Service boundary: This article is general education, not a plan recommendation. Monaco CPA may address federal and NJ tax-return treatment and contribution-limit reporting only for an account the client has already established under an accepted written scope. Monaco CPA does not recommend, select, open, set up, administer, or manage plans; provide investment allocation, Backdoor Roth, or individualized IRA strategy; or provide defined-benefit or cash-balance services.
In This Article
- How Does a SEP-IRA Work for NJ Small Business Owners?
- How Does a Solo 401(k) Compare With a SEP-IRA?
- How Does a SIMPLE IRA Work for Businesses With Employees?
- How Does a Defined Benefit Plan Work?
- How Does New Jersey Treat Retirement-Plan Contributions and Distributions?
- Key Takeaway
- Frequently Asked Questions
- Request a Scope
Retirement-plan contribution and reporting rules differ by plan type, and New Jersey treatment likewise depends on the contribution and taxpayer involved. For a W-2 employee, an employer's SEP contribution is limited to 25% of compensation; for a sole proprietor or working partner, a 25%-of-compensation plan rate works out to roughly 20% of adjusted net self-employment earnings after the deductible portion of self-employment tax and the contribution-rate adjustment. The 2026 federal defined-contribution annual-additions limit is generally the lesser of 100% of compensation or $72,000, with catch-up contributions tested separately when available. Important NJ nuance per N.J.S.A. 54A:6-21: 401(k) employee deferrals ARE excludable from NJ gross income; NJ guidance resolves the employer share affirmatively: NJ-BUS-1 instructs the self-employed to deduct qualified Solo 401(k) contributions up to the federal limits, and employer contributions to qualified plans receive tax-deferred treatment under NJ wage guidance (amounts above the federal limits are not deductible for NJ). Qualified defined-benefit employer contributions generally receive tax-deferred NJ treatment and do not create previously taxed employee basis. NJ wage guidance instead includes both employee and employer SEP and SIMPLE IRA contributions in NJ wages; a self-employed owner's federal SEP or SIMPLE deduction does not itself create an NJ deduction. At distribution, apply the actual plan type, previously NJ-taxed contributions, rollover facts, Worksheet C or the applicable pension method, current return instructions, and any return-level retirement-income exclusion rather than promising a fixed tax result.
Federal and New Jersey return treatment varies by plan type under the applicable contribution and reporting rules.
How Does a SEP-IRA Work for NJ Small Business Owners?
For a W-2 employee, an employer's SEP contribution cannot exceed 25% of compensation. For a sole proprietor or working partner, a 25%-of-compensation plan rate works out to roughly 20% of adjusted net self-employment earnings after the deductible portion of self-employment tax and the contribution-rate adjustment. The SEP employer contribution remains subject to that separate percentage limit and the $70,000 maximum for 2025 ($72,000 for 2026 per IRS Notice 2025-67). Separately, aggregate annual additions across defined-contribution plans maintained by the employer are generally limited under Section 415(c) to the lesser of 100% of compensation or the applicable $70,000/$72,000 dollar ceiling, with contributions coordinated across those plans. Setup, maintenance, and filing obligations depend on the plan and facts. The contribution deadline generally extends to the employer's tax-return due date, including extensions, and an employer contribution generally uses the same percentage for eligible employees. NJ treatment: NJ wage guidance includes both employee and employer SEP contributions in NJ taxable wages. A self-employed owner's federal SEP deduction does not itself create an NJ deduction. Track any contribution previously taxed by NJ as potential IRA basis and use Worksheet C to separate that basis from earnings and other untaxed amounts when distributions occur.
A SEP is employer-funded with no employee-deferral component and generally does not require an annual employer Form 5500. An eligible self-employed owner generally claims the contribution on Schedule 1 (Form 1040); an eligible S-corporation employer claims its contribution on the corporate return. Eligibility, uniform contributions, calculation and administration rules still apply.
SECURE 2.0 added Roth SEP and Roth SIMPLE options effective in 2023, where the arrangement and provider support them. Roth contributions are included in the participant's federal income even when an employer can deduct its contribution; they do not receive the participant's traditional-contribution exclusion. See IRS Notice 2024-2 and the applicable plan terms.
How Does a Solo 401(k) Compare With a SEP-IRA?
