client "maxed" his SEP at 25% of gross revenue — how do i have the conversation?
new client. 2024 return prepared by someone else. SEP contribution claimed at $52,500 on gross revenue of $210k. Schedule C net was $148k.
25% of gross → wrong denominator. SEP max is 25% of net SE earnings (after the half-SE-tax deduction). real max would have been around $27,500. he over-contributed by $25,000.
ok so: excess contribution → 6% excise tax per year it stays in → form 5329. can be fixed by withdrawing excess plus earnings by the extended due date... but we're past that for 2024.
how bad is this and whats the cleanup path? thinking: amend 2024 to correct the deduction, file 5329 for the excise, work with custodian to withdraw excess + earnings to stop the bleeding for 2025.
3 replies
yep that's the cleanup. amend 2024 with corrected Schedule 1 Line 16, file 5329 for the 6% excise on the $25k excess. then coordinate with custodian for a "corrective distribution" — excess + allocable earnings.
the tricky bit: earnings are taxable in the year distributed and subject to 10% early withdrawal penalty if under 59.5. so if he's 45 and the $25k earned 8% since contribution, that's ~$2k of earnings taxed as ordinary income + penalized.
also: the prior preparer has malpractice exposure here. worth mentioning so client can pursue if they want.
ugh yeah the prior prep thing. i'll let the client decide if they want to pursue. the 6% stacks each year excess stays in the account so the sooner we clean it up the better.
a good reminder for all of us to triple-check the denominator. the 25%-of-net trap catches preparers because most benefit calculators use gross input.
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