How much money do you have to make to file taxes? What is the minimum income to file taxes?

Let’s take a look at the requirements for the minimum income to file taxes in 2018 (and due in 2019).

2018 Minimum Income Requirements

The IRS released the minimum income to file taxes in 2018.

For the 2018 tax year, you will need to file taxes if your gross income meets the minimum income for your filing status and age. Here are the minimum income limits for the 2018 tax year.

How Much Money Do You Have to Make to File Taxes 2018

 
Filing Status Minimum Gross Income
(under 65)
Minimum Gross Income (65+)
Single $12,000 $13,600
Head of Household $18,000 $19,600
Married Filing Jointly $24,000 $25,300 (one spouse)
$26,600 (both spouses)
Married Filing Separately $5 $5
Widow with Dependent Child $24,000 $25,300

This table does not apply to dependents. See When Do Kids Need to File Taxes? for minimum income to file taxes for children.

Once you find out if you meet the minimum income to file taxes, you can determine your tax rate using the current tax brackets.

Social Security Income

Gross income doesn’t include social security benefits.

However, there is an exception to this rule if half of your social security benefits plus your other gross income is more than $25,000 ($32,000 if married filing jointly). Once that happens, you’ll need to file a 2018 tax return. Married filing separate also have different social security rules. For more information, see Do You Have to Pay Income Tax on Social Security?

Other Income Sources

There are special rules for self employment earnings and church earnings. You must file taxes if your:

  • Self employment net earnings are greater than $400.
  • Church earnings are greater than $108.28 and are exempt from employer Social Security and Medicare.

If you are self employed, you will also need to file and pay self employment tax.

Filing Requirement for Health Care Responsibility

The filing requirement for health insurance continues for the 2018 tax year. If you received advancements of the health insurance premium tax credit to pay for health insurance, you will need to file a tax return. Here’s how to reconcile your payments and Claim the Health Insurance Premium Tax Credit. In addition, you will also report any penalties for no health insurance on your tax return. This is the final year for penalties.

More Tax Filing Requirements

Optional filing. Even if you are not required to file a tax return, you can choose to file one. You may want to file an optional tax return if you had any federal withholding or are entitled to tax credits, like the earned income tax credit or the Health Insurance Premium Tax Credit and want to get a refund.

Other filing requirements. In addition to the income requirements, there are other circumstances when you must file a tax return. One example is if you sold your home. For all the requirements, see Publication 17.

When to file. If you earn enough money to file a tax return, you must file your tax return by the tax deadline.

After you file. Once you file, you can see How Long Does it Take to Get Your Tax Refund Back?

Tax Filing Online

Now that you know how much money you have to make to file taxes, go ahead and file your free federal and state taxes online with TurboTax!

More Tax Topics





Self employed tax deductions are an important part of offsetting your extra income when filing your federal tax return. For example, if you are flying for business, one of the 7 Commonly Overlooked Tax Deductions is baggage fees!

An old business partner wanted to know what he needed to keep track of for his venture into self employment. I ran through the list of self employed business deductions I have used in the past to get him started.

Tax Deductions for the Self Employed

The tax deadline is just around the corner; many of you could also benefit from this information. This list is not a complete list, but rather the deductions that I routinely use. Most of the deductions are taken on Schedule C unless otherwise noted.

You can use TurboTax to enter your tax deductions yourself or you can provide the amounts to your tax accountant.

