How to Calculate SEP Contribution for an S Corp Owner

Understanding how to calculate SEP contributions for an S Corp owner is crucial for optimizing retirement savings while adhering to IRS regulations. As a tax-advantaged option, Simplified Employee Pension (SEP) IRAs allow business owners to contribute to their retirement in a flexible way.

Determining Eligible Compensation

For S Corp owners, eligible compensation for SEP contributions is based on the W-2 wages received from the corporation. Distributions or dividends from the S Corp are not included. The IRS caps eligible compensation at $330,000 for the 2024 tax year, with adjustments made annually for inflation. This cap ensures contributions are calculated based on earned income, in line with the IRS’s intent to promote savings derived from actual work.

Selecting a Contribution Percentage

The contribution percentage for a SEP IRA can be up to 25% of eligible compensation for the 2024 tax year but must stay within the IRS’s annual cap. Business owners should consider balancing retirement savings with maintaining operational liquidity. A financially stable S Corp may support a higher percentage, while businesses facing cash flow challenges might opt for a lower rate. Reviewing financial statements and cash flow projections can help identify the most appropriate contribution level.

Applying IRS Limits

For 2024, the maximum SEP IRA contribution is $66,000 or 25% of eligible compensation, whichever is lower. Exceeding these limits can result in penalties, including excise taxes on excess contributions. Accurate calculations and careful monitoring are essential to avoid errors. Regularly reviewing contributions is particularly important if compensation or business profits vary throughout the year.

Calculating the Employer Contribution

To calculate the employer contribution, determine eligible compensation and apply the chosen percentage. For S Corp owners with a fixed salary, this process is straightforward. For those with variable compensation, such as bonuses, the calculation requires extra care. Ensure contributions do not exceed the IRS cap. Internal controls, such as audits and payroll reviews, can help maintain compliance and prevent mistakes.

Recordkeeping and Documentation

Accurate recordkeeping is critical for managing SEP IRA contributions. Retain all documents related to compensation, such as W-2 forms and payroll summaries, as well as records of contributions, including bank statements and transfer confirmations. Document the method used to determine the contribution percentage, ensuring it aligns with the plan’s terms and IRS guidelines.

Employers should keep SEP-related records for at least six years, though retaining them longer is advisable. Using accounting software or cloud-based platforms can simplify this process by centralizing documents and ensuring they are easily accessible. These tools can also help track contribution limits, generate reports, and set reminders for deadlines, reducing the risk of errors.