IRS provides tips on fixing SEP contribution errors due to use of wrong definition of compensation

In the IRS SEP Plan Fix-It Guide, the IRS has provided tips on fixing simplified employee pension individual retirement account (SEP-IRA) contribution miscalculations due to the use of the wrong definition of compensation. Employers are reminded to review the SEP plan document and follow the definition of compensation stated in the plan document in the operation of the plan.

Generally, compensation encompasses the pay an employee received from an employer for personal services for a year including: wages and salary, fees for professional services, and other amounts received (cash or non-cash) for personal services actually rendered by the employee, covering (but not limited to) commissions and tips, overtime, fringe benefits, and bonuses. Also, an alternative definition of compensation is allowed under Code Sec. 414(s) that excludes some of the above listed items. The IRS notes that any exclusions of compensation must be specified in the SEP plan document. If Form 5305-SEP is being used, allocations should be based on total compensation. If the SEP plan has a complicated definition of compensation, the IRS advises developing a worksheet to calculate the correct amounts.

To fix the mistake, the IRS states that a corrective contribution, including earnings through the date of correction, should be made to each affected employee’s SEP IRA if the compensation was understated. If it is not feasible to determine what the actual investment results would have been, a reasonable rate of interest may be used, such as the interest rate used by the Department of Labor’s Voluntary Fiduciary Correction Program Online Calculator. Depending on the circumstances involved, plan sponsors may be able to use the IRS Self-Correction Program, the Voluntary Correction Program, or the Audit Closing Agreement Program to correct the error.

Source: IRS website, SEP Plan Fix-It Guide.

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