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Suppose husband has a single member LLC, has a SEP IRA, and makes more than enough to max out annual SEP contributions.

I'm curious if the wife could be added to the LLC to allow the wife to also receive SEP contributions and thus reduce overall tax burden. Let's suppose the following:

  • Let's not address risk of divorce, etc. I understand this is a true risk but I don't want to get sidetracked from the tax question.
  • LLC always makes a profit so no need to address losses in a tax year
  • Non community-property state
  • 50-50 split between couple and taxed as partnership
  • Wife's involvement is purely passive

In this situation, could SEP IRA contributions be made to both the husband and wife?

  • Contribution maximums for a SEP are 25% of compensation. If you reallocate compensation to her, his share will go down and the sum of the two contributions will be unchanged. Are you asking because you hope to exceed the $54K hard maximum? – farnsy Jun 29 '17 at 15:17
  • Contribution maximums are 25% per person. So if we split profits and can each contribute 25% then we could potentially contribute up to $108k for the two of us. You can definitely do this for an active partner, but I was wondering if you could also do this for a passive partner. – gaefan Jun 29 '17 at 15:33
  • Another thing to be aware of: LLC is not a federal tax designation. You will likely be taxed either as an S corp or partnership. Exactly what can be considered "compensation" as opposed to "distributions" may depend on how you set it up and divide things up on schedule K-1. Sorry to bore you with details but they will likely be relevant. – farnsy Jun 29 '17 at 15:50
  • Already had in my question that we'd be taxed as partnership but thanks. – gaefan Jun 29 '17 at 15:58
4

It sounds like you can't do this. Not too surprising that the IRS prevents you from getting a free lunch...

It seems that you can only contribute to a retirement plan for "earned income." To have earned income, you must pass a "material participation test," which is not an easy thing. Here it would likely require my wife to work 500 hours per year.

This blog post has some good details as well.

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