Self Employed Tax Deductions

  1. Internet Access. Both at home and in coffee shops that you work at for WI-FI access.
  2. Website Expenses. Fees paid to purchase domains, hosting, and other fees associated with running a website.
  3. Cell Phone. You cannot deduct the primary phone line at your house, but if you have multiple lines or a cell phone you use for business, the extra lines are deductible.
  4. Contract Labor. Independent contractor’s that you hire to complete work are not employees, but the payments can be deducted.
  5. Computer. Did you buy a new business laptop before December 31? If so, it’s deductible.
  6. Advertising. Advertising costs are deductible. This includes prizes for giveaways if you purchase the prizes.
  7. Credit Card Fees to Pay Taxes. If you use a credit card to pay tax (to earn a profit) you can deduct the convience fees you pay on business tax payments and on qualified personal tax payments.
  8. Tax and Accounting Software. Software you buy to keep the books for your business is deductible. I use Quickbooks.
  9. Filing Fees. You can deduct fees you pay to the state to maintain your business license.
  10. Postage and P.O. Box Fees. Don’t want your business mail going to your home address? Set up a P.O. Box and deduct the cost.
  11. Office Supplies. In addition to postage, you can deduct the cost of paper, pens, etc.
  12. Mileage. You can deduct business mileage on your personal car. Make sure you keep good records.
  13. Business Meals. Business meals are deductible at a rate of 50%.
  14. Retirement Contributions. Contributions to a Solo 401k or other qualified plan are deductible.
  15. Self Employment Tax. Half of the self employment tax you pay can be deducted.
  16. Home Office Deduction. If you work from home, you can deduct the costs associated with maintaining an exclusive home office on form 8829 as a Home Office Tax Deduction. You can include a portion of real estate tax, mortgage interest, insurance, maintenance, utilities, office furniture, casualty losses and depreciation.
  17. Health Insurance. Part of your self employed health insurance costs are deductible if you were not eligible to take part in an employer-subsidized health plan. However, to determine the amount, there is an iterative calculation if you also qualify for the Health Insurance Premium Tax Credit.
  18. Cost of Goods. If you are selling products on Amazon or any other platform, don’t forget to deduct the product costs when they are sold.

More Self Employed Tax Topics





Did you recently start your own business and you need to learn how to calculate your self employment tax to file your tax return before the tax deadline?

If you are an individual who is self employed, you have many advantages over people who are employed by companies. Of course, you get to set your own hours and rates, which is something many other employees cannot do.

However, at the same time, you are required to pay your own self employment taxes, which can be somewhat complicated if you have never done so before. But don’t worry; once you walk through it, it’s pretty painless. Let’s walk through how to calculate self employment tax.

How to Calculate Self Employment Tax
How to Calculate Self Employment Tax

What are Self Employment Taxes?

People who are self-employed differ from those employed by an outside company in that they do not have a portion of their salary deducted from their pay. Therefore, there is no withholding of money toward taxes or for Social Security or Medicare. If you work for an outside company, the company pays half and the individual pays half of the Social Security and Medicare taxes. However, when you are self-employed, you must pay the entire amount of Social Security and Medicare taxes yourself. This is known as self-employment tax.

Self employment tax is separate from and in addition to state and federal income tax rates. Self-employment tax must be paid in addition to your regular income taxes. Self employment tax is applicable at any age, and you are still responsible for paying self employment tax, even if you are already receiving Social Security benefits or if you are a minor.

Self Employment Tax Rate

The self employment tax rate for 2016 is 15.3%. (12.4% for Social Security tax and 2.9% for Medicare tax). Since 2013 there is also an additional 0.9% Medicare Surtax that applies to earnings over the threshold for high earners.

How to Calculate Self Employment Tax

Calculating your self-employment tax is not as difficult as it may seem. Once your net earnings from self-employment are at least $400 (or church employee income of at least $108.28), you are responsible for paying self-employment taxes and filing a tax return. Here is how to calculate the self employment tax:

  1. Determine your net income. The net income for your business is income minus any of your expenses related to your work. For instance, if you have purchased a laptop and printer for your business, you are entitled to tally up the costs of them and other work related expenses and deduct them from your income. For a list of common expenses see Tax Deductions for the Self Employed.
  2. Calculate Net Earnings from Self Employment. To do this, multiply the net income by 92.35 percent.
  3. Calculate Self Employment Tax. Next, for any income less than the social security wage base (2015 and 2016: $118,500) multiply the amount by 15.3%. For any amount over the wage base, multiply by 2.9%. Add the two figures together to arrive at your self employment tax.

Self Employment Tax Calculator

If you don’t want to calculate your self employment tax by hand, you can use the tax calculator to calculate it automatically. In addition, if you are using tax software like TurboTax, the software will also calculate your self employment tax automatically.

