Tax Strategy: Small Business Retirement Plan Startup Credit and Employer Contribution Credit

 

For small business owners, offering a retirement plan can seem like a daunting, expensive administrative burden. But what if we told you that the government is ready to help cover the costs—not just with a deduction, but with dollar-for-dollar tax credits?

 

Thanks to the SECURE Act 2.0 of 2022, there are two powerful federal tax credits that make launching and funding an employee retirement plan more affordable than ever: the Retirement Plan Start-Up Costs Tax Credit and the new Employer Contribution Tax Credit.

 

Credit 1: The Retirement Plan Start-Up Costs Tax Credit

 

This credit is designed to help you cover the administrative and educational expenses of establishing a new retirement plan.

 

What it Covers

 

This credit applies to the ordinary and necessary costs of establishing and administering an eligible plan, as well as the costs of educating your employees about the plan. Eligible plans include 401(k)s, SIMPLE IRAs, and SEP IRAs.

 

The Generous Increase from SECURE 2.0

 

The SECURE 2.0 Act significantly enhanced this credit, especially for the smallest businesses.

  • For Businesses with 50 or Fewer Employees: The credit is now 100% of your qualified start-up costs (previously 50%).
  • For Businesses with 51 to 100 Employees: The credit remains at 50% of qualified start-up costs.

 

Maximum Credit Amount

 

The maximum annual credit is the greater of $500 or the lesser of:

  1. $250 multiplied by the number of non-highly compensated employees (NHCEs) eligible to participate in the plan, or
  2. $5,000.

 

This credit is available for the first three years the plan is in effect.

 

Example: If you have 10 non-highly compensated employees, the maximum credit is $250 x 10 = $2,500 per year for three years, for a total potential credit of $7,500. If your qualified expenses are less than the calculated maximum, your credit is limited to your actual expenses.

 

Credit 2: The Employer Contribution Tax Credit

 

This is one of the most exciting additions from SECURE 2.0. This credit helps offset the cost of making matching or non-elective contributions to your employees' accounts.

 

How it Works

 

This credit is based on the contributions you make to your employees' retirement accounts. The maximum credit is $1,000 per employee per year.

 

The Phase-In/Phase-Out Schedule

 

The credit applies for the first five years of the plan and phases down over time to encourage continued participation:

 

Plan Year    Credit Percentage

Year 1          100% of your contribution, up to $1,000/employee

Year 2          100% of your contribution, up to $1,000/employee

Year 3          75% of your contribution, up to $1,000/employee

Year 4          50% of your contribution, up to $1,000/employee

Year 5          25% of your contribution, up to $1,000/employee

 

Employee Limits

 

The full credit is available to employers with 50 or fewer employees.

 

  • Employees with over $100,000 in wages (indexed for inflation) are excluded from the calculation.
  • For employers with 51 to 100 employees, the credit is phased out further (reduced by 2% for each employee over 50).

 

Do You Qualify? Key Eligibility Requirements

 

To be considered an eligible small employer for these credits, you generally must meet these two criteria:

  1. Employee Count: You must have had 100 or fewer employees who received at least $5,000 in compensation from you in the tax year immediately preceding the first year you claim the credit.
  2. New Plan: You must not have had a retirement plan covering substantially the same employees in the three tax years before the first year you became eligible for the credit.

 

The small business retirement tax credits are claimed using IRS Form 8881.

 

Attract and Retain Talent While Saving on Taxes

 

These credits transform the math for small business retirement plans. Instead of viewing a plan as a significant expense, you can now see it as a virtually cost-neutral or low-cost way to invest in your team and your company's future.

 

By leveraging these enhanced tax credits, you can:

  • Attract Top Talent: A robust 401(k) or retirement plan is a key benefit for job seekers.
  • Boost Retention: Employees are more likely to stay with an employer that helps them build financial security.
  • Save Big: Turn thousands of dollars in plan setup and contribution costs into significant tax savings.