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Publication 560

Salary Reduction Simplified Employee Pensions (SARSEPs)(p7)

A SARSEP is a SEP set up before 1997 that includes a salary reduction arrangement. (See the Caution, next.) Under a SARSEP, your employees can choose to have you contribute part of their pay to their SEP-IRAs rather than receive it in cash. This contribution is called an "elective deferral" because employees choose (elect) to set aside the money, and they defer the tax on the money until it is distributed to them.
You are not allowed to set up a SARSEP after 1996. However, participants (including employees hired after 1996) in a SARSEP set up before 1997 can continue to have you contribute part of their pay to the plan. If you are interested in setting up a retirement plan that includes a salary reduction arrangement, see chapter 3.

Who can have a SARSEP?(p7)

A SARSEP set up before 1997 is available to you and your eligible employees only if all the following requirements are met.
SARSEP ADP test.(p7)
Under the SARSEP ADP test, the amount deferred each year by each eligible highly compensated employee as a percentage of pay (the deferral percentage) cannot be more than 125% of the average deferral percentage (ADP) of all non-highly compensated employees eligible to participate. A highly compensated employee is defined in chapter 1.
Deferral percentage.(p7)
The deferral percentage for an employee for a year is figured as follows.
 The elective employer contributions
(excluding certain catch-up contributions)
paid to the SEP for the employee for the year
 The employee's compensation
(limited to $260,000 in 2014)
The instructions for Form 5305A-SEP have a worksheet you can use to determine whether the elective deferrals of your highly compensated employees meet the SARSEP ADP test.
Employee compensation.(p7)
For figuring the deferral percentage, compensation is generally the amount you pay to the employee for the year. Compensation includes the elective deferral and other amounts deferred in certain employee benefit plans. See Compensation in chapter 1. Elective deferrals under the SARSEP are included in figuring your employees' deferral percentage even though they are not included in the income of your employees for income tax purposes.
Compensation of self-employed individuals.(p7)
If you are self-employed, compensation is your net earnings from self-employment as defined in chapter 1.
Compensation does not include tax-free items (or deductions related to them) other than foreign earned income and housing cost amounts.
Choice not to treat deferrals as compensation.(p7)
You can choose not to treat elective deferrals (and other amounts deferred in certain employee benefit plans) for a year as compensation under your SARSEP.

Limit on Elective Deferrals(p8)

The most a participant can choose to defer for calendar year 2014 is the lesser of the following amounts.
  1. 25% of the participant's compensation (limited to $260,000 of the participant's compensation).
  2. $17,500.
The $17,500 limit applies to the total elective deferrals the employee makes for the year to a SEP and any of the following.
In 2015, the $260,000 limit increases to $265,000 and the $17,500 limit increases to $18,000.

Catch-up contributions.(p8)

A SARSEP can permit participants who are age 50 or over at the end of the calendar year to also make catch-up contributions. The catch-up contribution limit remains at $5,500 for 2014 and increases to $6,000 for 2015. Elective deferrals are not treated as catch-up contributions for 2014 until they exceed the elective deferral limit (the lesser of 25% of compensation or $17,500), the SARSEP ADP test limit discussed earlier, or the plan limit (if any). However, the catch-up contribution a participant can make for a year cannot exceed the lesser of the following amounts.
Catch-up contributions are not subject to the elective deferral limit (the lesser of 25% of compensation or $17,500 in 2014 and $18,000 in 2015).

Overall limit on SEP contributions.(p8)

If you also make nonelective contributions to a SEP-IRA, the total of the nonelective and elective contributions to that SEP-IRA cannot exceed the lesser of 25% of the employee's compensation or $52,000 for 2014 ($53,000 for 2015). The same rule applies to contributions you make to your own SEP-IRA. See Contribution Limits, earlier.

Figuring the elective deferral.(p8)

For figuring the 25% limit on elective deferrals, compensation does not include SEP contributions, including elective deferrals or other amounts deferred in certain employee benefit plans.

Tax Treatment of Deferrals(p8)

Elective deferrals that are not more than the limits discussed earlier under Limit on Elective Deferrals are excluded from your employees' wages subject to federal income tax in the year of deferral. However, these deferrals are included in wages for social security, Medicare, and federal unemployment (FUTA) tax.

Excess deferrals.(p8)

For 2014, excess deferrals are the elective deferrals for the year that are more than the $17,500 limit discussed earlier. For a participant who is eligible to make catch-up contributions, excess deferrals are the elective deferrals that are more than $23,000. The treatment of excess deferrals made under a SARSEP is similar to the treatment of excess deferrals made under a qualified plan. See Treatment of Excess Deferrals under Elective Deferrals (401(k) Plans) in chapter 4.

Excess SEP contributions.(p8)

Excess SEP contributions are elective deferrals of highly compensated employees that are more than the amount permitted under the SARSEP ADP test. You must notify your highly compensated employees within 21/2 months after the end of the plan year of their excess SEP contributions. If you do not notify them within this time period, you must pay a 10% tax on the excess. For an explanation of the notification requirements, see Rev. Proc. 91-44, 1991-2 C.B. 733. If you adopted a SARSEP using Form 5305A-SEP, the notification requirements are explained in the instructions for that form.

Reporting on Form W-2.(p8)

Do not include elective deferrals in the "Wages, tips, other compensation" box of Form W-2. You must, however, include them in the "Social security wages" and "Medicare wages and tips" boxes. You must also include them in box 12. Mark the "Retirement plan" checkbox in box 13. For more information, see the Form W-2 instructions.