How to Claim a Tax Credit for Your Small Business Retirement Plan

Looking for another perk to attract and retain employees, now is a good time to add a retirement plan to your business’s benefits package. As part of the SECURE Act (Setting Every Community Up for Retirement Enhancement Act), enhancements were made to retirement plan start-up tax credits benefitting small business owners. 

The new tax credit is designed to offset up to 50% of the cost of starting a retirement plan for the first three years of the plan. It includes enhanced tax credits for small businesses that start a new 401(k) plan and/or add an automatic enrollment feature to any 401(k) plan.

The purpose of the enhanced tax credit is to make it easier and more affordable for small businesses to offer retirement plans to their employees to invest in their future.

What Businesses are Eligible for the Retirement Plan Tax Credit?

To claim the enhanced tax credits, employers must:

• Have 100 or fewer employees who received at least $5,000 in compensation from for the preceding year;
• Have at least one plan participant who was a non-highly compensated employee (NHCE); and
• In the three tax years before the first year of eligibility for the credit, the business’s employees weren’t substantially the same employees who received contributions or accrued benefits in another business-sponsored plan, a member of a controlled group that includes the business, or a predecessor of either.

How Much is the Retirement Plan Tax Credit?

The tax credit can be as high as $16,500 ($5,500 per year). The retirement plan tax credit is calculated by multiplying the number of non-highly compensated employees by $250. 

Additional provisions include:

• The annual tax credit will be the greater of $500, or $250 for every eligible NHCE.
• The annual tax credit is 50% of the total qualified start-up cost up to $5,000.
• Plans that add automatic enrollment get a bonus tax credit of an additional $500 per year.

While tax deductions and exemptions are helpful to business owners, they only reduce a business’s taxable income. Tax credits, on the other hand, reduce the actual amount of tax owed by a business dollar for dollar. 

How Does the Addition of Automatic Enrollment Result in Retirement Plan Tax Credits?

If your small business already has an existing retirement plan, you may be eligible for a tax credit for adding automatic contribution arrangements where employees make regular contributions by default unless they opt-out. The credit is $500 for the year the automatic enrollment is incorporated into the plan and for each of the following two years for a total of $1,500.

What Retirement Plan Expenses are Considered Qualified Startup Costs?

Qualified startup costs include the routine and necessary costs that a small business incurs when establishing a retirement plan such as:

• Setting up and administering the plan, and
• Educating employees about the plan

What Retirement Plans Qualify for the Tax Credits?

401(k) plans, Simplified Employee Pensions (SEPs), and Savings Incentive Match Plan for Employees (SIMPLE IRAs) qualify for the retirement plan tax credits. Solo(k) and 403(b) plans are not eligible.

How Does a Small Business Claim the Retirement Plan Tax Credits?

Small businesses may claim the qualified retirement plan startup costs tax credit using IRS Form 8881 for the first three years of the plan. The credit may be claimed in the tax year before the plan becomes effective to offset the retirement plan start-up costs. 

This credit is considered a general business credit that may be carried back or forward to other tax years if it can’t be used in the current year. We are happy to discuss how the retirement plan tax credit may impact your Accounting, Bookkeeping, and/or Business Tax Planning.

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