SEP IRA for an S Corp: W-2 Wages, Limits, and Deadlines

An S Corporation sets up a SEP IRA by adopting a written plan document, opening an individual SEP IRA for every eligible employee, and contributing a uniform percentage of each person’s W-2 wages, up to 25% or $72,000 per participant for 2026, whichever is less.¹ The plan can be adopted and funded as late as the corporation’s tax filing deadline, including extensions, for the year the contribution applies to.² The piece that trips up most S Corp owners is that only W-2 wages count. Shareholder distributions don’t.

Why Your W-2 Wages Are the Only Number That Matters

A sole proprietor or partner calculates SEP contributions from net self-employment income. An S Corporation shareholder-employee doesn’t have that option. Your salary on Form W-2 is the sole basis for the contribution. Distributions, dividends, and other shareholder payments are invisible to the SEP calculation.³

That creates a direct conflict with the usual S Corp tax-planning instinct, which is to keep W-2 wages modest and take more as distributions to reduce payroll taxes. Every dollar you shift from salary to distribution shrinks your SEP ceiling by 25 cents. The IRS also requires officers who perform more than minor services to receive reasonable compensation as wages before taking distributions, and courts have consistently backed that position.⁴ Set your salary at a defensible figure, then calculate the SEP from it.

Watch out for one widely repeated error: some sources apply a reduced 20% effective rate to S Corp owner-employees. That adjustment exists only for sole proprietors and partners, whose SEP deduction has to be solved for inside a circular self-employment formula. S Corp shareholder-employees are W-2 employees. The full 25% rate applies directly to the wage figure with no reduction.⁵

Adopting the Plan

You formally establish the SEP by signing a written plan agreement. The easiest route is IRS Form 5305-SEP, which you complete and keep in your corporate records. You do not file it with the IRS.⁶ Banks, brokerages, and insurers also offer prototype SEP documents that do the same job.

Form 5305-SEP has restrictions. You cannot use it if your S Corp maintains any other qualified retirement plan during the year (even an unfunded one), if the plan year differs from the calendar year, or if the contribution formula factors in Social Security.⁷ In any of those cases, use a prototype or individually designed document instead.

After adopting the document, open a SEP IRA for each eligible employee at a bank, brokerage, or other financial institution. The employer picks the initial custodian, but the account belongs to the employee, who can later transfer it elsewhere.

Adoption and Funding Deadline

Both plan adoption and contribution funding are due by the S Corp’s income tax filing deadline, including extensions.² For a calendar-year S Corp, that is March 15 originally, or September 15 of the following year on extension.⁸ A calendar-year S Corp wanting to deduct SEP contributions for 2025 has until September 15, 2026 with an extension to both adopt the plan and fund it. Few retirement plans give you that much runway after year-end.

Who You Have to Cover

SEP coverage rules are mandatory, not optional. The plan must include every employee who meets all three of these tests:

Is age 21 or older
Has worked for the business in at least three of the last five years
Received at least $800 in compensation during 2026 (adjusted annually for inflation)⁹

You can set looser rules (for example, one year of service instead of three), but never stricter ones.² Excluding an eligible employee is one of the most common SEP failures, and it can jeopardize the plan’s tax-advantaged status for everyone, owner included. Review payroll before contributing each year.

If you own more than one business, be aware of the controlled group rules. The IRS may treat employees across all commonly owned entities as employees of a single employer for SEP coverage purposes.¹⁰ You cannot run a SEP in one company and ignore eligible workers at a related company.

How Much You Can Contribute

The maximum contribution for any employee is the lesser of 25% of W-2 compensation or $72,000 for 2026.¹ The 25% calculation is capped at $360,000 of compensation for 2026; wages above that are ignored.⁹ An owner-employee drawing $400,000 in W-2 wages hits the $72,000 ceiling, because 25% of the $360,000 cap is $90,000 and the dollar limit kicks in first.

Here is the rule that bites: the S Corp picks one contribution percentage, somewhere between 0% and 25%, and applies it uniformly to every eligible employee.³ If you give yourself 15%, every eligible staff member gets 15% of their W-2 wages too. You can change the percentage from year to year and skip entirely in lean years, but whatever rate you pick in a given year applies to everyone.

A sample two-person S Corp for 2026, using a 15% rate:

Owner-employee: $200,000 W-2 wages × 15% = $30,000
Staff employee: $55,000 W-2 wages × 15% = $8,250
Total deductible contribution: $38,250

Both contributions are funded and deducted by the corporation. They don’t appear on anyone’s W-2, and they are 100% vested immediately in each employee’s account.⁷ An employee who quits a week later keeps the full balance.

Where It Shows Up on the Tax Return

The S Corp deducts its SEP contribution on Form 1120-S, reducing the ordinary business income that passes through to shareholders on Schedule K-1.¹¹ The deduction lowers each shareholder’s taxable income indirectly, through the K-1. It does not reduce W-2 wages for payroll tax purposes.

