“Small” employers may be missing out on an opportunity to take advantage of one or two Federal Tax Credits in connection with starting or maintaining a retirement plan, such as a 401k plan. For this purpose, a small employer is one with fewer than 100 employees earning at least $5,000 in compensation in the prior year.
One Tax Credit is for starting a plan. In this case, the employer generally cannot have maintained an employer retirement plan in the three prior years. The Tax Credit is based on the “ordinary and necessary” start-up and administrative costs paid by the employer in connection with the new plan. These costs include third party administration (TPA) fees, recordkeeping fees, and employee education expenses. The Tax Credit is claimed using IRS Form 8881, “Credit for Small Employer Pension Plan Startup Costs”.
Previously limited to $500 per year for three years, the Tax Credit has been significantly increased, and now the maximum is $5,000 per year. The Tax Credit, which is a minimum of $500, is determined by a formula, generally $250 a year per each eligible “non-highly compensated employee” (NHCE) (i.e., NHCEs typically are non-owners paid less than $130,000 in the prior year). Although the Tax Credit is capped at 50% of the employer’s eligible costs, the other 50% paid by the employer likely is tax-deductible.
The other Tax Credit is available for new or existing 401k plans. This Tax Credit is intended to encourage employers to use “automatic enrollment”: when an employee becomes eligible for the plan, the employee automatically has 401k contributions deducted from pay and contributed to the plan, unless the employee opts-out. A recent study, done by the Plan Sponsor Council of America (PSCA), reported in its 2020 survey of 518 plans that 62% of plans now use automatic enrollment.
Starting a plan with automatic enrollment, or adding automatic enrollment to an existing plan, likely qualifies the small employer for a Federal Tax Credit of $500 per year for three years. The Tax Credit is not conditioned on the employer incurring any out-of-pocket costs, but is based solely on adding the feature to the plan.
An employer that is considering starting a plan, or enhancing an existing plan, should contact its Tax Accountant to determine whether it will qualify for any plan-related Federal Tax Credits.
ACSI is available to help you learn more about the alternative types of retirement plans, and optional plan features that you may want to consider.