29.2 SEPs, Self-Employed Contributions & Owner Compensation
Key Takeaways
A SEP generally uses employer contributions rather than new employee salary-reduction elections.
For 2025, an employee’s SEP contribution generally is limited to the lesser of $70,000 or 25% of compensation.
For a self-employed owner, a 25% plan rate generally becomes a 20% reduced rate applied after the deductible half of SE tax.
What a SEP provides
A Simplified Employee Pension (SEP) is an employer arrangement that funds eligible participants' SEP IRAs. It offers relatively simple administration and allows discretionary employer contributions, but simplicity does not eliminate coverage requirements. An owner who establishes a SEP generally must include eligible common-law employees under the plan's terms and statutory limits.
A modern SEP generally does not allow employees to make salary-reduction contributions through the employer as though it were a 401(k). Certain older salary-reduction SEPs, or SARSEPs, have grandfathered rules. Do not apply SARSEP deferral limits to an ordinary newly established SEP. An individual's separate IRA contribution is also not the same as an employer SEP contribution.
Employee eligibility and allocation
The statutory SEP eligibility rules generally cover an employee who has reached age 21, worked for the employer in at least three of the preceding five years, and received at least $750 in compensation in 2025, subject to permitted exclusions. The employer may use less restrictive conditions. Part-time and seasonal work can count toward the service requirement; it is not automatically limited to three full calendar years of full-time service.
Permitted exclusions can include certain employees covered by a collective bargaining agreement and certain nonresident aliens without U.S.-source compensation. Check the plan document before excluding anyone. An eligible employee who leaves during the year is not automatically excluded from a contribution for that year. SEP contributions generally vest immediately.
Employer contributions typically use a uniform percentage of compensation for eligible employees under the basic SEP arrangement. The business cannot pay the owner 25% and an otherwise eligible employee zero merely because the employee did not request an account. Employer contributions for common-law employees and the self-employed owner's personal contribution can appear in different places on the income-tax returns.
2025 limits for employees
For a common-law employee, the maximum contribution generally is the lesser of 25% of compensation or $70,000 for 2025. Compensation above $350,000 is not considered for the applicable calculation. These limits interact: 25% of $350,000 is $87,500, but the $70,000 dollar ceiling still controls.
Example: An eligible employee earns $200,000 and the employer selects a 20% contribution rate. The contribution is $40,000. A 25% contribution would be $50,000, still below the $70,000 limit. An employer contribution is not reduced merely because the employee already made a separate ordinary IRA contribution, but other applicable retirement-plan limits and arrangements must still be reviewed.
The self-employed circular computation
A self-employed person's plan compensation is net earnings from self-employment under the retirement-plan rules. It reflects the deduction for the deductible part of SE tax and the owner's own retirement contribution. Because the contribution reduces the earnings base used to compute itself, use the reduced-rate formula rather than simply applying 25% to Schedule C net profit.
For a plan rate of 25%, the reduced rate is 25% divided by 125%, or 20%. Apply it to the appropriate net earnings after deducting the deductible half of SE tax and before deducting the owner's own plan contribution, using Publication 560's worksheet and applicable limits.
Example: A sole proprietor has $100,000 of earnings after the deductible half of SE tax, before the proprietor's own SEP contribution. With a 25% plan contribution rate, the proprietor's maximum percentage-based contribution is $20,000. After that contribution, the compensation base is $80,000; 25% of $80,000 equals $20,000, confirming the circular calculation. A $25,000 contribution based on the original $100,000 would overstate it.
The owner's own qualified-plan deduction is generally an adjustment on the individual return rather than a Schedule C deduction. It does not reduce the Schedule SE calculation the way an ordinary operating expense would. Contributions for the proprietor's common-law employees generally are business deductions on the appropriate business schedule.
Compare owner types
| Owner | Contribution base to examine |
|---|---|
| Sole proprietor | Adjusted self-employed earned income |
| Partner | Qualifying partnership earned income under the plan rules |
| S corporation shareholder-employee | Qualifying W-2 compensation, rather than distributions |
| C corporation shareholder-employee | Compensation as an employee, subject to plan rules |
A partner can have guaranteed payments and distributive income affecting earned income, but investment income or excluded items cannot be assumed to be plan compensation. An S corporation's $100,000 distribution to its owner does not create $100,000 of SEP compensation. Wages and distributions serve different tax roles.
Timing and records
A SEP generally may be established and funded by the due date of the employer's return, including extensions, under the applicable rules. Keep adoption documents, employee eligibility records, allocation calculations, and deposit evidence. Traditional SEP employer contributions generally are not included as ordinary wages on Form W-2. Roth SEP arrangements, where permitted, have different current-income reporting; do not describe every SEP contribution as automatically tax-deferred.
Official reference
2025 Publication 560, SEP and self-employed deduction worksheets, checked October 17, 2026.
A sole proprietor has $100,000 of earnings after the deductible half of SE tax but before their own SEP contribution. The plan contribution rate is 25%. Ignoring other limits, what is the owner’s contribution?
$25,000
$20,000
$70,000
$0 because sole proprietors cannot use SEPs
Sections you finish are checked off in the contents.