Running bonuses through SEPs.

• Author: Peterson, John M.
• Position: Simplified employee pensions

The traditional method of paying cash bonuses entails not only immediate income taxation to the employee but also immediate FICA taxability to both the employer and employee. However, amounts contributed to and distributed from simplified employee pensions (SEPs) are never subject to FICA taxation (although distributions prior to age 591/2 are subject to a 10% early distribution penalty). Because the combined FICA tax rate (15.3%) exceeds the early withdrawal penalty (10%), an employer can put the same bonus dollars in an employee's pocket by contributing the bonus to an SEP and allowing the employee to immediately withdraw the contribution (if he desires) while saving the employer-side FICA. In addition, under this plan the business owner/highly compensated employee effectively gets the option to shelter their bonus (by leaving it in the SEP) without having to pass the usual Sec. 401(a)(4) and (k) antidiscrimination tests. The rank and file also have the option of keeping the money in a tax-deferred vehicle. See the example on page 488.

Of course, the $157 per-employee savings to the employer in the example is not the primary motivation for using this plan (unless the number of employees is so large that the total savings is significant). The real benefit is the business owner's opportunity to shelter $22,500 (15% of $150,000) in a retirement plan at no cost for coverage of employees. A subsidiary advantage is the...