I have a client that wants to max out his SEP amount to 25% of his net earnings form self-employment, schedule C. The Keogh, SEP and Simple contribution Worksheet on line 4 of SEP and individual limits shows .20. why isn't it .25 if the max is 25%?
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The worksheet makes an adjustment for SE tax and other stuff: Pub 560
Deduction Limit for Self-Employed Individuals.
If you make contributions for yourself, you need to make a special computation to figure your maximum deduction for these contributions. Compensation is your net earnings from self-employment, defined in chapter 1. This definition takes into account both the following items.
The deduction for the deductible part of your self-employment tax.
The deduction for contributions on your behalf to the plan.
The deduction for your own contributions and your net earnings depend on each other. For this reason, you determine the deduction for your own contributions indirectly by reducing the contribution rate called for in your plan. To do this, use either the Rate Table for Self-Employed or the Rate Worksheet for Self-Employed in chapter 6. Then, figure your maximum deduction by using the Deduction Worksheet for Self-Employed in chapter 6.
Employer has $125,000 to give to employee. Gives wages of $100,000, plus 25% for SEP ($25,000).
Self Employed person has Net Earnings of $125,000. To keep things equal, SEP is still $25,000, which is 20% of Net Earnings. That is why Self Employed people use 20%.
As was pointed out, after factoring the 1/2 SE tax deduction, it actually works out to something like 18.57% of SE profit.