Yes, SEP IRA contributions are tax deductible when made to a traditional SEP. Employer contributions reduce the business’s taxable income for the year, and the employee owes no income tax on the money until it comes out in retirement. For 2026, the deduction is capped at the lesser of 25% of the employee’s compensation or $72,000, with compensation itself capped at $360,000.1Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Changes in Cost-of-Living2Internal Revenue Service. SEP Contribution Limits (Including Grandfathered SARSEPs) Contributions are also exempt from Social Security, Medicare, and federal unemployment taxes.3Internal Revenue Service. Simplified Employee Pension Plan (SEP)
How Much You Can Deduct in 2026
The statutory rule is set by 26 U.S. Code 404: the deduction equals up to 25% of an employee’s compensation, subject to an annually adjusted dollar cap.4Office of the Law Revision Counsel. 26 U.S. Code 404 – Deduction for Contributions of an Employer For 2026, that cap is $72,000, and the compensation that can feed the calculation stops at $360,000.1Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Changes in Cost-of-Living
Which limit binds depends on pay. For a W-2 employee earning $200,000, the deductible contribution tops out at $50,000, because 25% of compensation is lower than the dollar cap. For someone earning $360,000 or more, the $72,000 dollar ceiling takes over.
One point often missed: only the employer funds a SEP. Employees cannot make salary deferrals into these accounts.5Internal Revenue Service. Retirement Plans FAQs Regarding SEPs The employer chooses the contribution amount each year and can change it, or skip a year entirely.
The Self-Employed Calculation Isn’t 25%
If you’re a sole proprietor or otherwise unincorporated, you can’t just multiply Schedule C net profit by 25%. The contribution reduces the income it’s calculated on, so the math becomes circular. The IRS handles this with a reduced contribution rate: divide the plan rate by one plus the plan rate. A 25% plan rate becomes 25% ÷ 125% = 20%.6Internal Revenue Service. Calculating Your Own Retirement Plan Contribution and Deduction
Working through it with $100,000 of Schedule C net profit and $14,130 of self-employment tax:
- Start with net profit: $100,000
- Subtract half of self-employment tax ($7,065): $92,935
- Multiply by the reduced rate of 20%: $18,587
That $18,587 is both your maximum contribution and your maximum deduction. For most self-employed filers, net profit — not the $72,000 dollar ceiling — is what actually caps the deduction. Publication 560 contains the official rate table and deduction worksheet.
Where You Claim the Deduction
The form the deduction lands on depends on how the business is structured.
Sole proprietors and partners take it as an above-the-line adjustment. On Schedule 1 (Form 1040), line 16 is labeled “Self-employed SEP, SIMPLE, and qualified plans.”7Internal Revenue Service. 2025 Schedule 1 (Form 1040) That figure carries to Form 1040, line 10, and reduces adjusted gross income. Because it’s a personal adjustment rather than a business expense, it does not appear on Schedule C. You’ll need Schedule C (or a Schedule K-1) and Schedule SE finished first, since both net profit and self-employment tax feed the calculation.
Corporations deduct the contribution on the business return. S corporations report it on Form 1120-S, line 17, under pension and profit-sharing plans, which lowers taxable income before anything flows through to shareholders.8Internal Revenue Service. Instructions for Form 1120-S, U.S. Income Tax Return for an S Corporation C corporations use the equivalent line on Form 1120.
Form 5305-SEP, the model plan document, is not filed with the IRS but must be kept in your records to prove the plan exists.9Internal Revenue Service. Form 5305-SEP Simplified Employee Pension Individual Retirement Accounts Contribution Agreement Your account custodian reports contributions to the IRS on Form 5498.10Internal Revenue Service. Reporting IRA and Retirement Plan Transactions
Deadline to Get the Deduction
Contributions are deductible for a given tax year if they’re made by the due date of the business’s federal return, including extensions.3Internal Revenue Service. Simplified Employee Pension Plan (SEP) A sole proprietor who files Form 4868 typically has until October 15. A corporation extending with Form 7004 gets a similar window based on its fiscal year.
The practical benefit is real. You can close the books, calculate actual profit, and then decide how much to put in, rather than guessing during the year. You can even set up a brand-new SEP after the tax year ends and still make a deductible contribution for that prior year, as long as the plan is established and funded before your extended filing deadline. Miss that deadline and the contribution simply isn’t deductible for that year.
Roth SEP Contributions Are Not Deductible
The SECURE 2.0 Act, effective 2023, lets employers designate SEP contributions as Roth. If you make that choice, the tax treatment flips. Roth employer contributions are not deductible; instead, they are included in the employee’s taxable income for the year and reported on Form 1099-R.11Internal Revenue Service. SECURE 2.0 Act Changes Affect How Businesses Complete Forms W-2 Qualified withdrawals later come out tax-free. Roth employer SEP contributions still avoid Social Security, Medicare, and federal unemployment taxes; only income tax applies.
The Employee Coverage Rule That Limits the Deduction in Practice
A SEP requires the same contribution percentage for every eligible employee that the employer contributes for themselves.5Internal Revenue Service. Retirement Plans FAQs Regarding SEPs Put in 15% for yourself, and every qualifying employee also gets 15% of their compensation. An employee qualifies if they are at least 21, have worked for you in three of the last five years, and received at least $800 in compensation in 2026.3Internal Revenue Service. Simplified Employee Pension Plan (SEP)
The rule is why the SEP’s generous deduction ceiling is easiest to fully use when you’re a solo operator or employ only your spouse. Once employees enter the picture, the mandatory proportional funding is part of the true cost of the deduction you’re claiming for yourself.
Excess Contributions Get Taxed Every Year Until You Fix Them
Contributing more than the allowable amount creates an excess contribution, which carries a 6% excise tax for every year the excess sits in the account.12Office of the Law Revision Counsel. 26 USC 4973 – Tax on Excess Contributions to Certain Tax-Favored Accounts The two most common causes are applying a flat 25% to net profit instead of the reduced self-employed rate, and miscalculating net earnings.
Catch it before the filing deadline and you can withdraw the excess plus any earnings on it and avoid the penalty for that year. After the deadline, report the excess on Form 5329 and pay the 6% tax, which will keep applying annually until the excess is removed or absorbed by a later year’s contribution room. Running the numbers through the Publication 560 worksheet before you fund the account is the simplest way to avoid the problem.