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Take Advantage of Your Tax Extension and Create a Simplified Employee Pension Plan

Remember back on April 15th, you needed a few more figures and documents before you filed your 2013 tax return. So, you (or your accountant) requested an extension. The decision gave you another six months to file your return.  The day of reckoning is fast approaching. There are only 2 more weeks before October 15—the extended return due date. If you want to avoid late-filing penalties, it’s time to get busy. 

But, your delay may work to your advantage. How?  By providing you an opportunity to do some last-minute retirement planning that can lower your tax bill while increasing your long-term financial security. That’s a win-win if ever there was one.  And, if you’ve had a success year-to-date, you may be able to fund that plan with a larger contribution that would have been possible last April.

You can set up a Simplified Employee Pension as late as the due date (including extensions) of your business income tax return for the year you want to establish the plan. This means that if you haven’t filed your 2013 return, you have until October 15, 2014, to establish and contribute to a SEP.

SEPs are designed specifically for the small business, whether that business operates as a sole proprietorship, LLC, S Corporation or C Corporation. You can establish a SEP even if you have another type of retirement plan. And, you can establish one even if you are the only employee in the business. If you aren’t the only employee, you must cover every “eligible” employee. The IRS says an employee is eligible if the employee: (1) is at least 21 years old, (2) has worked for your business in at least 3 of the last 5 years, and (3) received $550 or more in compensation in 2013. You cannot set higher standards, but you can set lower ones.  This can come in handy if you just hired your 18-year old child.  In this case, you could change the age requirement to 18 and the length of employment to three months.

As the name implies, one of the advantages of a SEP is the ease with which you can set it up. There are three straightforward steps to establish a SEP:

  • Execute a written agreement to provide benefits to all eligible employees. Most employers can use the IRS model plan document, Form 5305-SEP, Simplified Employee Pension - Individual Retirement Accounts Contribution Agreement. Many banks also can provide IRS-approved documents, which can make for “one-stop shopping” since you will need to set up an Individual Retirement Account (IRA) for each employee.
  • Give your employees certain information about the agreement. If you used the IRS form, you must provide each employee a copy; you must provide similar information if you used an IRS-approved form.
  • Set up a SEP-IRA account for each employee. Once you set it up  the employee owns and controls the account.

In addition to simplicity, the contribution limit is another factor that can make a SEP a good choice for funding your retirement. Exactly how much you can contribute for an employee depends upon the employee’s compensation.  You can contribute up to 25% of the employee’s compensation or $51,000, whichever is lesser.  This is substantially more than what you could contribute to an IRA or a SIMPLE plan.

The 25% or $51,000 contribution amounts apply if you operate your business as an S corporation, a C corporation or an LLC that has elected to be taxed as a corporation.  If you operate as an LLC taxed as a partnership (the default taxation status) or a sole proprietorship, then you the contribution percentage is a maximum of 20% of your net adjusted self-employment income.

In addition, you can claim a deduction from your taxes for all, or part, of your contribution. This provides both a short-term tax savings by reducing the amount of taxable income and a long-term financial benefit. Now is the time to talk with your tax professional to see if establishing a SEP makes sense for you and your business.

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