Self Employment Tax Form to Use

When you are ready to file your taxes, you will need the Schedule SE for self-employment taxes. The self employment tax form is in addition to your regular Form 1040 and business Schedule C for profit or loss; they are all due on the same tax deadline.

Self Employment Tax Deduction

In addition to paying the self employment tax, you also get a personal tax deduction for paying it! You can deduct half of the self employment tax, which will lower your adjusted gross income, and lower your income tax.

More Self Employed Topics





There has been a huge change to our household this year that goes far beyond a change in taxes: I quit my day job in January and started working for myself. Though this decision was drastic, I did not make it on my own, nor did I make it with complete disregard to our financial future.

Four and a half years ago I started my blog by moonlighting. At the same time, I began writing for other blogs (including here!). Over the years I have learned a lot about blogging, built a network of blogging and tech friends, and worked on the craft of writing. When I knew that I wanted to try and make a go of it, I kept it to myself for six months. Then I got up the courage to talk to my husband, and we had several honest conversations about the likelihood of my success, our finances, and our feelings. Once we were on the same page (and had run the numbers), it took several more months for me to take the plunge and tell my boss.

Taking the plunge—having the courage to let go of a steady paycheck and tell my boss and co-workers of my decision—was as difficult as it was exhilarating. Eight months later, I can say that it was exactly the right decision for me. But things have changed. Along with no longer having coworkers whom I see in person, or steady pay, or a commute, I also have changes to the way that I need to pay my taxes. You see, generally speaking, no taxes are taken out of any of my sources of income.

This is where estimated taxes come in.

What are Estimated Tax Payments?

I earn income by staff writing for other blogs and making money with my blog selling advertisements, earning commissions on affiliate products and services, and selling eBooks. None of this extra income is subject to tax withholding (like the kind you would see a normal paycheck). The IRS works on a pay-as-you-go system, so you are supposed to pay taxes as you earn income rather than all at once at the end of the year.

How Often do Estimated Tax Payments Need to be Paid?

Estimated taxes are generally referred to as quarterly estimated taxes. However, they are not due exactly three months apart. Estimated tax payments are due:

  • April 15th
  • June 15th
  • September 15th
  • January 15th

Who Has to Pay Estimated Tax Payments?

If you do not have taxes withheld due to being self-employed, or from receiving income from interest, dividends, alimony, rent, gains from the sale of assets, prizes and awards, then you likely need to file estimated taxes. Know also that if your employer does not withhold enough taxes, you may need to pay estimated taxes as well.

Those of you who file as a sole proprietor, partner, S corporation shareholder, and/or a self-employed individual generally have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your return. Last year I wasn’t sure if I would meet this tax threshold (based on my income from the previous several years). If you are in the same boat, you can fill out 1040-ES: Estimated Tax for Individuals in order to see if you will need to fill out estimated taxes or not. When figuring your estimated tax for the current year, it can be helpful to use your income, deductions, and credits for prior year as a starting point. The two most important lines on your prior tax returns on Form 1040 are lines 62 (total tax) and 63 (withholding).

What Happens If I Don’t Pay My Estimated Taxes?

Even if you are supposed to receive a tax refund, if you do not pay enough tax by each of the due dates above, then you may be charged a penalty. You generally will not be assessed a penalty if:

  • You owe less than $1,000 in taxes
  • or if you paid at least 90% of the tax for the current year
  • or if you paid 100% of the tax shown on the return for the prior year (whichever is smaller)

Also, if you failed to make the payment due to a casualty, disaster or other unusual circumstances, or if you retired/became disabled and there is a reasonable cause for not paying, then you may not be given a penalty. Fill out Form 2210 to get out of a penalty if any other reasons listed are why you did not pay on time.

The easiest way for you to send in payments for your estimated quarterly taxes is through the Electronic Federal Tax Payment System (EFTPS). Using this system, you can pay your estimated quarterly taxes weekly, bi-weekly, or monthly, so long as by the due date all of the estimated taxes are paid for that quarter. For further information, see Publication 505 Tax Withholding and Estimated Tax.

More Tax Topics





What is Schedule SE?

Schedule SE is used to report your self-employment taxes. The self employment tax form is in addition to your regular Form 1040 and business Schedule C for profit or loss.

