SEP-IRA.
A SEP-IRA can be established for the 2015 calendar year up until the business files its 2015 business tax return.
How a SEP-IRA Works
The SEP-IRA is an employer contribution plan. This means that the business must make the contribution for everyone who is eligible. If there are a large number of rank and file employees eligible to receive a contribution, it could be expensive for your business to contribute for all those employees.
The contribution to each eligible rank and file employee is going to be the same percentage of salary as you contribute for yourself. So if you, as the business owner, gave yourself 25% of your salary as a contribution, you would also have to give each of your eligible employees 25% of their salary as a contribution.
You establish the SEP-IRA plan for your business by completing the IRS Form 5305-SEP and keeping that completed form on file in your place of business. The form is easy to complete. It asks for the name of employer and then you select the plan eligibility requirements up to the maximum allowed. Eligible employees are anyone who is age 21, has worked for you in three out of the last five calendar years and earns at least $550 annually. You can use an age less than 21 if desired. But you cannot use an age greater than 21. You can also use years of service less than three years, if desired.
Note that the eligibility requirements apply to everyone in the business: both you and your employees. So, if you started your business in 2014 you could not use the three year service requirement because you would not be eligible to receive a contribution. The only other information to complete on the form is to check boxes to indicate whether or not you wish to include employees of your firm who are covered under a collective bargaining agreement, are non-resident aliens, or earn less than $550 annually. Once you have completed this form you have a SEP-IRA plan. It sounds straight forward but there is one additional step.
Any employee who is eligible to receive a contribution under the SEP-IRA plan must have an IRA account established to receive the contribution. The IRA account would be set up for the benefit of the employee but it would be titled in the name of the business because it is the business that is establishing the SEP-IRA plan. Each employee does get to select which investments they want in their IRA account. Once the contribution is made, it is allocated to that employee’s IRA into the investments the employee selected.
The plan has two contribution limits. There is the plan limit which is 25% of the total eligible payroll of the business. What does this mean? Total eligible payroll would be the salaries of all of your employees, including yourself, who are eligible to receive a contribution. Whatever that amount is, you can contribute up to 25% of that as your annual contribution to the plan. But there is also an individual limit. No one participant under the plan can receive a contribution greater than $53,000. In order to get a $53,000 contribution, the participant would have to have a salary of at least $212,000 (.25% x $212,000 = $53,000).
An additional benefit to a SEP-IRA is that no third party administrative firm is needed to administer the plan. This is good because if a third party administrative firm was involved you would have to pay them annual fees to administer the plan.
Keep In Mind Your Needs for 2016
So if you need a tax deduction for the 2015 calendar year you could establish the SEP-IRA for the 2015 year, make the contribution and get the tax deduction. But you could also be looking ahead at 2016 to determine if there is some other type of qualified plan that would be better for your business. In addition to SEP-IRA plans there are other employee contribution plans like profit sharing and defined benefit that might be more beneficial to you, as the business owner, and might allow you to make a lower contribution for your rank and file employees. It is going to be dependent on the ages and salaries of the employees versus your age and salary. Most qualified plans will favor owners over employees if the owners are older than the employees and earn a higher salary than their employees.
There are also employee deferrals plans such as a SIMPLE-IRA or 401(k) plan. These plans are suitable for a business where the owner wants to allow employees to save money toward their own retirement. So if an employee deferral plan is something you want to offer to your employees, 2016 would be the year to establish such a plan.
If you do establish a different plan in 2016, the SEP-IRA plan can simply be stopped. Each employee who had a contribution made to their IRA account could retitle their IRA into their own name. Or, depending on the type of plan you went to in 2016, it might be possible for employees to roll their SEP-IRA contribution in to the new plan, if they wished to do so.
So you can establish a SEP-IRA plan now and get a tax deduction for 2015. Learn more about SEP IRAs and other types of qualified plans that may work for your business.
Distributions from traditional IRAs are taxed as ordinary income and, if taken prior to reaching age 59½ may be subject to an additional 10% federal income tax penalty.