A SEP IRA lets a small business owner contribute up to $72,000 for 2026 — but for S-Corp owners, the contribution caps at 25% of W-2 wages only, not profit. That single rule changes everything. For most owner-operators with an optimized salary, a Solo 401(k) produces a larger deduction from the same payroll. The SEP wins in a narrow set of circumstances. Everything else is habit.

"A lot of Schedule C small businesses default to a SEP because it is the easiest thing to do. If they come to somebody who is experienced in tax planning, it can make a lot more sense to convert to an LLC taxed as an S corporation and implement a Solo 401(k) instead."

— Neal McSpadden, Founder, Tax Sherpa

Key Takeaways

• For S-Corp owners, SEP contributions are calculated on W-2 wages only — not distributions, not total profit. At a $60,000 W-2, the 2026 max SEP is $15,000.
• A Solo 401(k) at that same $60,000 W-2 produces up to $39,500 ($24,500 employee deferral + $15,000 employer match) — more than double the SEP result.
• There is no SEP IRA catch-up contribution. Owners over 50 leave $8,000 per year on the table ($11,250 for ages 60–63) compared to a Solo 401(k).
• The SEP's real advantage is deadline flexibility: it can be opened and funded up to the extended return due date — October 15, 2027 for the 2026 tax year — making it the only tool that retroactively reduces prior-year tax at filing time.
• The narrow case where SEP wins: Schedule C owners in states like Tennessee and Washington, D.C. where S-Corp election is penalized so heavily that staying sole proprietor is the better strategy.

The Formula Most Articles Get Wrong

Two versions of the SEP formula apply, and conflating them creates real over-contribution risk.

S-Corp owners: 25% of W-2 wages. Not profit, not distributions plus salary — only W-2 wages. Specifically, Medicare wages from Box 5 of the W-2, because that figure correctly accounts for more-than-2% shareholder health insurance premiums that can distort Box 1.

Sole proprietors: approximately 20% of net SE income. The deduction for half of self-employment tax reduces the base before the 25% rate applies. On $100,000 of net profit, using 25% straight instead of the correct ~20% produces a $5,000 over-contribution.

Why the S-Corp formula matters: a standard S-Corp tax strategy sets W-2 well below total profit — say, $60,000 on a $200,000 business — because distributions above that threshold avoid payroll tax. Efficient for FICA. But it caps the SEP contribution at a fraction of what the business earns.

Worked example — $200k S-Corp owner, $60k W-2:

• Max SEP IRA: 25% × $60,000 = $15,000