When do you use Schedule SE?

You must fill out Schedule SE if you earned $400 or more from your self-employed position. For church employees, this amount is $108.28 or more. Your self employment is subject to self employment tax.

What is Self Employment Tax?

The self-employment tax is for independent contractors and self-employed individuals who do not get taxes taken out of their salary already. Since there is no withholding for Medicare or Social Security, you pay the self-employment tax.

How to Calculate Self Employment Tax

To determine the amount you need to pay on Schedule SE use the following formula to calculate your self-employment tax.

IRS Schedule SE Forms

While you are figuring out your net income, you can deduct items you have purchased or other costs related to your work. Here is a list of common tax deductions for the self-employed.

More Self Employed Tax Topics





Typically people spend money in order to pursue their hobby: equipment for a sport, ticket fees to events, materials such as yarn and needles for knitting, seeds for a part-time farm, etc. But some hobbies have the added perk of making you money. You have to be careful with this earned income come tax time because unlike with business income, you cannot claim a loss from this activity or deduct certain expenses (in accordance with Internal Revenue Code Section 183, Activities Not Engaged in for Profit, or the “hobby loss rule”). In 2007, the IRS estimated that $30 billion of tax revenue was lost due to the misunderstanding among taxpayers between business vs hobby.

Definition of Hobby

For clarification, the IRS defines a hobby as an activity that is not pursued for profit, and defines a business as an activity that is carried out with the reasonable expectation of earning a profit.

Business vs Hobby?

First you need to determine if your activity is a business or a hobby. Here are some questions that the IRS gives in order to help you determine whether or not your activity can be considered a hobby:

  • Have you made a profit at this activity for at least 3 out of the last 5 years (including the current year)?
  • Are there indications that you intend to make a profit from the activity (for example, enough time and energy are put into the venture to show that you intend to make a profit)?
  • Do you depend on the income made from your activity?
  • Can you explain losses from this activity?
  • Are you qualified to be doing the activity in a way to be making a profit from it?
  • Do you expect to make money from this activity in the future?

Hobby Tax Deduction Rules

If you answered “no” to several of the questions above, or if you just know for certain that the activity you make money from is a hobby, then there are certain rules for expenses and deductions you need to know. As mentioned above, you are not allowed to deduct most of the expenses you incur from your income earned from a hobby. You also are not allowed to show a tax loss from a hobby (i.e. allowable deductions cannot exceed the gross receipts for the activity). However, you are allowed to take the following deductions (only in the order of these categories; as soon as a loss is shown no other deductions may be taken).

  • You may deduct what taxpayers deduct from certain personal expenses such as home mortgage interest and taxes.
  • Next you can take deductions that don’t result in an adjustment to the basis of property (advertising, insurance premiums and wages).
  • Finally, you can next take deductions that reduce the basis of property, such as depreciation and amortization.

Deductions for hobby activities are claimed as itemized deductions on Schedule A, Form 1040. For more information on business deductions, check out IRS Publication 535.

More Tax Topics for Your Business

Retirement Plans for Your Business





How much money do you have to make to file taxes? What is the minimum income to file taxes? Every year, those are familiar questions that I get. Let’s take a look at the requirements for the minimum income to file taxes in 2010.

2010 Minimum Income Requirements

For the 2010 tax year, you need to file taxes if your gross income meets the minimum income for your filing status and age:

 
Filing Status Minimum Gross Income (under 65) Minimum Gross Income (65+)
Single $9,350 $10,750
Head of Household $12,050 $13,450
Married Filing Jointly $18,700 $19,800 (one spouse)
$20,900 (both spouses)
Married Filing Separately $3,650 $3,650
Widow with Dependent Child $15,050 $16,150

This table does not apply to dependents. See When Do Kids Need to File Taxes? for minimum income to file taxes for children.

Social Security Income

Gross income doesn’t include social security benefits.

However, there is an exception to this rule if half of your social security benefits plus your other gross income is more than $25,000 ($32,000 if married filing jointly). Once that happens, you’ll need to file a 2010 tax return. Married filing separate also have different social security rules.