Annual filing is light. When the SEP is funded only by employer contributions, which is the standard setup, the S Corp generally does not have to file Form 5500.⁷ You do need to keep the plan document, the contribution calculations, and proof of deposits, and give each eligible employee a copy of the SEP agreement and notice of what was contributed.

Fixing Excess Contributions

If the corporation contributes more than the limit to anyone’s SEP IRA, the excess carries a 6% excise tax for every year it stays in the account.² The employee can avoid the tax by withdrawing the excess, plus earnings on it, before the due date of their personal return including extensions. The earnings portion is taxable income in the year withdrawn.

On the plan side, the IRS offers two correction routes. The Self-Correction Program lets the S Corp fix the mistake without IRS involvement if compliance procedures were reasonable and the failure was insignificant. Larger or more complex errors go through the Voluntary Correction Program, which is a formal IRS submission.¹² In both cases, the typical cure is pulling the excess (adjusted for earnings) back out of the employee’s account to the employer.

The Roth SEP Option

For tax years beginning after December 31, 2022, the SECURE 2.0 Act lets employers offer employees a choice to receive SEP contributions as Roth contributions instead of pre-tax.¹³ The employee has to affirmatively elect Roth treatment; it is not the default.

The economic trade is familiar. The corporation still deducts the contribution, but the employee owes income tax on the amount in the year it goes in, and qualified withdrawals in retirement come out tax-free. The contribution is reported on Form 1099-R in the year made and is not subject to income tax withholding, FICA, or FUTA.¹⁴ The employee handles the tax on their own return.

Prohibited Transactions: The Trap for Owners

Shareholder-employees need to keep the SEP IRA strictly separate from the business. The IRS prohibits certain dealings between an IRA and “disqualified persons,” a category that includes the account owner, the owner’s spouse, lineal descendants and ancestors, and entities the owner controls. Prohibited transactions include selling property to the IRA, borrowing from it, using IRA assets for personal benefit, and paying yourself from an IRA-owned entity.¹⁵

The penalty is harsher than for a 401(k). A prohibited transaction in an IRA causes the entire account to lose its tax-exempt status. The IRS treats the whole balance as distributed on the first day of the year, triggering income tax on the full amount and potentially the 10% early withdrawal penalty if the owner is under 59½.¹⁶ For an S Corp owner with substantial SEP balances, a single mistake can be catastrophic.

When a Solo 401(k) Beats the SEP for an S Corp

A SEP IRA isn’t always the right answer for an S Corp. If the only employees are you (and maybe your spouse), a solo 401(k) often allows a larger total contribution at the same salary. A SEP permits only employer contributions capped at 25% of W-2 wages. A solo 401(k) adds an employee deferral on top, up to $24,500 for 2026, or $32,500 at age 50 or older.⁹

The gap is biggest at middle salary levels. An owner with $100,000 in W-2 wages can put $25,000 into a SEP. The same owner could defer $24,500 as employee contribution plus receive $25,000 as employer contribution in a solo 401(k), totaling $49,500. By about $300,000 in W-2 wages, both plans hit the $72,000 ceiling and the difference disappears.

The SEP wins on simplicity. A solo 401(k) needs its own plan document, may require Form 5500-EZ once assets exceed $250,000, and loses its simplified character the moment you hire a non-spouse employee. The SEP scales to additional employees without much extra paperwork. And remember: if you adopted the SEP on Form 5305-SEP, you cannot run a solo 401(k) or any other qualified plan alongside it.² Pick the structure that fits where the business is going, not just where it is today.

1
Internal Revenue Service. SEP Contribution Limits
2
Internal Revenue Service. Retirement Plans FAQs Regarding SEPs
3
U.S. Department of Labor. SEP Retirement Plans For Small Businesses
4
Internal Revenue Service. S Corporation Employees, Shareholders and Corporate Officers
5
Internal Revenue Service. Calculating Your Own Retirement Plan Contribution and Deduction
6
Internal Revenue Service. Form 5305-SEP Simplified Employee Pension Individual Retirement Accounts Contribution Agreement
7
Internal Revenue Service. Simplified Employee Pension Plan SEP
8
Internal Revenue Service. Starting or Ending a Business
9
Internal Revenue Service. Notice 2025-67 – 2026 Amounts Relating to Retirement Plans and IRAs
10
Internal Revenue Service. Controlled and Affiliated Service Groups
11
Internal Revenue Service. About Form 1120-S, U.S. Income Tax Return for an S Corporation
12
Internal Revenue Service. SEP Plan Fix-It Guide – Contributions to the SEP-IRA Exceeded the Maximum Legal Limits
13
Internal Revenue Service. SECURE 2.0 Act Impacts How Businesses Complete Forms W-2
14
Internal Revenue Service. Notice 2024-02 – Miscellaneous Changes Under the SECURE 2.0 Act of 2022
15
Internal Revenue Service. Retirement Topics – Tax on Prohibited Transactions
16
Office of the Law Revision Counsel. 26 U.S. Code 4975 – Tax on Prohibited Transactions