A Solo 401(k) may combine employee deferrals ($23,500 for 2025, $24,500 for 2026 per IRS Notice 2025-67) with employer contributions. The employer contribution is based on W-2 compensation for a corporate employee and on the adjusted net-earnings computation for a sole proprietor or working partner. Annual additions are generally limited to the lesser of 100% of compensation or $70,000 for 2025 ($72,000 for 2026), with a separate $7,500 catch-up for age 50 or older in 2025 ($8,000 for 2026) or $11,250 for ages 60 through 63 under SECURE 2.0. For 2026, if the plan permits catch-up contributions, a participant whose 2025 FICA wages under Section 3121(a) from the employer or employers sponsoring the plan (generally Social Security wages reported in Form W-2 Box 3, subject to applicable aggregation rules) exceeded $150,000 must designate any catch-up contribution as Roth; self-employment income alone is not that FICA-wage input. The statutory requirement applies for 2026 under a reasonable, good-faith interpretation, while the final-regulation provisions generally apply beginning in 2027. Employee deferral elections are generally prospective, subject to the SECURE 2.0 section 317 first-plan-year exception described below. Form 5500-EZ is generally required for each one-participant plan when the combined end-of-year assets of all one-participant plans maintained by the employer exceed $250,000, and a final return is required for the final plan year regardless of asset value. NJ treatment: Solo 401(k) employee deferrals are excludable from NJ gross income under N.J.S.A. 54A:6-21, and published NJ guidance resolves the employer share affirmatively: NJ-BUS-1 instructs the self-employed to deduct qualified Solo 401(k) contributions up to the federal limits, and employer contributions to qualified plans receive tax-deferred treatment under NJ wage guidance. Amounts above the federal limits are not deductible for NJ, and the deduction assumes a qualified plan.
A one-participant (Solo) 401(k) covers a business owner, or the owner and spouse. Employees who meet the plan's eligibility requirements must be included; part-time status alone does not exclude them, and the applicable long-term part-time service rules must be checked. Review employee age, service, related-employer coverage and plan terms before treating a plan as owner-only.
If the plan permits Roth employee deferrals, those deferrals are made after tax and do not reduce federal W-2 Box 1. Roth earnings and distributions receive favorable treatment only when the applicable qualification and distribution requirements are met. The 2026 $24,500 employee-deferral limit plus the eligible catch-up produces $32,500 for the ordinary age-50 catch-up or $35,750 for the age-60-through-63 catch-up; the eligibility, plan and mandatory-Roth conditions above still apply.
Loan provision: If the plan permits loans and there are no other outstanding or prior-year plan loans, the ordinary maximum is the lesser of $50,000 or 50% of the vested balance; the plan may permit a $10,000 floor in the vested-balance test. With other plan loans, apply the outstanding-balance aggregation and preceding-12-month high-balance reduction under IRC §72(p)(2)(A) and (D). The plan document and federal repayment requirements also control. SEP-IRAs do not offer participant loans.
SIMPLE IRAs also do not offer participant loans. A defined-benefit plan's loan availability depends on its terms and the federal loan rules.
How Does a SIMPLE IRA Work for Businesses With Employees?
A SIMPLE IRA or SIMPLE 401(k) is generally available to an employer that had 100 or fewer employees who received at least $5,000 of compensation in the preceding year and generally did not maintain another qualified plan under which contributions were made or benefits accrued for service in that year, subject to the collective-bargaining exception, the two-year grace period after ceasing to meet the employee limit, and special acquisition, disposition, and similar-transaction rules. For a SIMPLE IRA, the plan generally must cover each employee who received at least $5,000 in any two preceding years and is reasonably expected to receive at least $5,000 in the current year, subject to permitted exclusions and less-restrictive plan terms. Employee salary-reduction contributions are limited to $16,500 for 2025 and $17,000 for 2026 per IRS Notice 2025-67. The separate $18,100 salary-reduction and $3,850 catch-up limits require the employer-history test in Section 408(p)(2)(E)(iv): during the three taxable years before the employer first maintained the SIMPLE arrangement, neither the employer, a controlled-group member, nor a predecessor may have maintained a Section 401(a), 403(a), or 403(b) plan with contributions or benefit accruals for substantially the same employees. For an employer meeting that test, the enhanced limits apply automatically with 25 or fewer employees paid at least $5,000 in the preceding year; an employer with 26–100 such employees may elect them with the required 4% match or 3% non-elective contribution. For 2026, the general SIMPLE catch-up limit is $4,000 for an eligible participant age 50 or older, while the higher age-60-through-63 catch-up limit is $5,250. The employer must make a dollar-for-dollar match up to 3% of compensation (reducible to no less than 1% in no more than 2 of 5 years, with notice) or a 2% non-elective contribution for all eligible employees (4% match or 3% non-elective under the enhanced election). The employer may also make an additional uniform non-elective contribution for each eligible employee up to the lesser of 10% of compensation or $5,300 for 2026 (Section 408(p)(2)(A)(iv), Notice 2025-67). A SIMPLE IRA setup deadline is generally October 1 (a business formed after October 1 may set up as soon as administratively feasible; an employer that previously maintained a SIMPLE must use a January 1 effective date). NJ treatment: NJ wage guidance includes both employee and employer SIMPLE IRA contributions in NJ taxable wages. A self-employed owner's federal SIMPLE deduction does not itself create an NJ deduction. Track amounts previously taxed by NJ as potential IRA basis and use Worksheet C to separate that basis from earnings and other untaxed amounts when distributions occur.
