Retirement plan tax answers for your small business clients

When a self-employed client or small business owner starts thinking about retirement savings, the questions rarely stop at "which plan is best." They want to know what happens when a plan fails testing, whether a spouse counts as an employee and how much wiggle room the IRS actually allows. Below are the retirement plan questions tax professionals ask most this season, along with straightforward answers you can use with clients right now.

SEP IRA vs. solo §401(k): the real tradeoffs

A SEP IRA is easy to set up and skips the Form 5500, Annual Return/Report of Employee Benefit Plan, filing in most cases. Contributions come only from the employer, and every eligible employee must receive the same percentage of pay. A solo §401(k) lets an owner contribute as both employee and employer, often producing a bigger deduction at lower income levels, and it opens the door to catch-up contributions once the owner qualifies. A solo §401(k) only works when the business has no common-law employees besides the owner and spouse. Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan or a Foreign Plan, is generally required when plan assets are $250,000 or more at year-end or for the final plan year.

Can a client max out both plans at once? Not quite. A self-employed taxpayer can contribute to a SEP IRA and a solo §401(k) through the same business if the SEP document allows another plan. However, Form 5305-SEP generally cannot be used when the employer maintains another qualified plan. SEP contributions and solo §401(k) annual additions are combined under one overall defined contribution limit, $72,000 for 2026, before catch-up contributions.

SEP IRA rules for S corporation shareholders

S corporation shareholder-employees generate a steady stream of questions, and for good reason: the rules hinge entirely on Form W-2 compensation, not distributions. If two shareholder-employees are both eligible under the plan, the corporation can fund SEP IRAs for each of them, capped at the lesser of 25% of compensation or $72,000 for 2026, using no more than $360,000 of compensation. Distributions never count toward that calculation, no matter how the client's return is structured.

What about timing? The SEP contribution deadline follows the employer's return due date, including extensions, and for an S corporation, the corporate deadline controls, not the shareholder's Form 1040 date. Schedule C filers get the same flexibility: an extended individual return pushes the SEP contribution deadline to Oct. 15.

One detail that confuses new preparers is that SEP eligibility is not automatic. A SEP may use the most restrictive standard allowed, meaning an employee under age 21, one who has not worked for the employer in at least three of the last five years or one earning less than $800 for 2026 can be excluded. The employer can choose looser rules, but whatever the plan document says controls the contributions.

SIMPLE IRA employer obligations don’t disappear in a bad year

A SIMPLE IRA employer offering a dollar-for-dollar match of up to 3% cannot drop that match to zero just because revenue is down. The match can fall as low as 1%, but only for two years within any five-year period, and employees must be notified within a reasonable period before the 60-day election period. Employees can always decline salary deferrals. Under the matching method, no deferral means no match. Under the 2% nonelective method, though, the employer still owes a contribution to every eligible employee, whether that employee defers or not.

When testing fails and money must move

A traditional §401(k) plan generally must undergo annual nondiscrimination testing unless an exception, such as a safe harbor design, applies. A failed test, especially when corrective distributions generate taxable income, is a signal to involve the plan administrator right away. The ADP test compares elective deferral rates, while the ACP test compares employer matching and employee after-tax contribution rates.

Corrections may include distributions to highly compensated employees, qualified nonelective contributions for non-highly compensated employees or correction through the Self-Correction Program or Voluntary Correction Program under EPCRS. A safe harbor §401(k) design can help prevent the problem from repeating year after year. For a practical IRS overview of common correction methods, see the IRS §401(k) Plan Fix-It Guide: The plan failed the §401(k) ADP and ACP nondiscrimination tests.

SEP and Roth IRA contributions don’t compete

Funding a SEP IRA does not reduce a client's combined traditional and Roth IRA contribution limit. For 2026, a taxpayer with sufficient taxable compensation can contribute up to $7,500, or $8,600 if age 50 or older, across traditional and Roth IRAs, separate from employer SEP contributions. Roth IRA income limits still apply, and SEP participation may limit the deduction for a traditional IRA contribution.

Review plans annually to ensure the best fit

Retirement plan rules and contribution limits change every year, so double-check current figures before finalizing a client's strategy. Helping clients identify retirement plan options for their businesses can strengthen your advisory services and expand their retirement savings opportunities.