For many years, Federal tax law has provided an incentive to small employers (i.e., generally up to 100 employees) to establish a tax-qualified retirement plan, such as a 401k Plan. The incentive has been a Federal tax credit for the employer, for the first three (3) years the employer maintains the Plan. The Federal tax law changes adopted in December 2019 (the SECURE Act) significantly increased the potential tax credit.
The enhanced Federal tax credit is based on the payments made by the employer for the “ordinary and necessary” start-up and ongoing administrative costs regarding the Plan (i.e., the “out-of-pocket Plan expenses”). The credit, which previously had been limited to $500 per year for three (3) years, has been increased to 50% of the out-of-pocket Plan expenses, to a maximum of $5,000 per year (determined by a formula, generally $250 a year for each eligible “non-highly compensated employee”), beginning with the 2020 tax year.
The credit is claimed using IRS Form 8881, “Credit for Small Employer Pension Plan Startup Costs”.
A small employer also may qualify for a three (3) year, $500 annual Federal tax credit if starting a 401k Plan with automatic enrollment or later adding automatic enrollment to the Plan. Automatic enrollment is a 401k Plan feature whereby employees who do not voluntarily elect to contribute, or do not opt-out, will automatically have contributions deducted from pay at a predetermined rate. This credit is in addition to the start-up tax credit. For more details about the automatic enrollment tax credit, please see the ACSI September 14th article at https://acsi-ny.com/federal-tax-credit-available-for-a-small-business-that-adds-or-maybe-added-401k-plan-auto-enrollment/.
ACSI (www.acsi-ny.com or mbrand@acsi-ny.com) is available to help you learn more about Plan start-up and auto-enrollment.