Key limitation: A taxable SIMPLE IRA withdrawal before age 59½ is generally subject to an additional 25% tax, instead of 10%, during the two-year period beginning when you first participated, unless an applicable exception removes the additional tax. This "2-year lock" makes SIMPLEs less flexible than 401(k)s for participants who may need early access.
How Does a Defined Benefit Plan Work?
Service boundary: Monaco CPA does not provide defined-benefit or cash-balance plan design or analysis; consult an actuary/TPA and your plan adviser. Defined benefit (DB) pension plans target a specified annual benefit at retirement and require actuarial calculations annually. For 2026, the §415(b) annual-benefit ceiling is the LESSER of 100% of the participant's average compensation for the (up to) three consecutive calendar years with the highest aggregate compensation or $290,000 (per IRS Notice 2025-67, up from $280,000 in 2025), before applicable commencement-age, participation, service, benefit-form, and plan-specific adjustments. This is a benefit ceiling, not a contribution amount. Contribution and deduction amounts depend on the actuarial design, participant facts, funding rules, and applicable limits, and the plan carries continuing contribution and administrative obligations (plans covering only an owner, or an owner and spouse, are generally outside ERISA Title I, though tax-qualification, funding, and filing rules still apply; covering a common-law employee brings ERISA in). NJ treatment: Qualified employer contributions to a defined-benefit plan generally receive tax-deferred treatment for New Jersey, are not current taxable wages, and do not create previously taxed employee basis. At distribution, determine NJ gross-income inclusion from the plan, rollover, and previously taxed contribution facts under the current return instructions; any available retirement-income exclusion and tax effect are complete-return questions.
How Does New Jersey Treat Retirement-Plan Contributions and Distributions?
NJ treatment depends on the contribution, plan, entity, and taxpayer capacity under N.J.S.A. 54A:6-21, NJ-BUS-1, NJ wage guidance, GIT-1&2, and the current return instructions. Solo 401(k): employee deferrals are excluded from NJ gross income in the applicable computation; NJ guidance resolves the employer share affirmatively: NJ-BUS-1 instructs the self-employed to deduct qualified Solo 401(k) contributions up to the federal limits, and employer contributions to qualified plans receive tax-deferred treatment under NJ wage guidance (amounts above the federal limits are not deductible for NJ). Defined Benefit: qualified employer contributions generally receive tax-deferred NJ treatment, are not current wages, and do not create previously taxed employee basis. SEP-IRA and SIMPLE IRA: NJ wage guidance includes both employee and employer contributions in NJ wages, and a self-employed owner's federal deduction does not itself create an NJ deduction. Previously NJ-taxed IRA contributions may create basis recoverable under Worksheet C; earnings, untaxed rollover amounts, pension-method rules, and any return-level retirement-income exclusion are computed separately. Plan choice also depends on employee coverage, plan terms, administration, and federal limits.
Traditional SIMPLE salary reductions generally reduce federal W-2 Box 1 but remain in NJ Box 16; Roth SIMPLE salary reductions remain in both. Traditional IRA contributions also receive no NJ-1040 deduction, even when a federal deduction is available subject to contribution and income limits. Track previously NJ-taxed IRA amounts using Worksheet C: the Three-Year Rule and General Rule apply to contributory pensions and annuities other than IRAs. A qualified Roth distribution, including from a Roth SEP or Roth SIMPLE IRA, is excluded and not reported on the NJ return.
