To correct an excess SEP contribution, have the SEP-IRA custodian distribute the overage along with any investment earnings it generated, return that money to the employer who made the contribution, and do it before the employer’s tax filing deadline including extensions. Move fast enough and the 6% excise tax on the employee disappears entirely. Miss the window, and penalties start stacking on both sides of the transaction.
For 2026, a SEP contribution cannot exceed the lesser of 25% of the employee’s compensation or $72,000. Anything above that is excess and needs to come out.
Figure Out Exactly How Much Is Excess
Start with simple subtraction: actual contribution minus maximum allowable contribution. Run the math separately for each affected participant. Only the first $360,000 of compensation counts in the 2026 calculation, so an employee earning more than that has their contribution ceiling pegged at $72,000 regardless. Self-employed filers use an effective rate of roughly 20% of net self-employment income rather than 25%, because the SEP deduction and half of self-employment tax both reduce the base.
Pulling the principal is only half the job. The IRS requires the attributable earnings (or losses) on the excess to come out with it, measured from the deposit date to the distribution date. A pro-rata method works for most situations. If the excess is $5,000 and the SEP-IRA held $50,000 when the contribution landed, the excess is 10% of the account; apply that 10% to the net gain or loss over the correction window. A $2,000 gain means $200 attributable to the excess, so $5,200 comes out. A loss during the window means less than $5,000 comes out. If you can’t pin down actual investment results, the IRS permits a reasonable interest rate, such as the one used by the Department of Labor’s Voluntary Fiduciary Correction Program Online Calculator. Keep the worksheet. The custodian will want it, and so will the IRS if questions arise.
Distribute the Excess and Return It to the Employer
Contact the SEP-IRA custodian, explain that you are correcting an excess contribution, and request a corrective distribution for the calculated amount. The money goes back to the employer, not to the employee, because the employee never actually earned the right to that contribution.
The deadline that controls everything is the employer’s tax filing deadline, including extensions. A calendar-year business that extends generally has until October. Complete the distribution by then and the 6% annual excise tax on the employee is avoided. Blow past it and the 6% starts applying for every year the excess remains in the account.
The custodian will issue Form 1099-R to the employee. Under IRS guidance, the distributed amount is reported with a taxable amount of zero, because the funds are returning to the employer rather than paying out to the employee.
Fix the Deduction on the Tax Return
The employer cannot deduct the excess portion of the contribution. If the full contribution was already claimed on a filed business return, that return needs to be amended to back the excess out of the deduction. The IRS states plainly that the plan sponsor is not entitled to a deduction for excess contributions, regardless of which correction route is used.
For a self-employed filer, the SEP deduction sits on Schedule 1 of Form 1040. Use Form 1040X to remove the excess and recalculate what’s owed. Filing sooner limits the interest that accrues on the underpayment.
What It Costs If You Don’t Correct in Time
Two separate excise taxes apply when excess contributions linger, and they fall on different parties.
The first is a 6% tax under IRC §4973, paid by the employee on Form 5329 with their personal return. It applies every year the excess remains in the SEP-IRA, until the overage is distributed or absorbed by future contribution room. A $10,000 excess left in place costs the employee $600 a year, every year, indefinitely.
The second is a 10% tax under IRC §4972 on nondeductible employer contributions. Because the excess is nondeductible, the employer owes 10% of it, reported on Form 5330.
The 10% Early Distribution Tax on the Earnings
When attributable earnings come out with the excess, those earnings are generally taxable to the employee as ordinary income in the year of distribution. For an employee under age 59½, the IRS exception tables show the 10% early distribution penalty does not apply to the returned principal, but it does apply to the earnings. If a 40-year-old has $1,500 in attributable earnings distributed, that’s $1,500 of ordinary income plus an additional $150 penalty. Factor this in before you treat the correction as cost-free.
When the Excess Should Stay in the Account: VCP
A second path exists under the IRS Voluntary Correction Program. The employer applies, and if the IRS accepts the submission, the excess stays in the employee’s SEP-IRA. In exchange, the employer enters a closing agreement and pays a sanction of at least 10% of the excess amount (excluding earnings). Excesses under $100 are not subject to the additional sanction.
This route generally makes sense when the excess has been in the account long enough to generate meaningful gains, or when pulling it out would create logistical problems with the custodian. SEP plans generally cannot use the Self-Correction Program for these errors, so when the straightforward distribute-and-return method is not feasible, VCP is typically the formal route. The IRS reviews the submission and, if satisfied, issues a compliance statement that confirms the fix and preserves the plan’s tax-favored status.
For most small businesses catching a one-time excess within the filing window, the simple distribution and return is enough. Once Form 5329 or Form 5330 is in play, or the excess spans multiple years or participants, a tax professional who works in retirement plan compliance earns the fee.