Question

Ken is a self-employed architect in a small firm with four employees: himself, his office assistant, and two drafters, all of whom have worked for Ken full-time for the last four years. The office assistant earns $30,000 per year and each drafter earns $40,000. Ken’s net earnings from self-employment (after deducting all expenses and one-half of self-employment taxes) are $310,000. Ken is considering whether to establish a SIMPLE plan and has a few questions. Is he eligible to establish a SIMPLE plan? Is he required to cover his employees under the plan? If his employees must be covered, what is the maximum amount that can be contributed on their behalf? If the employees are not covered, what is the maximum amount Ken can contribute for himself? If Ken is required to contribute for his employees and chooses to contribute the maximum amount, what is the maximum amount Ken can contribute for himself? (Hint: Calculate the employee amounts first.) Ignore any changes in Ken’s self-employment tax.

Answer 1

Answer:

a. Yes, Ken is eligible to establish an SEP plan.

b. Ken must cover all his employees since they have worked for him at least three of the last five years, and they all earned at least $500 in compensation. This assumes that all the employees are at least 21 years old.

c. The maximum benefit for Ken’s employees is the lesser of $49,000 or 25% of their earnings.

d. Zero, because he would not be qualified to have an SEP plan.

e. The office assistant would be entitled to $7,500 ($30,000 x .25) and each draftsman would be credited for $10,000 ($40,000 x .25). Ken’s earnings from self-employment would be reduced by $27,500 to $277,500. Ken is entitled to use the same $49,000 or 25% figures as his employees, but he is limited to earnings of $245,000 that must also be reduced by the amount of his contribution. Thus, the amount of self-employed income after the contribution is $245,000-.25x = x, or $196,000. Ken would be entitled to an SEP contribution of $49,000 (25% of $196,000).