A SARSEP is a SEP set up before 1997 that includes a salary reduction arrangement. (See the Caution, next.) Under a SARSEP, your employees can choose to have you contribute part of their pay to their SEP-IRAs rather than receive it in cash. This contribution is called an "elective deferral" because employees choose (elect) to set aside the money, and they defer the tax on the money until it is distributed to them.
You are not allowed to set up a SARSEP after 1996. However, participants (including employees hired after 1996) in a SARSEP set up before 1997 can continue to have you contribute part of their pay to the plan. If you are interested in setting up a retirement plan that includes a salary reduction arrangement, see chapter 3.
A SARSEP set up before 1997 is available to you and your eligible employees only if all the following requirements are met.
- At least 50% of your employees eligible to participate choose to make elective deferrals.
- You have 25 or fewer employees who were eligible to participate in the SEP at any time during the preceding year.
- The elective deferrals of your highly compensated employees meet the SARSEP ADP test.
Under the SARSEP ADP test, the amount deferred each year by each eligible highly compensated employee as a percentage of pay (the deferral percentage) cannot be more than 125% of the average deferral percentage (ADP) of all non-highly compensated employees eligible to participate. A highly compensated employee is defined in chapter 1. taxmap/pubs/p560-005.htm#en_us_publink10008852
The deferral percentage for an employee for a year is figured as follows.
| ||The elective employer contributions|
(excluding certain catch-up contributions)
paid to the SEP for the employee for the year
| ||The employee's compensation|
(limited to $245,000 in 2009)
The instructions for Form 5305A-SEP have a worksheet you can use to determine whether the elective deferrals of your highly compensated employees meet the SARSEP ADP test.
For figuring the deferral percentage, compensation is generally the amount you pay to the employee for the year. Compensation includes the elective deferral and other amounts deferred in certain employee benefit plans. See Compensation
in chapter 1. Elective deferrals under the SARSEP are included in figuring your employees' deferral percentage even though they are not included in the income of your employees for income tax purposes.
If you are self-employed, compensation is your net earnings from self-employment as defined in chapter 1.
Compensation does not include tax-free items (or deductions related to them) other than foreign earned income and housing cost amounts.taxmap/pubs/p560-005.htm#en_us_publink10008856
You can choose not to treat elective deferrals (and other amounts deferred in certain employee benefit plans) for a year as compensation under your SARSEP. taxmap/pubs/p560-005.htm#en_us_publink10008857
The most a participant can choose to defer for calendar year 2009 is the lesser of the following amounts.
- 25% of the participant's compensation (limited to $245,000 of the participant's compensation in 2009 and unchanged in 2010).
- $16,500 in 2009 and unchanged in 2010.
The $16,500 limit applies to the total elective deferrals the employee makes for the year to a SEP and any of the following.
- Cash or deferred arrangement (section 401(k) plan).
- Salary reduction arrangement under a tax-sheltered annuity plan (section 403(b) plan).
- SIMPLE IRA plan.
A SARSEP can permit participants who are age 50 or over at the end of the calendar year to also make catch-up contributions. The catch-up contribution limit for 2009 is $5,500. This limit remains the same in 2010. Elective deferrals are not treated as catch-up contributions for 2009 until they exceed the elective deferral limit (the lesser of 25% of compensation or $16,500), the SARSEP ADP test limit discussed earlier, or the plan limit (if any). However, the catch-up contribution a participant can make for a year cannot exceed the lesser of the following amounts.
- The catch-up contribution limit.
- The excess of the participant's compensation over the elective deferrals that are not catch-up contributions.
Catch-up contributions are not subject to the elective deferral limit (the lesser of 25% of compensation or $16,500 in 2009).taxmap/pubs/p560-005.htm#en_us_publink10008859
If you also make nonelective contributions to a SEP-IRA, the total of the nonelective and elective contributions to that SEP-IRA cannot exceed the lesser of 25% of the employee's compensation or $49,000 for 2009 (unchanged for 2010). The same rule applies to contributions you make to your own SEP-IRA. See Contribution Limits,
For figuring the 25% limit on elective deferrals, compensation does not include SEP contributions, including elective deferrals or other amounts deferred in certain employee benefit plans.taxmap/pubs/p560-005.htm#en_us_publink10008861
Elective deferrals that are not more than the limits discussed earlier under Limit on Elective Deferrals are excluded from your employees' wages subject to federal income tax in the year of deferral. However, these deferrals are included in wages for social security, Medicare, and federal unemployment (FUTA) tax.taxmap/pubs/p560-005.htm#en_us_publink10008862
For 2009, excess deferrals are the elective deferrals for the year that are more than the $16,500 limit discussed earlier. For a participant who is eligible to make catch-up contributions, excess deferrals are the elective deferrals that are more than $22,000. The treatment of excess deferrals made under a SARSEP is similar to the treatment of excess deferrals made under a qualified plan. See Treatment of Excess Deferrals
under Elective Deferrals (401(k) Plans)
in chapter 4.
Excess SEP contributions are elective deferrals of highly compensated employees that are more than the amount permitted under the SARSEP ADP test. You must notify your highly compensated employees within 21/2 months after the end of the plan year of their excess SEP contributions. If you do not notify them within this time period, you must pay a 10% tax on the excess. For an explanation of the notification requirements, see Rev. Proc. 91-44, 1991-2 C.B. 733. If you adopted a SARSEP using Form 5305A-SEP, the notification requirements are explained in the instructions for that form.taxmap/pubs/p560-005.htm#en_us_publink10008864
Do not include elective deferrals in the "Wages, tips, other compensation" box of Form W-2. You must, however, include them in the "Social security wages" and "Medicare wages and tips" boxes. You must also include them in box 12. Mark the "Retirement plan" checkbox in box 13. For more information, see the Form W-2 instructions.