Chapter 4 — Contributions

The employer’s deduction for SEP contributions is limited to the lesser of:

• 25% of each employee’s compensation (excluding the SEP contribution itself), or
• $72,000 per employee (2026).

Only the first $360,000 of each employee’s annual compensation (2026) may be used in calculating contributions. Amounts contributed within these limits are not included in the employee’s taxable income and are fully deductible by the employer.

In addition to the per-employee limit, the employer’s total SEP deduction may not exceed 25% of the aggregate compensation paid to all eligible employees during the year (each capped at $360,000).

SEP contributions for a tax year must be deposited by the employer’s tax return due date, including extensions. The applicable deduction year depends on whether the SEP plan year and the employer’s fiscal year are the same.

Contributions are deductible for the tax year in which they are made, provided they are deposited by the employer’s tax return due date plus extensions.

If the SEP operates on a calendar year but the employer uses a fiscal year, the deduction is claimed in the fiscal year in which the calendar plan year ends. Contributions are deductible if made by the employer’s tax filing deadline (including extensions) for that fiscal year.

The tax code imposes a 10% excise tax on employers who contribute more than the permissible deductible amount to a SEP. Excess contributions:

• are not deductible by the employer in the year of the contribution,
• may be carried forward to the following year and deducted then — provided the next year’s total contributions (including the carryover) do not exceed that year’s limit, and
• remain subject to the 10% excise tax each year the excess is outstanding and being carried over.

Note: this is the employer’s 10% excise tax on excess deductible contributions, which is different from the 6% excise tax on employee excess IRA contributions discussed in Chapter 3.

For employers who maintain both a SEP and other qualified defined contribution plans, SEP contributions reduce the deductible contributions available under those other plans. A SEP contribution is treated as an employer contribution to a defined contribution plan. The SEP contribution is combined with contributions to any other DC plans, and the total is subject to the overall DC limit (lesser of 25% of compensation or $72,000 per employee in 2026).

A SEP cannot be used to circumvent the overall annual additions limit for defined contribution plans.

For self-employed individuals (sole proprietors and partners), “compensation” for SEP contribution purposes means net earnings from self-employment — not gross revenues. Net earnings are calculated after deducting:

• ordinary and necessary business expenses,
• SEP contributions made on behalf of any employees,
• the deductible half of self-employment (SE) taxes (the employer-equivalent portion), and
• the SEP contribution for the self-employed individual’s own account.

Because the SEP contribution itself reduces net earnings, the calculation is circular. The IRS provides a worksheet. The effective contribution rate for a self-employed person works out to approximately 20% of adjusted net SE income (for a 25% rate plan) — not 25%.

Regular employer SEP contributions have favorable employment tax treatment:

• SEP contributions are not considered wages for income tax withholding purposes (provided it is reasonable to believe they will be excluded from the employee’s income).
• Employer contributions to an employee’s SEP-IRA are exempt from FICA (Social Security/Medicare) and FUTA (federal unemployment) taxes.

However, for SARSEPs (salary reduction SEPs), the treatment differs — the employer must pay FICA and FUTA taxes on employee salary deferrals, since the deferrals originate from employee wages. (Note: new SARSEPs cannot be established after 1996, but existing plans may continue — see ch46.)