Other Income Sources

There are special rules for self employment earnings and church earnings. You must file taxes if your:

  • Self employment net earnings are greater than $400.
  • Church earnings are greater than $108.28 and are exempt from employer Social Security and Medicare.

If you earn enough money to file a tax return, you must file your tax return by the tax deadline.

Other Tax Filing Requirements

In addition to the income requirements, there are other circumstances when you must file a tax return. One example is if you sold your home. For all the requirements, see Publication 17.

For last years requirements you can see the minimum income to file taxes in 2009.

Optional Filing

Even if you are not required to file a tax return, you can choose to file one. You may want to file an optional tax return if you had any federal withholding or are entitled to tax credits, like the earned income tax credit, and want to get a refund.

Once you file, you can see How Long Does it Take to Get Your Tax Refund Back?

2010 Tax Calculator

If you are under the minimum income to file taxes, and are unsure whether or not filing your taxes will benefit you, use our 2010 Tax Calculator to compute your tax liability and refund.

Tax Filing Online

Now that you know how much money you have to make to file taxes, you can go ahead and file your taxes online right now for free with TurboTax!





Today we’ll wrap up our look at various retirement plans ideal for small business owners and the self-employed with the one that inspired the series – the Solo 401k. So far, we’ve looked at the SEP-IRA and the SIMPLE IRA.

Solo 401k Overview

A Solo 401k combines the characteristics of a regular 401k plan with a profit-sharing plan. A Solo 401k can only be established by self employed individuals or small business owners with no other employees or just one employee – the owner’s spouse. For most people with no employees the Solo 401k will maximize the allowable contributions you can make to a retirement plan in a given year.

Solo 401k Basics

  • Coverage: A Solo 401k is only established for the business owner and the business owner’s spouse if he is an employee.
  • Contributors: Solo 401ks are funded by both the employee and the business. The employee contribution is deferred compensation while the business contribution is a portion of profits.
  • Contribution limits: In 2009, an employee can defer up to $16,500 to a Solo 401k. Employees who are 50 or older at the end of the year may make a “catch-up” contribution of an additional $5,500. The total amount allowed is reduced by any contributions to a 401k, 403(b), or 457 at another employer. In addition to the employee deferral limit, the business can make a contribution of up to 20% of your total income (25% of earned income, which is total income reduced by self-employment taxes). The total employee and employer contributions must not exceed $49,000 in 2009, or 100% of your income.
  • Deadlines: You must establish the plan by December 31 of the calendar year for which you first want to contribute. Contributions, however, can be delayed until the tax-filing deadline for that year, including extensions. For most people this is October 15 of the following calendar year.
  • Taxation: Both individual and business contributions to a Solo 401k are deductible from the employer’s income, and are not included as employee income at the time of the contribution. Taxes on withdrawals are explained below.
  • Vesting: There is no vesting period for Solo 401k contributions. Note that this is different from most tradtional 401k plans.
  • Withdrawals: Solo 401k withdrawals are subject to the same withdrawal rules as regular 401ks. All withdrawals will be subject to income tax. Penalties may apply if taking withdrawals before the age of 59 1/2. A unique feature of Solo 401ks as opposed to other self-employed retirement options is that loans may be available depending on how the plan is set up.

Special Characteristics

  • Once the plan reaches $250,000 in assets, you must complete a Form 5500.
  • A Solo 401k can accept rollovers from many other retirement plans, making it easy for you to consolidate accounts in one place before beginning withdrawals in retirment.
  • Contributions are discretionary, so you can choose not to contribute in years where your business has low revenue and increase contribution if you want to minimize taxes.

Establishing a Solo 401k

There are no regulations governing the establishment of a Solo 401k. You can open one with most major financial institutions, including Vanguard and Fidelity.

Solo 401k Pros

The biggest advantage of a Solo 401k is that it typically allows for the largest contribution when compared to other self-employed plans.

Solo 401k Cons

You cannot use a Solo 401k if you have any employees other than a spouse.

Stay tuned Madison’s wrap-up of this series: an analysis of which self-employed retirement plan is best, in Solo 401k Versus SEP-IRA.





