Are American business owners living abroad allowed to contribute to a SEP IRA if their business is not US-based?

[tsabar]

I am an American living abroad, and have incorporated a business in another country. I am the sole owner and employee of my company. Am I allowed to open a SEP IRA if my foreign business is owned by an American citizen?

[SusanY1]

There is no restriction requiring that the company be a U.S. company.

However, to contribute you must have taxable earned income.  If you are a taxpayer using the Foreign Earned Income and Exclusion and it covers the full value of your compensation, you will not be able to contribute.  

If you have compensation in excess of the exclusion or use the foreign tax credit instead, you may qualify. 

It is possible, using the foreign tax credit, to have taxable earned income, but no tax due.  However, the income must appear on the tax return.

Proceed with caution if you have used the FEIE in prior years and wish to stop using this election.  A switch from FEIE to foreign tax credit results in the revocation of the FEIE election making the taxpayer ineligible to use the exclusion without written permission from the IRS for five (5) years.  Permission is requested by filing for a Private Letter Ruling, for which there is a $2,000 fee.

[tsabar]

@SusanY1 

THANK YOU! Finally, someone has been able to provide me with an answer! 🤗 

I hope it's ok to ask a follow-up question 😇 I have a Roth IRA, and as I understand it, I can make contributions to my SEP IRA thru my (incorporated) company without affecting my contributions to my Roth IRA, but any contributions that I make myself to my SEP IRA have to be reduced from the amount that I contributed to my Roth IRA. Is that correct?

Also, is there any benefit to a SEP IRA if it's pretax, but I pay higher taxes in my country so am mostly exempt from paying taxes in the US (thus far) anyway?

[dmertz]

If your business was a sole proprietorship reporting on Schedule C, your net earnings for the purpose of calculating your maximum SEP contribution would be your net profit minus the deductible portion of self-employment taxes.  Excluded foreign-earned income would count toward net earnings for making a SEP contribution.  Excluded foreign-earned income only would not count toward compensation for making a regular personal traditional or Roth IRA contribution.

However, you have an incorporated business.  Assuming it's a US corporation filing Form 1120 or 1120S, your maximum SEP contribution is based on the amount of compensation reported on your W-2 and the deduction is taken on the corporate tax return regardless of whether or not you exclude the foreign-earned income on your personal tax return.  If the business is not a US corporation, it can't have a SEP plan.  Your maximum regular personal IRA contribution would be limited by the amount in box 1 of your W-2 minus any excluded foreign-earned income.

To avoid your IRA custodian making mistakes in reporting contributions as either SEP or regular traditional IRA contributions, SEP and regular personal traditional IRA contributions should be made to different IRAs.  Some custodians do not permit regular personal contributions to be made to an IRA that is designated as a SEP IRA.

[Rybird]

Hi dmertz

So, if I understand correctly... regarding SEP-IRA contributions, FEIE, and personal IRA contributions...

A US S-corp can set up a SEP-IRA and contribute to an employee's SEP IRA regardless if that same employee deducts the W2 income using the Foreign earned income exclusion on their 1040? 

I know that using the FEIE limits what the employee can personally contribute to a personal IRA / Roth IRA. For example, if the employee has $50,000 in W2 income, but claims or deducts $47,000 of that income under the FEIE on their 1040, then only $3000 of W2 income is eligible to contribute to a personal IRA/Roth IRA. 

However, given the above situation as an example... are you saying that the S-corp can still contribute up to the total SEP-IRA limit (which I believe is 25%) ($12,500 in this case) of the employee's total W2 income ($50,000) to the SEP-IRA even though the employee claims $47,000 is FEI? 

Of course, the S-corp and the employee are two different entities. But I just want to get it perfectly clear that the FEIE does not affect whatsoever "if" or "how much" the S-corp can contribute to the employee's SEP-IRA (which is what I believe you said in your answer above... but please clarify or confirm).

Thanks!

[dmertz]

SEP contributions made by an S-corp have nothing to do with what the employee reports on the employee's individual tax return.  SEP contributions are employer contributions and are deducted on the employer's tax return, Form 1120-S in this case.

You can look in the participation requirements in section 408(k):  https://www.law.cornell.edu/uscode/text/26/408#k

[SusanY1]

.

[Rybird]

Thank you for clarifying dmertz. That's good news! 

The Foreign earned income exclusion is a huge benefit to those of us working abroad but makes it hard to save/invest in tax-advantaged accounts (IRAs, etc.). So I have been looking for a vehicle to get more money into tax-advantaged retirement accounts but could never get a clear or convincing answer about how and/or if it was possible via our S-corp while still claiming the FEIE individually. 

Now I know it is possible! Appreciate your knowledge and for taking the time to respond.

Thanks again!

[les69]

(Sorry, I see "dmertz" already adressed this... anyway, my reply gives the code support for that answer)

I do not think the "taxable earnings" requirement applicable for traditional and Roth IRA's is likewise applicable for SEP-IRA contributions, see IRC 408(k)(8)(B), 414(s)(1), 415(c)(3)(B):

"(B)Special rule for self-employed individuals: In the case of an employee within the meaning of section 401(c)(1), subparagraph (A) shall be applied by substituting “the participant’s earned income (within the meaning of section 401(c)(2) but determined without regard to any exclusion under section 911)” for “compensation of the participant from the employer”.