Setting up an SEP-IRA for my single member LLC (taxed as an S-Corp)

Question

I've set up a single member LLC (taxed as an S-Corp) for my self-employment work. I'm hoping to have the S-corp contribute some of my salary to an SEP-IRA which, as I understand it, means the S-corp can deduct that on taxes later on.

I already have an SEP-IRA I set up that I made contributions to myself (when I was just a sole proprietorship). I'm wondering if I need to create a new, separate SEP-IRA account that only the S-corp contributes to or if can I just contribute as an S-Corp to that same SEP-IRA (if so, would I still be able to contribute part of my salary as an employee or would only the S-corp employer be able to contribute)?

Or is there some other way to get more tax benefits here?

Answer 1

Your SEP IRA custodian can tell you if they'll allow you to submit an updated 5305-SEP for your existing SEP IRA with the LLC's information or if they want you to open a new one.

Assuming you have no employees, your S-corp can contribute up to 25% of your W-2 compensation, which is deductible on the S-corp's 1120S and not your personal return (it all flows through to you anyway).

Only you as the employer can make contributions to your SEP IRA. Employee deferrals aren't allowed. This means that if you wanted to contribute up to the $66,000 limit for 2023, you'd need W-2 compensation of $264,000.

Contrast that with a Solo 401k (only if you have no non-spouse employees), which allows both employee deferrals (up to 100% of compensation up to $22,500) and employer contributions (up to 25% of compensation to a combined maximum of $66,000). This lowers the compensation needed to max out your contributions, meaning a larger tax deduction is possible with lower income.

There are definitely pros and cons of using a SEP IRA vs. a Solo 401k to consider. Here's a few:

1. SEP IRAs have fewer administrative requirements. For example, I had to do a plan restatement in 2022 for my Solo 401k in order to maintain qualified status with the IRS. Additionally, Solo 401ks with more than $250,000 in plan assets need to file form 5500-EZ annually. Neither is too bad, but that's two more items compared to a SEP IRA.

2. SEP IRAs are counted in pre-tax IRA balances for the purpose of IRA aggregation/the pro-rata rule. 401ks aren't counted, which is generally seen as a good thing for those considering non-taxable/backdoor Roth IRA conversions.

3. Solo 401ks can allow Roth contributions (custodian-dependent), which SEP IRAs couldn't have until Secure Act 2.0 introduced Roth SEP IRA accounts starting in 2023. That puts them more on par with 401ks in that regard. However, this is a recent law and some provisions have not yet come into effect and the IRS hasn't published any guidance or regulations on the matter.

4. A SEP IRA plan can be continued even if you hire employees, but a Solo 401k must be shut down or converted to a Traditional 401k plan if you have non-spouse employees.

Answer 2

SEP plans are per employer, so no, the S-Corp cannot contribute to a plan that you've established as a sole-proprietor.

The SEP plans are for employer contributions only, employees cannot contribute to them.

See more details on the IRS SEP page here.

Or is there some other way to get more tax benefits here?

Consider 401k instead - this allows more flexibility, but works a bit differently than SEP.

Answer 3

I'm self-employed and I have used a SEP for many years.

A SEP plan is created by an employer with form 5305-SEP.

A SEP-IRA account is owned by an employee. If you are self-employed, then you can open this up at a custodian who offers this. I did this at Fidelity, and it was easy.

The employer then contributes to the employees SEP-IRA.

When I do this at Fidelity, I need to confirm that the contribution is from an employer, but they do not have restrictions as to who the employer is. Two different employers could make contributions as long as you don't exceed contribution limits.

Other custodians may be different, but since the SEP-IRA is an account owned by an individual, I suspect not.