What Does the SEP-IRA vs. Solo 401(k) Tax Difference Look Like in Real Numbers?
Illustrative scenario: NJ S-corp owner (single filer, 100% shareholder), $200,000 W-2 from the S-corp, and $100,000 of positive NJ S-corporation income before the corporation's retirement-plan deductions, for $300,000 of NJ taxable income before retirement contributions. Compare a $50,000 SEP-IRA employer contribution with a $50,000 Solo 401(k) package consisting of a $24,500 employee deferral and a $25,500 employer share. The illustration assumes a 24% federal rate for arithmetic only and a 6.37% NJ marginal rate; it does not model QBI, payroll, plan costs, or other return items.
| Item | SEP-IRA ($50,000 employer) | Solo 401(k) ($24,500 employee + $25,500 employer) |
|---|---|---|
| Federal income reduction | $50,000 | $50,000 |
| Federal income-tax effect (24% simplifying assumption) | ~$12,000 | ~$12,000 |
| NJ income reduction (current year) | $0 - the corporation's $50,000 deduction reduces NJ S-corporation income, but SEP employer contributions are included in NJ wages (njit5), so the total is unchanged | $50,000 - the $24,500 employee deferral (N.J.S.A. 54A:6-21) reduces NJ wages, and the $25,500 employer share is excluded from NJ wages because employer contributions to a qualified plan receive tax-deferred treatment under NJ wage guidance (njit5), while the corporation's deduction reduces the owner's positive NJ S-corporation income |
| NJ income-tax effect (6.37%) | $0 | $3,185.00 |
| NJ basis | $50,000 | $0 - deferrals are excluded and the employer share is excluded from NJ wages under NJ wage guidance (njit5) and deducted by the corporation on CBT-100S, so no NJ basis is created |
The $3,185.00 NJ figure is $50,000 × 6.37%: NJ guidance resolves the Solo 401(k) employer share affirmatively by entity type - for this S-corp W-2 owner, employer contributions to a qualified plan receive tax-deferred treatment under NJ wage guidance (njit5) and the corporation's deduction reduces the owner's positive NJ S-corporation income, while the SEP employer contribution is included in NJ wages and offsets its own corporate deduction; a sole proprietor or partner instead deducts qualified self-employed 401(k) contributions on NJ-BUS-1 up to the federal limits - so both Solo 401(k) components reduce NJ income. The result assumes the S-corp has enough positive NJ income to absorb its deductions, because NJ does not let a net loss in the S-corporation income category offset wages. Amounts above the federal limits are not deductible for NJ, and plan qualification and the taxpayer's facts still control. The choice also depends on contribution limits, employee coverage, Roth and loan provisions, administration, QBI, payroll, and plan costs. Neither owner contribution is a Schedule C expense or reduces self-employment tax.
Key Takeaway
Retirement plan contributions may reduce federal taxable income in the contribution year, subject to contribution limits, deduction rules, and QBI interaction. For NJ, treatment depends on the contribution and plan: Solo 401(k) employee elective deferrals are excludable from NJ gross income under N.J.S.A. 54A:6-21; NJ guidance resolves the employer share affirmatively: NJ-BUS-1 instructs the self-employed to deduct qualified Solo 401(k) contributions up to the federal limits, and employer contributions to qualified plans receive tax-deferred treatment under NJ wage guidance (amounts above the federal limits are not deductible for NJ). Qualified defined-benefit employer contributions generally receive tax-deferred NJ treatment and do not create previously taxed employee basis. NJ wage guidance includes employee and employer SEP and SIMPLE IRA contributions in NJ wages, while a self-employed owner's federal deduction does not itself create an NJ deduction. Track previously NJ-taxed IRA contributions as potential basis and apply the current distribution and return rules rather than assuming a fixed tax result. The residual checks on the Solo 401(k) employer share are plan qualification and the federal-limit cap. Owner contributions are not Schedule C expenses and do not reduce Schedule C profit or self-employment tax.
Related reading: Year-End Tax Moves for NJ Business Owners | S-Corp Salary vs. Distributions | Top 5 Overlooked Deductions | Tax planning services
Official sources: IRS Notice 2025-67 (opens in a new tab) | IRS Publication 560 (opens in a new tab) | IRS Notice 2024-2 (opens in a new tab) | IRS catch-up guidance (opens in a new tab) | IRS final Roth catch-up regulations (opens in a new tab) | IRS defined-benefit limits (opens in a new tab) | IRS Form 5500-EZ instructions (opens in a new tab) | NJ wage guidance (opens in a new tab) | NJ business-income guidance (opens in a new tab) | NJ GIT-1&2 retirement-income guidance (opens in a new tab)
Frequently Asked Questions
What is the maximum SEP-IRA contribution for self-employed?
