How to Deduct a SEP IRA Contribution

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The Simplified Employer Pension Plan, or SEP IRA, is a popular retirement plan with small business owners. With a top contribution rate of 25 percent of compensation, up to $49,000 per year, as of 2011, SEP IRAs allow business owners to set aside far more money on a tax-deferred basis than a traditional IRA or even a 401k plan. The procedure for deducting contributions varies, depending on the structure of the business.

Sole Proprietorships

Contributions to a SEP IRA are a business expense. But if you have a sole proprietorship, there is no formal or legal difference between your business and personal assets. Your profits from the business "flow through" the business to your individual tax return. Therefore, you will claim any deductions for SEP IRA contributions for yourself on your IRS Form 1040 Individual Income Tax Return, line 28. You cannot use a Form EZ. Contributions you make for employees, however, are deductible as business expenses, using Schedule C. Farmers would use Schedule F for this purpose.

Partnerships

If you are a member of a partnership, the process is similar to that for sole proprietors. Like sole proprietorships, partnerships are pass-through entities. Contributions for yourself are listed on your personal tax return. However, partnerships have their own tax returns to file as well. Any contributions the partnership makes on behalf of employees are deducted using IRS Form 1065, U.S. Return of Partnership Income.

Corporations

SEP IRA contributions for corporations are considered a business expense, reportable on the corporate tax return, Form 1120 for C-corporations, and Form 1120-S for S-corporations. This is also true for shareholder employees. The employee in this case is a separate legal entity from the corporation.

Considerations

You may wish to consider a SEP IRA if you wish to set more money aside on a tax-advantaged basis each year than a traditional IRA allows, or if you were considering a 401k but you want to avoid the onerous administrative requirements. Furthermore, for self-employed individuals, the deduction isn't quite as straightforward as simply subtracting your total contribution from your gross earnings. You must also account for Social Security tax and the deductions from your SEP IRA contributions themselves. Use the worksheet provided in IRS Publication 560 to calculate your deduction (see Resources).

References

About the Author

Jason Van Steenwyk has been writing professionally since 1998. A former staff reporter for "Mutual Funds Magazine," he has been published in "Wealth and Retirement Planner," "Annuity Selling Guide," "Registered Rep." "Bankrate.com" and "Senior Market Advisor." He holds a Bachelor of Arts in humanities from the University of Southern California.

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