How to Calculate the SEP-IRA Contribution Limit for Self-Employed

The SEP-IRA contribution limit for self-employed workers is up to 25% of compensation (or net self-employment income after adjusting for self-employment tax), capped at $69,000 annually (2024). The calculation is not straightforward because the contribution itself reduces taxable income, creating a circular formula.

The basic principle

A SEP-IRA (Simplified Employee Pension IRA) allows self-employed workers and small business owners to contribute to retirement accounts. The legal limit is up to 25% of “compensation.” For a W-2 employee, compensation is straightforward. For the self-employed, it’s net self-employment income after a specific adjustment for self-employment tax.

This is not the same as 25% of gross business income. It’s 25% of adjusted net income, which is why the calculation trips up many filers.

The three-step formula

Step 1: Calculate net self-employment income

Start with your net business income (profit after business expenses). This is the “Schedule C profit” if you’re a sole proprietor, or the net distributive share if you’re a partner.

Example: You’re a freelance consultant with $100,000 in revenue and $20,000 in deductible business expenses (home office, equipment, etc.). Your net business income is $80,000.

Step 2: Subtract ½ of self-employment tax

Self-employed workers pay both the employer and employee portions of Social Security and Medicare tax (about 15.3% total, though only up to the Social Security wage base applies). When calculating SEP-IRA limits, you’re allowed to deduct half of this tax from your net income.

The formula for self-employment tax is:

Self-employment tax = Net income × 0.9235 × 0.153 (approximately)

The 0.9235 factor accounts for the fact that SE tax is calculated on 92.35% of net income. The 0.153 is the 15.3% rate.

For the same $80,000 example:

• Self-employment tax = $80,000 × 0.9235 × 0.153 = $11,296
• Half of SE tax = $11,296 ÷ 2 = $5,648
• Adjusted net income = $80,000 − $5,648 = $74,352

Step 3: Calculate 25% of adjusted net income (or use the IRS worksheet)

The SEP-IRA limit for self-employed is technically up to 20% of adjusted net income, not 25%. (The 25% limit applies to the employer deferral portion when a business is structured as an S-corp or pays you a W-2; for sole proprietors, it works out to roughly 20% after the SE tax adjustment.)

For the $74,352 adjusted income:

• SEP-IRA contribution = $74,352 × 0.20 = $14,870

This is capped by the annual limit: in 2024, you cannot contribute more than $69,000; in 2025, it’s $70,000. Our example stays well below the cap.

Why the adjustment exists

The circular logic is deliberate. When you contribute to a SEP-IRA, that contribution reduces your taxable income, which in turn reduces your self-employment tax (because SE tax is calculated on net income). The IRS has built in the adjustment so you’re not “double-dipping”—claiming the full 25% contribution and saving SE tax on the contribution itself.

If you skip this adjustment and just multiply net income by 0.25, you’ll overestimate your limit. The IRS worksheet (below) handles it automatically.

Using the IRS worksheet

Rather than manual calculation, most tax software and the IRS Form 1040 Schedule SE comes with Worksheet B, which walks you through:

1. Net business income (line 31 of Schedule C for sole proprietors)
2. One-half of self-employment tax (calculated on a separate line)
3. Adjusted income (step 1 minus step 2)
4. Maximum deduction (step 3 × 0.20)

The worksheet automatically applies the adjustment and caps the result at the annual limit.

Example with a higher income

Imagine you are a freelancer with $150,000 net business income.

1. Net income: $150,000
2. Self-employment tax: $150,000 × 0.9235 × 0.153 = $21,170
3. Half of SE tax: $21,170 ÷ 2 = $10,585
4. Adjusted income: $150,000 − $10,585 = $139,415
5. SEP-IRA contribution: $139,415 × 0.20 = $27,883

This is below the 2024 cap of $69,000, so $27,883 is your maximum deductible SEP-IRA contribution.

The annual limit cap

If your adjusted net income is high enough, the contribution can be capped by the annual limit rather than the formula. For example, if your adjusted net income is $345,000 (roughly), then 20% would exceed $69,000. You’d be limited to $69,000 (2024) or $70,000 (2025), regardless of the formula.

This cap rises with inflation each year, so the IRS publishes the current limit in announcements early in the year.

Contribution deadline

The SEP-IRA contribution must be made by the tax-filing deadline (including extensions). If you file a timely extension (by October 15), you have until then. If you file on time (April 15), you can still contribute to your SEP-IRA up until the extended deadline, but you must file an extension form to claim the deduction on your return.

Many filers contribute after April 15 but before October 15 while an extension is pending, then amend or file their return claiming the deduction.

Multiple income sources

If you have both self-employment income and W-2 wages (e.g., you work a day job and freelance on the side), SEP-IRA rules allow you to contribute based on the self-employment income alone. The W-2 wages don’t combine with self-employment income for SEP-IRA purposes.

However, if you are an employee of your own S-corp and also take a distribution, the rules interact with 401(k) deferrals and are more complex. Consult a tax professional if you have both a W-2 and self-employment income.

Choosing a SEP-IRA vs. a Solo 401(k)

For the self-employed, a SEP-IRA is simple to set up and administer, but a Solo 401(k) can allow higher contributions in some cases (because you can defer as an employee and contribute as an employer). The SEP-IRA is often favored for simplicity; the Solo 401(k) for those with very high self-employment income seeking maximum tax deferral.

The SEP-IRA contribution limit is straightforward once you know your adjusted net income; the Solo 401(k) calculation is more complex. Both are subject to annual contribution limits, which can shift over time.

See also