For a sole proprietor or working partner, the SEP-IRA employer contribution uses adjusted plan compensation: a 25%-of-compensation plan rate works out to roughly 20% of adjusted net self-employment earnings after the deductible portion of self-employment tax and the contribution-rate adjustment. The maximum is $70,000 for 2025 ($72,000 for 2026 per IRS Notice 2025-67). For example, $100,000 of Schedule C profit does not produce a $25,000 SEP contribution; use the IRS Publication 560 worksheet. Contributions are due by the tax return filing deadline, including extensions.
How does a Solo 401(k) differ from a SEP-IRA?
A Solo 401(k) may combine employee deferrals ($23,500 for 2025, $24,500 for 2026) with employer contributions. The employer component uses W-2 compensation for a corporate employee and the adjusted net-earnings computation for a sole proprietor or working partner. Annual additions are subject to the federal compensation and combined-plan limits, with catch-up contributions tested separately. Employee deferrals generally require a prospective election; the SECURE 2.0 section 317 first-plan-year exception is described below.
Do retirement plan contributions reduce NJ state taxes?
It depends on the contribution, plan, entity, and taxpayer capacity. Solo 401(k): Per N.J.S.A. 54A:6-21, employee deferrals (Box 12 Code D) are excludable from NJ gross income; NJ guidance resolves the employer share affirmatively: NJ-BUS-1 instructs the self-employed to deduct qualified Solo 401(k) contributions up to the federal limits, and employer contributions to qualified plans receive tax-deferred treatment under NJ wage guidance (amounts above the federal limits are not deductible for NJ). Defined Benefit plans: qualified employer contributions generally receive tax-deferred NJ treatment and do not create previously taxed employee basis. SEP-IRA and SIMPLE IRA: NJ wage guidance includes both employee and employer contributions in NJ wages, while a self-employed owner's federal deduction does not itself create an NJ deduction. Worksheet C separates previously NJ-taxed IRA basis from earnings and untaxed amounts at distribution; other pension methods, rollovers, any retirement-income exclusion, and the complete return determine the result.
Can I set up a retirement plan after year-end?
It depends on the plan type. A SEP-IRA can generally be established and funded by the employer's tax-return due date, including extensions. Under SECURE Act section 201, an employer may adopt a qualified plan by the employer-return due date, including extensions, and treat it as adopted on the last day of the prior tax year for employer-contribution purposes. Elective deferrals are generally prospective. SECURE 2.0 section 317 separately permits an individual who owns the entire interest in an unincorporated business and is its only employee to adopt a new 401(k) after year-end and make a first-plan-year deferral by the individual's unextended return due date. A SIMPLE IRA generally must be established by October 1, subject to the new-employer and prior-plan rules.
Can I contribute to both a Solo 401(k) and a SEP-IRA in the same year?
An employer may maintain a SEP and another qualified plan for the same business, but plan documents, elective-deferral coordination, and the combined IRC §415(c) limits must be applied. The simplified Form 5305-SEP generally cannot be used when the employer maintains another qualified plan unless that other plan is also a SEP; a prototype or individually designed SEP may be needed. Coordinate the plan documents and contribution limits before funding both.
The Section 317 first-plan-year exception does not automatically cover an owner-and-spouse plan or an S-corporation owner. An S-corporation owner generally makes employee deferrals through timely payroll elections. Employer adoption and funding by an extended return deadline do not by themselves authorize a retroactive employee election.
I have a SEP-IRA already set up. Should I switch to a Solo 401(k)?
A switch is not implied by this comparison. Existing SEP-IRA funds may remain in place or may be eligible for rollover if the receiving plan permits it, but plan documents, deadlines, contribution coordination, fees, investments, and federal and NJ treatment must be reviewed. Use an independent TPA, custodian, and financial adviser for selection, establishment, rollover, administration, and investments.
Request a Scope
Tax rules change frequently. Use the contact form to request a written scope; sending the form creates no engagement or promise of an outcome. Greg Monaco is a NJ-licensed CPA and the firm's sole practitioner.
