This page describes a composite hypothetical. It is not a real client or a real result. Plan deadlines and limits have changed under recent legislation and vary by plan type, so confirm current dates with a plan provider.
The Scenario in Brief
An S corporation owner meets an advisor in March to prepare the prior year's return. The company had a good year, and the owner would like to reduce taxable income by contributing to a retirement plan. The owner never set up a plan. The owner asks whether it is too late.
Assumptions Used
- The prior year's W-2 salary for the owner was 80,000 dollars.
- The corporation is an S corporation with only the owner as an employee.
- The return for the S corporation is due in mid-March, and the owner can request an extension to mid-September.
- An assumed contribution rate of 25 percent of W-2 wages is available under the plan for employer contributions.
- An assumed marginal federal rate of 24 percent is used for illustration.
The SEP IRA Option
A simplified employee pension plan can generally be established and funded after the end of the year, up to the due date of the employer's tax return, including extensions, and the contribution can be deducted for the prior year. This is a major reason SEP IRAs are popular for last-minute planning. The employer contribution is a percentage of compensation, up to a dollar limit, and the same percentage applies to any eligible employees.
| Item | Amount |
|---|---|
| Prior-year W-2 salary | 80,000 dollars |
| Assumed employer contribution at 25 percent | 20,000 dollars |
| Illustrative federal tax reduction at an assumed 24 percent | 4,800 dollars |
The arithmetic is a rough illustration. The actual maximum depends on the plan's terms and the limits for the year, and the deduction depends on the corporation's income and on the plan being timely established and funded.
The Solo 401(k) Option
A solo 401(k) is a more flexible plan, with an employee deferral component. However, elective deferrals for a prior year generally must be elected by the end of that year, and salary deferrals require payroll withholding, so an S corporation owner generally cannot create deferrals for the prior year in March. There is also a provision for certain sole proprietors that allows a newly established plan to accept prior-year deferrals by the tax filing deadline under recent legislation, but that rule is narrow and does not apply to an S corporation owner-employee. The advisor would explain that the employer profit sharing portion of a 401(k) can generally be made up to the tax return due date, but the plan must have been established by the end of the year for that year's contributions in many cases, subject to the rules in effect. Some recent changes have relaxed certain deadlines for new plans, and the advisor would confirm the current provisions with a plan provider.
Why Deadlines Differ
The SEP is an employer-only plan with a post-year-end setup date, while a 401(k) includes employee deferrals that must be elected during the year. The difference reflects how the plans work rather than a technicality. The advisor would recommend a fall review each year to avoid the problem.
The Cash Flow Consideration
Funding a SEP for the prior year requires cash. The advisor would ask whether the corporation has the cash and whether it should be distributed as salary or retained. If the owner has already taken most of the cash as distributions, the corporation may need to fund the contribution from remaining balances. The advisor would also point out that the deduction reduces the owner's taxable income only if the corporation actually makes the contribution by the deadline and if the plan and contribution meet the rules.
A Comparison of the Approaches
| Question | SEP IRA | Solo 401(k) |
|---|---|---|
| Can it be established after year end for the prior year? | generally yes, by the return due date including extensions | generally no for employee deferrals, subject to current rules |
| Employee deferral component | no | yes |
| Simplicity | high | moderate |
| Roth features | generally limited | often available |
Scenario Variations Worth Considering
If the owner had employees, a SEP would require contributions for them at the same percentage. If the owner planned to make the maximum in future years, a solo 401(k) could offer more capacity. If the corporation had a low profit, the deduction might be limited. If the owner expected to hire soon, the plan choice could change.
Risks and Limits
- Plan rules and deadlines change.
- A SEP has a lower capacity than a 401(k) at some income levels.
- The contribution must be timely and properly documented.
- The example ignores state taxes and other items.
What This Scenario Teaches
Retirement planning has deadlines that differ by plan type. A late start is not always fatal, but options narrow. A calendar reminder in September can preserve them.
Questions to Bring to Your Advisor
- Which plan can I still establish for last year?
- What is the deadline for funding it?
- How would the contribution affect my return?
- What plan should I use next year?
Frequently Asked Questions
Can I still contribute for last year in March?
Sometimes, depending on the plan type and current rules. A SEP IRA is often the option with a post-year-end deadline.
Are the dates in this scenario current?
They are general. Rules change, so confirm dates with a plan provider.
Want to Talk Through Your Own Situation?
These scenarios are illustrations only. Book a discovery call with AE Tax Advisors to discuss the facts of your own business or portfolio.
Book a Discovery CallEducational purposes only. This page is an illustrative educational scenario, not tax, legal, or accounting advice, and it does not describe a real client or a real result. Tax laws change and outcomes depend on individual facts, so consult a qualified professional before acting. No result is guaranteed.