Can a self-employed individual establish a SEP-IRA after December 31 for the prior tax year?
Yes. One of the most valuable features of a SEP-IRA is that it can be established and funded up to the tax filing deadline, including extensions. For a sole proprietor filing on Schedule C, this means the SEP-IRA can be established and funded as late as October 15 of the following year (if an extension is filed). This allows practitioners to recommend SEP-IRAs as a last-minute tax reduction strategy even after year-end. In contrast, a Solo 401(k) must be established by December 31 of the plan year.
How is the SEP-IRA contribution calculated for a self-employed individual?
For a self-employed individual, the maximum SEP-IRA contribution is calculated as follows: (1) determine net self-employment income (gross self-employment income minus business expenses); (2) subtract one-half of self-employment tax (Form SE, Line 13); (3) multiply by the plan contribution rate (maximum 25% of compensation, but for self-employed this equates to approximately 20% of net SE income after the SE tax deduction). The maximum is the lesser of this calculated amount or $70,000 (2026). IRS Publication 560 contains the rate table and worksheet for this calculation.
What happens when an employer with a SEP-IRA hires employees?
When an employer with a SEP-IRA hires employees who meet the eligibility requirements, the employer must make contributions to SEP-IRAs for all eligible employees at the same percentage of compensation used for the owner. For example, if the owner contributes 20% of their compensation, the employer must contribute 20% of each eligible employee’s compensation. This can significantly increase the cost of the plan and is a primary reason why many growing businesses transition from a SEP-IRA to a 401(k) plan. Practitioners should model the cost of employee contributions before recommending a SEP-IRA to clients who may hire employees.
Where is the SEP-IRA contribution deducted on the tax return?
For self-employed individuals, the SEP-IRA contribution is deducted on Schedule 1 (Form 1040), Line 16 (Self-Employed SEP, SIMPLE, and Qualified Plans). This is an above-the-line deduction that reduces adjusted gross income (AGI), which is particularly valuable because it also reduces AGI-based phase-outs for other deductions and credits. For S-corporation owners, the corporation deducts the SEP contribution as a business expense on Form 1120-S, which flows through to the owner’s W-2 and reduces the owner’s taxable wages.
Can a business owner have both a SEP-IRA and a traditional IRA?
Yes. A business owner can contribute to both a SEP-IRA and a traditional or Roth IRA in the same year. However, the deductibility of the traditional IRA contribution may be limited if the owner is covered by a workplace retirement plan (which includes a SEP-IRA) and their income exceeds the phase-out thresholds. For 2026, the traditional IRA deduction phases out for active participants in employer plans between $79,000-$89,000 (single) and $126,000-$146,000 (married filing jointly). Roth IRA contributions are not affected by SEP-IRA participation but have separate income limits.
What are the distribution rules for SEP-IRA accounts?
SEP-IRA distributions follow the same rules as traditional IRA distributions. Distributions before age 59½ are subject to a 10% early withdrawal penalty under IRC §72(t) plus ordinary income tax, with exceptions for death, disability, substantially equal periodic payments (SEPP/72(t) distributions), first-time home purchase ($10,000 lifetime limit), and higher education expenses. Required minimum distributions (RMDs) must begin by April 1 of the year following the year the account owner reaches age 73 (SECURE 2.0 Act). RMD amounts are calculated based on the prior year-end account balance and the IRS Uniform Lifetime Table.
Is Form 5305-SEP filed with the IRS?
No. Form 5305-SEP is NOT filed with the IRS. It is the plan document that the employer retains and provides to each eligible employee. The employer must keep the signed Form 5305-SEP on file as long as the plan is in existence and for a reasonable period thereafter. The employer must also provide employees with information about the SEP, including the plan document and annual contribution amounts. There is no annual Form 5500 filing requirement for SEP-IRAs (unlike 401(k) plans, which require Form 5500 when assets exceed $250,000).
Can an S-corporation owner establish a SEP-IRA?
Yes. An S-corporation can establish a SEP-IRA for its owner-employees. The contribution is based on W-2 wages paid to the owner, not on the owner’s distributive share of S-corporation income. The maximum contribution is 25% of W-2 compensation, up to $70,000 (2026). The S-corporation deducts the contribution as a business expense. This is a key planning point: S-corporation owners who pay themselves low W-2 wages to minimize payroll taxes may also limit their SEP-IRA contribution capacity. Practitioners should model the optimal W-2/distribution split considering both payroll tax savings and retirement contribution capacity.
What is a SARSEP and is it still available?
A SARSEP (Salary Reduction Simplified Employee Pension) was a type of SEP that allowed employees to make elective salary deferrals. SARSEPs were eliminated by the Small Business Job Protection Act of 1996 — no new SARSEPs can be established after December 31, 1996. Existing SARSEPs established before 1997 can continue to operate. For new plans, the SIMPLE IRA or Solo 401(k) are the alternatives that allow employee elective deferrals. Practitioners should be aware of this distinction when advising clients who have legacy SARSEP plans.
How does a SEP-IRA affect the QBI deduction?
SEP-IRA contributions reduce the owner’s net income from the qualified trade or business, which is the base for the Qualified Business Income (QBI) deduction under IRC §199A. Specifically, for self-employed individuals, the SEP contribution reduces the net earnings from self-employment, which in turn reduces the QBI deduction (limited to 23% of QBI (OBBBA §70301)). Practitioners should model the combined effect of SEP contributions on both the direct deduction and the resulting reduction in the QBI deduction to determine the optimal contribution amount for each client.
Can a business owner with multiple businesses establish separate SEP-IRAs?
The contribution limits apply on an individual basis, not per plan. If a business owner has multiple businesses and establishes SEP-IRAs for each, the total contributions across all plans cannot exceed the lesser of 25% of total compensation or $70,000 (2026). Additionally, if the businesses are under common control (related businesses under IRC §414), they may be treated as a single employer for plan purposes, requiring all eligible employees across all related businesses to be covered. Practitioners should analyze common control rules before recommending multiple SEP-IRAs for clients with multiple business interests.
What is the deadline to make SEP-IRA contributions for the prior tax year?
SEP-IRA contributions for a given tax year can be made up to the employer’s tax filing deadline, including extensions. For sole proprietors (Schedule C filers), this is April 15 of the following year, or October 15 if a Form 4868 extension is filed. For S-corporations and partnerships, the deadline is March 15 (or September 15 with extension). The SEP-IRA account itself must also be established by this deadline if it is a new plan. Practitioners should remind clients of this deadline in early spring and consider filing extensions specifically to allow additional time to fund SEP-IRA contributions.
