Tax Planning
How a SEP-IRA Contribution Is Actually Calculated
This is the one I get asked to check most often, because the number people arrive at is usually too high. The rule sounds simple until you apply it to a self-employed person, at which point it turns circular.
01What the contribution is based on
Not revenue, and not profit as you think of it. For a self-employed person the SEP contribution is based on net earnings from self-employment, reduced by half of your self-employment tax and by your own SEP contribution. The IRS sets this out in the plan sponsor material.
02Why that last part makes it circular
Read it again: the contribution depends on a figure that has already been reduced by the contribution. You cannot calculate one without the other, which is why the effective percentage of your net earnings works out lower than the headline rate. This is not a trick — it is the same logic that stops an employer deduction from inflating the base it is calculated from — but it is why a mental estimate is almost always too high.
03The number that goes on the return
The deduction for your own SEP contribution is taken as an adjustment on your personal return rather than as a business expense on the Schedule C itself. Contributions made for employees are a business deduction. Two different places, and mixing them up changes both your self-employment tax and your income tax.
04Where people over-contribute
Four ways I see regularly. Applying the headline percentage straight to net profit. Forgetting the self-employment tax adjustment. Including W-2 wages from an unrelated job in the base. And, for anyone with more than one plan, ignoring the aggregate limits. Excess contributions are correctable, but the process has deadlines and the correction is more work than getting it right was.
05What to do before you fund it
Run the calculation on your actual year-to-date figures before you move money, not after. If your income is still moving, contribute conservatively and top up once the year is closed — SEPs are relatively forgiving on timing, which makes that sequence practical. Current caps and percentages are indexed and move; check the IRS figures for the year you are funding rather than carrying last year's number forward.
06Where I help
This is arithmetic against your real books, which is exactly the kind of thing that goes wrong when the books are behind. If your bookkeeping is current, the calculation takes minutes. If it is not, the calculation is a guess — and a guess is how the over-contribution happens in the first place.
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Schedule a ConsultationThis article is general information, not individualized tax, legal, or financial advice. Every situation is different — reach out and we'll look at yours directly.