SIMPLE IRAs are up next as we continue the series exploring three different types of retirement plans ideal for small business owners and the self-employed. Yesterday, we started the series with an in-depth look at the SEP-IRA.

SIMPLE IRA Overview

SIMPLE stands for Savings Incentive Match Plan for Employees. SIMPLEs were established to encourage small businesses to open retirement plans without the expense of maintaining a qualified plan.

Only businesses with less than 100 employees are eligible to establish a SIMPLE. A SIMPLE can actually use an IRA or a 401(k) to “hold” the contributions, but we are focusing only on the SIMPLE IRA since the 401(k) is rarely used. SIMPLE IRAs are easy to establish, have no annual filing requirements, and relatively few administrative expenses.

SIMPLE IRA Basics

  • Coverage: SIMPLE IRAs must cover all employees who either made $5,000 in two preceding calendar years or are expected to make $5,000 in the current calendar year.
  • Contributors: SIMPLE IRAs are funded by both employees and employers. Employees contribute by deferring a certain percentage of their income. Employers can choose to either match employee contributions or contribute to all eligible employees, regardless of participation. Employers who match contributions must generally match 100% of contributions up to 3% of employee compensation, with some exceptions. Alternatively, employers can contribute 2% of compensation to all eligible employees.
  • Contribution limits: During 2009-2012, the maximum SIMPLE IRA contribution per employee is $11,500 per year, including the employer match. Employees who are 50 or older at the end of the year may make a “catch-up” contribution of an additional $2,500. The catch-up amount is reduced by catch-up contributions to a 401(k), SEP-IRA, or 403(b).
  • Deadlines: Employers must establish SIMPLE IRA plans by October 1 of the calendar year that employees can first contribute. Employer contributions, however, can be delayed until the tax-filing deadline for that year, including extensions. Note that this only applies to the employer match portion. The employer must forward compensation deferred by employees no later than 30 days after the end of the month in which it was deferred (e.g., April 30 for March contributions).
  • Taxation: Both employer and employee contributions to a SIMPLE IRA are deductible from the employer’s income, and are not included as employee income at the time of the contribution. Taxes on withdrawals are explained below.
  • Vesting: There is no vesting period for SIMPLE IRA contributions. An employee has access to 100% of the contributions as soon as they are made.
  • Withdrawals: SIMPLE IRA withdrawal rules are the same as those for traditional IRAs. Employees can withdraw at all times, including while they are employed. Withdrawals will be subject to ordinary income tax regardless of age or reason for withdrawal. In addition, SIMPLE IRA withdrawals will be subject to a 10% penalty if the account owner is younger than 59½. Some exceptions to the 10% penalty apply. If it is applicable, the 10% penalty increases to 25% if withdrawals are made within the first two years of participating in the SIMPLE IRA.

Special Characteristics

  • Employers who maintain SIMPLE IRAs cannot maintain any other type of retirement/deferred compensation plan.
  • SIMPLE IRAs can be rolled over to other SIMPLE IRA accounts for the first two years of plan participation without tax or penalty. After two years, you can do a tax- and penalty-free rollover into an IRA, qualified plan, 403(b), or 457.
  • Airline pilots, nonresident aliens, and union employees who have separate retirement agreements can be excluded from the coverage requirements noted in the “Coverage” section above.

Establishing a SIMPLE IRA

To establish a SIMPLE IRA, an employer must only file a Form 5304 SIMPLE or a Form 5305 SIMPLE. The first is for employers who allow participants to select an institution to hold their SIMPLE IRAs, while the second allows the employer to select the institution for all employees. Any financial institution that offers traditional IRAs should be able to set up SIMPLE IRAs.

SIMPLE IRA Pros

The biggest advantage of a SIMPLE is that it allows both employers and employees to save in a manner similar to a qualified plan without extensive set-up or administrative fees.

SIMPLE IRA Cons

Because a SIMPLE IRA requires contributions to all employees, it is not a good plan for someone with employees who only wants to beef up his or her own retirement savings. The SIMPLE IRA has a lower contribution limit than any other retirement plan. If your small business is the sole source of your income and you make more than a few thousand dollars, a SIMPLE IRA will severely limit your ability for tax advantaged retirement savings.

