Smaller businesses seek alternatives to defined benefit plans because of the high administrative costs incurred. Simplified employee pensions (SEP) fill the needs of employers with few employees and limited financial resources. The financial commitment is less and the bookkeeping and reporting requirements are less than those required for regular ERISA plans. Also, the potential fiduciary liability is reduced. A SEP is a combined defined contribution plan/individual retirement account (IRA) that provides for employer contributions on behalf of participating employees. It allows for simplified administration provided the IRS’s model SEP is adopted. Annual contributions to SEPs are made at the employer’s discretion. Employers can skip a year without negatively impacting the program but must be careful not to discriminate in favor of highly compensated individuals. A SEP is a qualified, employer-funded IRA into which an employer makes contributions for all eligible employees. Each employee has his own IRA account, and annual contributions by the employer are limited to the lesser of 15% of compensation (subject to limitation) for each employee and $30,000. SEPs may be established by corporations, self- employed individuals, and partnerships. Self-employed participants and partners are treated under the plan as employees and are generally subject to the same rules as other employees. Although there are four types of SEPs recognized by the IRS, the easiest to establish and administer are the model and prototype SEPs. The model SEP is established by simply completing an IRS From 5305 SEP. Model SEPs, if adopted by an employer without modification, are not required to be filed with the IRS. Employers simply begin making contributions to the employee accounts. The model SEP cannot be used if an employer plans to integrate SEP contributions with Social Security Taxes, already maintains another qualified plan or has maintained a defined benefit plan in the past. If the employer is a member of an affiliated service group or a commonly controlled business, a model SEP can be used if all employees of the group of businesses are covered under the SEP. An affiliated service group is a group of organizations (individuals or entities) that owns or performs services for third parties through another organization in which they have a common ownership interest. The prototype SEP is also easy to establish and administer, and startup costs are usually under $100. Prototype SEPs are developed by banks, savings and loans, federally insured credit union, investment companies or professional societies that have already received approval from the IRS for their SEPs. The limitations are the same for the model SEP set forth in an earlier paragraph. Contributions immediately vest in the employee. The plan must not discriminate either in contributions or deferrals, in favor of highly compensated employees. To avoid discrimination, the employer must make contributions to the SEP that bear a “uniform relationship” to the compensation of the participating employees. For purposes of eligibility requirements, “employee” includes all members of a controlled group of corporations, trades or businesses under common control and all members of any affiliated service company. Any leased employees must also be included. Leased employees are those persons who over a 12-month period have worked at least 1500 hours or 75% of the hours customarily worked by an employee in a similar position. Even though part-time employees must be covered, the two requirements are rarely met and they rarely qualify. Mitigating factors are: 1) many part-time employees are transient and are excluded from participation by the three years service rule, and 2) in SEP plans in which the amount of contributions is based on a percentage of compensation, contributions for part-time employees will usually be low. To qualify as a SEP, a plan must cover all “eligible employees” including part-time, seasonal and shared employees who have reached age 21, performed services for the employer during at least 3 of the last 5 years and received at least $300 in compensation during the fiscal year. Every eligible employee must participate. If an employee refuses to participate, the employer must establish a SEP-IRA on that employee’s behalf and make the required contributions on his/her behalf. Employer contributions to a SEP are tax deductible as long as they do not exceed the individual limitation of the lesser of 15% (13.0435% for self-employed individuals) of compensation and $30,000 a year, or the overall limitation of 15% of total compensation paid to all employees. If an employer’s contribution exceeds the 15% of the compensation paid to all employees, the excess contribution can be carried forward and deducted the next year, subject to the 15% limitations. Andrea Sandor is an independent Small Business Management Advisor based in North Hollywood.