For a few years I've been contributing to a SEP-IRA for myself as the sole employee/employer. Until this year, I have been calculating my max contribution as 25% of my total SE income. I realize that is wrong now, but finding the exact contribution limit has been very confusing. We can ignore the inflation adjusted upper ceiling (50k+) since it's above my percentage limit.
The websites I've seen that mention there being a difference for the employer's own contributions usually say the percentage limit is 20% of net income. My understanding of
net income for my simple case (I work from home and don't have significant business-exclusive expenses) is
net income = income - 0.5*SEtax, equivalent to
20% * net income is much less than
0.25 * income, so it's a bit scary to think about correcting my contributions for 2019 and 2020 and taking out the excess with a 6% excise tax (I haven't yet done my contribution for 2021: got an extension).
Fortunately (!) I got a CP2000 notice from the IRS recently because I forgot to include some security trades on my 2020 return. In addition to the security correction, they also corrected my SEP contribution. But they didn't correct it to 20% on net income, they corrected it to 25% on net income. Can I take that as definitive evidence that my limit should be 25% of my net income?
Taking 100k income as an example:
|½ SE tax||7500|
|25% on SE income||25000|
|20% on SE income||20000|
|25% on net income||23125|
|20% on net income||18500|
If these had been my numbers, my original return would have the 25000 number and the CP2000 corrected it to 23125.
- One of the big ones didn't report cost basis, so it looked like a lot of unreported income. Actually though it was a big capital loss for me so the IRS owes me a little more refund even after correcting the SEP deduction. Sorry IRS, no substantial understatement of tax penalty for you (gotta love the irony)!