Stay tuned for more in the series, including an explanation of Solo 401ks, and Madison’s analysis of which is best, in Solo 401k Versus SEP-IRA.





After Madison posted about her Solo 401(k) woes, a reader, Lee, suggested she look into a SEP-IRA instead. Let’s take a step back and explore 3 different types of retirement plans ideal for small business owners and the self-employed. We’ll start the series with an in-depth look at the SEP-IRA.

SEP-IRA Overview

SEP stands for Simplified Employee Pension. A SEP uses an IRA to “hold” the contributions, is easy to establish, and is often more flexible than a qualified plan. It is ideal for sole proprietors and small businesses.

SEP-IRA Basics

  • Coverage: If you are a business owner and contribute to an SEP-IRA plan in a given year, you must make contributions on behalf of all employees who are 21 or older, have worked for three years or more, and have earned more than $500 ($550 in 2010-2012) during the year.
  • Contributors: A SEP-IRA is funded by employers only – employees cannot contribute.
  • Contribution limits: From 2009-2011, the maximum SEP-IRA contribution is the lesser of 25% of an employee’s compensation or $49,000 (increasing to $50,000 in 2012). The maximum contribution is reduced by any employer contributions to a profit-sharing plan, and vice versa – together, employer contributions to a SEP-IRA and a profit-sharing plan are capped at the lesser of 25% of compensation or $49,000 (or $50,000 in 2012). For self-employed business owners, “compensation” refers to earned income, which excludes self-employment taxes and contributions to other employees.
  • Deadlines: A SEP-IRA can be established and funded for a given calendar year up to the tax-filing deadline for that year, including extensions. For sole-proprietorships and partnerships, the final extension date is October 15 of the next calendar year, so you can establish and fund a SEP-IRA for one year as late as October 15 of the following year.
  • Taxation: Employer contributions to a SEP-IRA are deductible from the employer’s income, and are not included as employee income at the time of the contribution. Taxes on withdrawals are explained below.
  • Vesting: There is no vesting period for SEP-IRA contributions. An employee has access to 100% of the contributions as soon as they are made.
  • Withdrawals: Because SEP contributions are made to IRAs, the withdrawal rules are the same as those for traditional IRAs. Employees can withdraw at all times, including while they are employed. Withdrawals will be subject to ordinary income tax regardless of age or reason for withdrawal. In addition, SEP-IRA withdrawals will be subject to a 10% early withdrawal penalty if the account owner is younger than 59½. Some exceptions to the 10% penalty apply.

Special Characteristics

  • SEP contributions are made to traditional IRA accounts and cannot be made to Roth IRA accounts. Once contributions are made, the account can be rolled into a Roth IRA – the rolled over balance will be subject to income tax.
  • Employer contributions to SEP-IRAs can be made at the employer’s discretion, meaning that an employer can establish the plan without being obligated to fund it each year.

Establishing a SEP-IRA

To establish a SEP-IRA, an employer must execute a formal, written agreement to provide benefits to all eligible employees, and inform employees of that agreement and the account establishment. An individual SEP-IRA must then be established for each eligible employee. Any financial institution that offers traditional IRAs should be able to set up SEP-IRAs.

SEP-IRA Pros

Sole proprietors or employers with just a few employees love SEP-IRAs because they are easy to establish and require little effort from year to year. The ability to choose whether or not to make contributions is also ideal for business owners with highly variable income from year to year. Finally, the late contribution deadline makes it easy to use a SEP-IRA to lower your tax bill after you calculate it.

SEP-IRA Cons

Because a SEP-IRA requires contributions to all employees, it is not a good plan for someone with employees who only wants to beef up his or her own retirement savings. It is also not good for businesses with employees that want to be able to contribute to their own accounts. Finally, the SEP-IRA may not maximize savings opportunities for business owners because of the way self-employment income is treated.

Stay tuned for more in the series, including an explanation of SIMPLE IRAs, Solo 401ks, and Madison’s analysis of which is best, in Solo 401k Versus SEP-IRA.