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Tax Credits Available to Offset New Retirement Plan Costs

June 2022

Tax Credits Available to Offset New Retirement Plan Costs

A Federal Tax Credit of up to $5,000 per year for three consecutive years is available to small businesses who start a new retirement plan. Qualifying plans include 401(k)s, SEP, Cash Balance Plans, Profit Sharing Plans, and SIMPLE IRAs. Solo 401(k)s do not qualify for this credit. The credit is based on 50% of the startup, administration, and education costs paid by the company and is the greater of $500 or $250 times the number of Non-Highly Compensated Employees (“NHCEs”) in your plan up to $5,000. 

    • To be eligible, the employer must start a new plan, not have an existing plan in the prior three years (including SIMPLE or SEP), have less than 100 employees with at least $5,000 in compensation each in the prior year, and have at least one NHCE.
    • Also added is the ability to retroactively adopt a new plan after the close of the plan year. Employers have up to the due date of the business’s tax return to start a plan for the previous year. This is not applicable for the salary deferral portion in a 401(k) plan, but is applicable for profit sharing or a Cash Balance Plans.
    • Adding Automatic Enrollment to the plan will generate an additional $500 credit for a total of $5,500. This also runs for three years.
    • The 50% of expenses paid by the company that is not used against the credit are still deductible.
    • Employers that start a new retirement plan have the ability to offset a significant portion of startup costs
        • Example*: A firm with owners that pay 30% in marginal federal taxes and has 5 HCEs and 25 NHCEs with startup costs of $8,250 who also adds auto-enrollment can take tax credits & deductions of:
            • $500 credit for auto-enrollment
            • The greater of another $500 or the lessor of [(50% of $8,250 = $4,125) or 25 NHCEs * $250 = $6,250 or $5,000] = $4,125
            • Deductible part of fee not paid for by credit is 50% * $8,250 = $4,125 multiplied by 30% = $1,237
            • TOTAL: $1,237 + $4,125 + $500 = $5,862 which is 71% of total cost. Out of pocket costs total $2,388.

Already have a retirement plan? Add auto-enrollment to the plan and save $500 per year for a total of $1,500 over three years on your income taxes. To encourage companies to update their retirement plan, the SECURE Act of 2019 provides companies a credit of $500 per year for the first three years upon adoption of automatic enrollment. To claim the credit, include Form 8881 with your corporate return.

If auto-enrollment is applied, the employer automatically deducts a pre-determined percentage of elective deferrals from a new employee's wages. Employees must elect to opt out or change the withholding percentage to something that better suits them. This is different than most plans today which require the employee to take action to get into a plan.

For more information please visit:  https://www.irs.gov/retirement-plans/retirement-plans-startup-costs-tax-credit

*Example is for illustrative purposes only.  Please consult your Tax Preparer.