SEP Tax Deduction

Tina is a sole proprietor tech entrepreneur whose startup gained serious traction during the year, providing Tina with $300,000 of net self employment income (after retirement contributions and deductible self-employment tax). Tina has a SEP IRA and naturally wants to contribute as much as she can to help defer some taxes and set herself up for retirement. Since the 2020 maximum SEP IRA contribution is limited to the lesser of 25% of net self-employment income or $55,000, Tina would only be able to contribute and deduct $55,000 during the year as 25% of her compensation would total $75,000, which is above the IRS limit.

Tony is a tasker who can do anything you could ever want done around your house. He has one full-time employee. Both Tony and his employee have SEP IRA's. During the year, Tony had $66,000 of net self employment income (after retirement contributions and deductible self-employment tax), his employee had $35,000 of W-2 wages. Tony chose to contribute 10% to his SEP IRA and his employee's SEP IRA. Accordingly, Tony could deduct $6,600 for his own contribution on line 28 of his Form 1040, and $3,500 for the contribution he made to his employee's account on line 19 of his Schedule C.

Emilia is a 48-year-old professional speaker who once had a lucrative career giving presentations on dial-up internet. Recently, due to advances in technology, she fell on hard times. During the current year, she withdrew $25,000 from her SEP IRA to help pay for living expenses while she searched for a new job. Unfortunately, upon withdrawing the money, Emilia had to pay a 10% early withdrawal tax plus income tax on the money she took out of her IRA (since SEP IRAs are tax-deferred).

Anoush is a 27 year-old independent real estate agent who recently established a SEP IRA so he could defer tax on some of his commission income and save for retirement. Since SEP's don't have any reporting requirements, all he had to do was find a trustee (Fidelity, Merrill Lynch, etc.) to keep his account with and execute a written agreement outlining the his SEP plan benefits (Anoush used IRS Form 5305-SEP). Since Anoush chose the SEP over more complex profit sharing plans, setting up his plan was easy and he doesn't have to worry about ongoing reporting and compliance issues.