Question from a Small Business Owner

A small business owner running a pool service in Phoenix, Arizona, inquires about their eligibility for a SEP IRA despite their CPA’s suggestion that they do not qualify. They mention contributing to an IRA up to the maximum amount annually and seek advice on this matter, having researched the topic extensively without finding clear reasons for their potential ineligibility.

Response

It appears you might be eligible to contribute to a SEP IRA. However, it’s wise to consult your financial advisor or CPA for confirmation. Organizations like the CFP Board or NAPFA could provide resources to connect you with a fiduciary advisor. To find a suitable CPA, consider getting recommendations from friends or using directories provided by the National Association of Tax Professionals.

SEP IRAs allow higher contributions than traditional IRAs, which can be beneficial. But keep in mind that adding employees could complicate compliance and associated costs, so securing a second opinion from a knowledgeable CFP might be a good move, as suggested by Dustin Suttle, a certified financial planner.

Andrew Rotz, another certified financial planner, clarifies that qualifying for and contributing to a SEP IRA requires adherence to specific rules. For LLCs treated as S corporations, contributions are to be made from the business account, limited to 25% of the owner’s W-2 wages and capped at the annual contribution limit, which is $72,000 this year.

There’s often confusion between the rules for LLCs and S-Corps, particularly relating to IRS Publication 560. Rotz advises discussing these regulations with your current CPA or seeking out other CPAs specializing in this field.

According to Brad Lineberger of Seaside Wealth Management, if you opt for a SEP IRA, contributions can be made until the tax filing deadline, including any extensions. There’s a specific formula to determine your contribution amount, based on your income. For instance, if your net business income is $100,000 and your self-employment tax is about $14,130, your adjusted income leads to a potential SEP contribution of approximately $18,587. If you’re employing others, your contributions would be capped at 25% of their compensation as well.

Suttle notes that SEP IRAs require proportional contributions for all eligible employees. If your S corporation has employees meeting specific criteria, such as age and duration of service, you’d need to match your contribution rate to theirs.

Important Considerations: Do You Have Employees?

The number of employees significantly affects your SEP IRA plan. If there are employees, you’ll need to consider any matching requirements to ensure fairness. Bill Heydon from Wells Fargo Advisors emphasizes that this is crucial to maintain equity between owners and employees.

If you’re the sole employee, a standalone 401(k) could be a better option, offering greater flexibility and higher contribution limits. A solo 401(k) allows you to contribute a substantial amount as both an employee and employer, potentially exceeding what a SEP might offer, according to Gabriel Shahin, a certified financial planner.

If employees are part of your business, a SEP would necessitate contributing the same percentage for them, which could become costly. Therefore, if you’re uncertain about your CPA’s suggestion against a SEP or if a Solo 401(k) hasn’t been discussed, consider getting a fresh perspective from a professional knowledgeable in retirement strategies for small businesses.

Professional Support

Engaging in tax planning with your CPA or CFP can help you determine the best strategies for your situation. Matthew Saneholtz, a certified financial planner, advises reviewing how much you’re paying yourself through S Corp payroll, as combining a SEP IRA with a Roth IRA might be beneficial based on your tax situation.

When selecting a CFP, ensure they’ve completed extensive training and adhere to fiduciary responsibilities. Similarly, CPAs must meet substantial educational requirements and complete supervised work before they can obtain state licensure.

If you’re facing challenges with your financial planner or seeking a new one, you might consider reaching out to relevant experts for assistance.

Note: The question has been edited for brevity and clarity. By reaching out with a question, you consent to have it published anonymously.