SEP-IRA Contributions

The employer’s deduction for contributions to a SEP is limited to 25% of compensation paid to participating employees (excluding SEP contributions themselves) during the tax year, up to a maximum of $72,000 per employee in 2026. When computing the annual contribution, employers may only consider an employee’s first $360,000 of compensation (2026, adjusted annually for inflation).

Amounts contributed to an employee’s SEP-IRA by the employer are not included in the employee’s taxable income — provided they do not exceed these applicable limits. An employer that makes contributions to a SEP may take a deduction for allowable SEP contributions just as for any other type of tax-qualified retirement plan.

Contributions that exceed the contribution limits are subject to a 6% excise tax. However, the penalty may be avoided if the employee withdraws the excess amount before the date by which the tax return must be filed. Withdrawn excess contributions are taxable to the employee as ordinary income.

Since an employer’s fiscal year may or may not coincide with the SEP’s plan year, special rules apply when calculating an employer’s tax deduction. If the plan year and the employer’s tax year are the same, contributions are deductible for the taxable year if made by the due date of the employer’s tax return, plus extensions.

If the SEP is on a calendar year and the employer uses a fiscal year, contributions are deductible for the taxable year within which the calendar year ends. The employer claims the deduction for the fiscal (tax) year in which the plan (calendar) year ends, provided contributions are made by the due date of the employer’s return plus extensions.

The employer deduction cannot exceed 25% of the total compensation paid to eligible employees for the calendar year ending within the employer’s tax (fiscal) year.

The tax code imposes a 10% excise tax on employers who contribute more than the overall 25% deduction limit. Contributions in excess of this limit may not be deducted in the year of contribution. However, excess contributions may be carried forward to the next year and deducted then, provided the next year’s total contributions (including the carried-over excess) do not exceed the limit. The carry-over is still subject to the 10% penalty in the year of excess.

There is an additional 6% excise tax on individual SEP-IRAs that exceed the annual contribution limit (the lesser of 25% of compensation or $72,000 in 2026). Participants may avoid this penalty by withdrawing the excess by their tax filing date, plus extensions. The withdrawn excess is included in the participant’s taxable income for that year.

For employers who maintain a non-model SEP and other qualified plans, a SEP deduction reduces deductible contributions made to those other plans. The SEP contribution is counted as an employer contribution to a defined contribution plan and added to any other employer contributions to other defined contribution plans. The limit on “total additions” to defined contribution plans is the lesser of 100% of the employee’s compensation or $72,000 (2026). A SEP cannot be used to circumvent the limit on total contributions made to an employee’s account in a defined contribution plan.

For self-employed individuals, “compensation” for the 25% contribution limit refers to net earnings from self-employment — gross income from the business, minus allowable deductions. Allowable deductions include:

• Contributions to employees’ SEP-IRAs
• The deduction for one-half of the self-employment tax
• The deduction for contributions to the individual’s own SEP

These must be deducted from gross income before calculating the contribution to the owner’s own SEP. This creates a slight complexity when expressing the contribution as a percentage of income.