Tax considerations for SEP-IRAs with regards to severance & for RSUs

[jfkaemmerer]

Good afternoon,

Two questions to see about any recent changes that may has been made in the areas of SEP-IRAs or RSUs:

1) With regards to SEP-IRAs, I am being paid out one years salary ($242K - 8 months of which is incurred in 2023) in the form of severance in bi-weekly installment through the normal payroll process which will be ending on the one year anniversary of my term date .  Unfortunately, through the terms of the separation agreement participation in the 401K was not available.  What adds further complexity, is that I will be beginning a new role on July 17, 2023 ($200K annual salary prorated - nearly $100K incurred in 2023) and this position will be eligible to participate in the new company's 401K in Oct 2023.  So if I am eligible to contribute the maximum amount to my SEP-IRA since my severance is not 401K eligible, my thought is that this would be preferable to contributing to contributing to the new company's 401K on a lower salary basis for only a 3 month period, if my goal is to minimize my taxable income.

So the questions are as follows:  Am I eligible under this fact partner to contribute to my SEP-IRA pretax?  If so, what would be the maximum amount & by what date would I have to make this contribution?  Then if I am not eligible to contribute pretax to my SEP-IRA, is my next best option to lower my taxable income through pretax contributions to my new 401K or is there another option that I am not thinking about?

2) My new role will eventually include an equity incentive portion of the comp package via RSUs.  Never having participating in equity through this type of instrument, what types of tax consideration should I be thinking about or discussing with my new employer?  Unfortunately, this is the type of situation where I don't know what I don't know type of situation, but suspect that there are tax-related issues generally associated this this type of compensation instrument that may be evolving and I should familiarize myself with to become more educated.

Thanks for any insights you may be able to provide.

Thanks,

John

[Oliver6]

Hi,

If your goal is to contribute to a SEP IRA and you meet the requirements, generally, that should be fine. Please see:

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-seps

As per link above:

"Which employees are eligible to participate in my SEP plan?

Employees must be included in the SEP plan if they have:

• attained age 21;
• worked for your business in at least 3 of the last 5 years;
• received at least $750 in 2022; $650 in 2021 and 2022; $600 in compensation (in 2016 - 2020) from your business for the year.

Your plan may use less restrictive requirements, for example age 18 or three months of service, to determine which employees are eligible.

Is there a deadline to set up a SEP?

You can set up a SEP plan for a year as late as the due date (including extensions) of your business's income tax return for that year."

As for popular alternatives to SEP IRA, there are many retirement vehicles to help lower your taxable income, if that's your goal. Please see:

2022 Contribution Limits 

IRA: $6000 ($7000 if 50 or older)

401k: $20,500 general deferral limit

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-contributions

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-li...

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sha...

[Ruth C-L]

In regard to the RSUs, with RSUs, you are taxed when the shares are delivered, which is almost always at vesting. Your taxable income is the market value of the shares at vesting. You have compensation income subject to federal and employment tax (Social Security and Medicare) and any state and local tax. That income is subject to mandatory supplemental wage withholding. Withholding taxes, which for U.S. employees appear on Form W-2 along with the income, include the following:

• federal income tax at the flat supplemental wage rate, unless your company uses your W-4 rate
• Social Security (up to the yearly maximum) and Medicare
• state and local taxes, when applicable

A company may offer a choice of ways to pay taxes at vesting, or it may use a single mandatory method. The most common practice is taking the amount from the newly delivered shares by surrendering stock back to the company. This holds or "tenders" shares to cover the taxes under a net-settlement process, and company cash is used for the payroll tax deposit.

When you later sell the shares, you will pay capital gains tax on any appreciation over the market price of the shares on the vesting date. For the sale of the shares, the sale proceeds and basis will be reported on a 1099-B from the RSU stock administrator, e.g. Charles Schwab, Morgan Stanley, etc. The basis may or may not be "adjusted" to the appropriate amount. I recommend reaching out to our tax experts when you're preparing your tax return at the time you're entering any stock sales associated with the RSUs to ensure you report the correct basis.

Ruth C-L, CPA, Attorney

[TylerH_EA]

Hello John,

The good news is that SEP-IRAs and 401(k) plans are wholly independent of each other provided that you own the SEP-IRA as a self-employed individual and the 401(k) plan is maintained through your employer. That means that you can make the maximum contributions to both your SEP-IRA and a 401(k) plan maintained through your employer.  However, the maximum contribution to each retirement plan is subject to two distinct limits:

1. For SEP-IRAs owned by self-employed individuals, the maximum contribution such self-employed individuals can make into their own accounts as of January 1, 2023 is the lesser of 20% of net earnings from self-employment or $66,000.  Given that you will need to know your net earnings from self-employment prior to making the contribution, you have until the due date of the tax return (including the extended due date if you timely file an extension) to make the contribution.

2. For 401(k) plans maintained by your employer(s), the maximum amount of contributions that you can defer pre-tax (through payroll deductions) is $22,500 for 2023. However, that maximum is an aggregate number that applies when considering all 401(k) plans in which you participated throughout the year. Therefore, you will need to make sure that you did not already make $22,500 of pre-tax contributions to your 401(k) plan maintained by your old employer for 2023 before making additional contributions into the 401(k) plan with your new employer. If you have not reached that $22,500 limit, then you can continue to make 401(k) contributions into the 401(k) plan of your new employer until you have reached that limit.

See the following resources for more information:
SEP Plan FAQs

Self-Employed Individuals – Calculating Your Own Retirement-Plan Contribution and Deduction

Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits

Finally, with regard to your question about Restricted Stock Units (RSUs), they are essentially another form of compensation. Instead of getting paid in cash, you are paid in shares of stock. Furthermore, you typically have to meet Years of Service and/or other performance targets before you can obtain vested ownership of the shares of stock (hence the term "Restricted"). You will not realize a taxable event until the day upon which the RSUs you are initially granted vest. Therefore, you do not need to plan for anything regarding the RSUs at this moment because it typically takes some time for the RSUs to vest. 

When RSUs vest, the fair market value of the shares of stock on the vest date will be included in your income and reported on your W-2 for that year. Most employers, allow you to use some of the shares to cover the tax liability associated with the income inclusion (essentially selling enough shares for cash to cover the tax withholding on the income).  So, I hope that is enough information to quell your concerns at this moment.

Please feel free to look through the following resources for more information:

What are restricted stock units (RSUs) and how do I report them?

How to Report RSUs or Stock Grants on Your Tax Return

Good luck at your new job!