Thank you for attending this session on SARSEP IRA Plan options. The information in this session isn’t official guidance.

The SARSEP is a Salary Reduction Simplified Employee Pension IRA Plan. A SARSEP allows employees to defer part of their salary into the plan. The employer can also make contributions to the SARSEP.

We’ll be discussing a number of problem areas that we find in our SARSEP examinations.

SARSEPs take a lot of care to properly manage, and we find a lot of errors in our SARSEP examinations. We’ll discuss: The plan document and if it is timely adopted and updated, The 25-employee limit, including eligible employees in the plan, Deferral and contribution limits; the timely deposit of elective salary deferrals, The 50% participation test for elective deferrals; the SARSEP deferral percentage test, and Top-heavy contributions that may be required by the SARSEP.

Let’s look at the requirements for the SARSEP plan document first.

If you established a SARSEP before Jan. 1, 1997, you can continue to operate the plan. No new SARSEP can be established after 1996.

Retirement plan laws change periodically. You should’ve amended your SARSEP by adopting the most recent version of the IRS model Form 5305A-SEP. If you adopted a SARSEP plan from a financial institution, it should have a revision date of 2002 or later.

If you haven’t amended your SARSEP plan, see our SARSEP Fix-it Guide for information on how to correct this error.

If you had more than 25 eligible employees in the prior year, no salary deferrals allowed in the current year. You may still make employer contributions, but no salary deferrals are allowed.

If you have less than 26 eligible employees in the prior year, salary deferrals and employer contributions are allowed for the current year.

If you have less than 26 eligible employees in the prior year but more than 25 eligible employees in current year, salary deferrals and employer contributions are allowed in the current year, but no salary deferrals are allowed in the following year.

Employees eligible to participate in a SARSEP, include all employees who: Are at least 21 years of age.

Have performed for you in at least three of the immediately preceding five years, Had compensation of at least $600 for 2020 or $650 for 2021.

Your SARSEP document can allow less restrictive eligibility requirements. A SARSEP may not impose an hours-of-service requirement. The term “employee” includes working business owners, even if self-employed, as well as employees of related employers. If you or your family members own a controlling interest in another business, employees of the related business that meet the eligibility requirements are eligible to participate in your SARSEP.

Related employers include: Affiliated service groups that include your business; controlled groups of corporations that include your business; and trades or businesses under common control with your business.

Who can you exclude from your SARSEP? You can exclude: Employees covered by a collective bargaining agreement, nonresident alien employees who did not earn U.S. source income from you; and employees who received less than $650 in compensation for 2021 ($600 for 2015 - 2020) during the year.

Let’s take a look at SARSEP contributions.

When determining SARSEP contributions, it’s important to use the correct compensation as defined in the plan.

Read your SARSEP document. Compensation definitions under the plan may be different for different purposes, like determining the $650 limit. Self employed persons should use earned income as defined under section 401(c)(2).

Employee salary deferrals are limited to $19,500 for 2020 and 2021.

Taxpayers that are age 50+ can make catch-up contributions of up to an additional $6,500 for 2020 and 2021.

Employer contributions plus employee salary deferrals are limited to $58,000 (or $64,500 with the catch-up contribution) for 2021.

Employee salary deferrals must be timely deposited.

Deferrals must be sent to the appropriate financial institution as soon as possible.

The IRS hasn't determined what is reasonable, but has determined that it is UNreasonable to make the deposit more than 15 days following the month in which the employee would have otherwise received the money.

DOL provides a 7-business-day safe harbor for salary deferrals for plans with fewer than 100 participants.

Generally, if you or certain other family members own other businesses, you may have a controlled group or affiliated service group.

Your SARSEP must also cover the employees of these businesses, and they will be counted against the 25 employee limit.

Employees of other related businesses you own cannot be excluded from your SARSEP.

Let’s take a look at a few other SARSEP rules.

Each year, at least 50% of your eligible employees must choose to make employee elective deferrals into the SARSEP.

If fewer than 50% of your eligible employees elect to defer, you must stop all employee salary deferrals to the plan.

The law disallows all employee elective deferrals made for that year, and those deferrals must be withdrawn from the employees’ SEP-IRAs within 2 ½ months of the following year, which is March 15 for calendar year plans.

SARSEPs are held in IRA accounts owned by the participant, so you can’t take out the deferrals yourself.

You must notify each affected employee of what happened and what they need to do. Share with them: The amount of the disallowed deferrals to the employee’s SEP-IRA for the preceding year, The year the disallowed deferrals and earnings are includible in the employee's gross income, Information stating that the employee must withdraw the excess contributions (and earnings), and an explanation of the tax consequences if the employee doesn't withdraw the excess.

The plan must pass the deferral percentage test each year. The DP test compares the salary deferral percentage of each Highly Compensated Employee with the average percentage of all Non-Highly Compensated Employees.

This test limits the amount each highly compensated employee can defer to 1.25 times the average amount the non-highly non-highly compensated employees defer. Our agents have found that many SARSEPs don’t run this test each year.

If the test fails, you must notify each highly compensated employee who exceeded the limit within 2 ½ months after the end of the plan year (or March 15 for calendar year plans). If the employer fails to notify the employees within the 2 ½ month window, window, the employer must pay a 10% excise tax on the excess contributions and file Form 5330 to pay the excise tax.

If you don’t notify the employees by the end of the following plan year, the SARSEP will fail to be a tax-favored retirement plan.

If your SARSEP is top-heavy, you're required to make a minimum contribution for non-key employees. A SARSEP is considered top-heavy if: The plan document indicates the SARSEP is always considered top-heavy, A key employee’s salary deferral to the plan makes it top-heavy; or A top-heavy test indicates for the year that the plan is top-heavy. The top-heavy ratio is a comparison of the total of all salary deferrals and employer contributions of the key employees to the total of all salary deferrals and employer contributions of the non-key employees. If the ratio is greater than 60%, the plan is top-heavy.

Check your plan document, because SARSEPs are often drafted to operate as if they’re always top-heavy, which may eliminate the need for a top-heavy test.

When a SARSEP is top-heavy, non-key employees must receive a minimum employer contribution of up to 3% of pay.

This minimum contribution isn’t required for key employees. This contribution, in combination with other non-elective contributions, must be the lesser of: 3% of each eligible non-key employee’s compensation, or the highest percentage of compensation received by a key employee for the year.

You can’t use employee salary deferrals to satisfy the minimum contribution requirements for top-heavy plans.

A key employee is any employee who, at any time during the preceding year was: an officer of your company with compensation greater than $185,000 in 2021; a 5% owner of your company, which is someone who owns more than 5% of the business; or a 1% owner of your company with compensation greater than $150,000.

Let’s now look at some additional SARSEP resources that are available to you.

You can find more information on retirement plans at IRS.gov/retirement, our landing page on IRS.gov.

Also, check out the small business resources section at IRS.gov/SmallPlans.

You can subscribe to our newsletter at IRS.gov/RetirementNews The SARSEP Checklist, Pub 4286, is a list of the top 10 mistakes we find in our SARSEP audits.

Each mistake includes a link to more information on how to find, fix and avoid that mistake.

On irsvideos.gov, we have a 30-minute video on the types of plans available to small employers and self-employed individuals as well as additional, shorter videos on the different types of plans available to small employers.

Please contact us with any questions at TEGE.Outreach@irs.gov. Thank you for attending.