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“Supercharged” Tax Incentives for a “Small” Employer that Starts a Retirement Plan

By January 5, 2023No Comments

The SECURE Act passed in December 2019 made significant changes to the rules regarding Retirement Plans, including 401k Plans, 403b Plans, Profit Sharing Plans, and Defined Benefit and Cash Balance Plans.  The year-end 2022 legislation that was passed to fund the Federal government through September 2023 included a section referred to as SECURE 2.0 because it includes numerous Retirement Plan law changes that even more significantly enhance what was done by the 2019 SECURE Act.

A substantial improvement under the SECURE Act and SECURE 2.0 involves the Federal Tax Credits available to a “small” employer that maintains a Retirement 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 Federal 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” startup and administrative costs paid by the employer in connection with establishing and operating the new plan.  These costs include third party administration (TPA) fees, recordkeeping fees, and employee education expenses.  The Tax Credit is available for the first three years of the plan.

The startup Tax Credit is a minimum of $500, and the maximum 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 2021 for 2022 Tax Year purposes, or less than $135,000 in 2022 for 2023 Tax Year purposes).

Before the 2023 Tax Year, the Tax Credit is capped at the lesser of 50% of the employer’s eligible costs, or $5,000 per year.  The other 50% paid by the employer likely is tax-deductible.

Beginning with the 2023 Tax Year, employers with up to 50 employees are eligible for a potential Tax Credit of 100% (rather than 50%) of these out-of-pocket expenses.  The $5,000 maximum per-year limit for the Tax Credit is unchanged.

Another Tax Credit, added by the SECURE Act, is available for new or existing plans.  This Tax Credit is intended to encourage employers to use “automatic enrollment”, typically in a 401k Plan:  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.

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.

SECURE 2.0 added an additional startup Federal Tax Credit, beginning with the 2023 Tax Year.  It is available for the first five Tax Years of the plan.  This Tax Credit is equal to a percentage of the employer contributions to the plan, up to $1,000 per employee (excluding certain highly paid employees with wages in excess of $100,000 (indexed for future years)).  The percentage starts at 100% for the first two years for employers with up to 50 employees, and is 75%, 50% and 25%, respectively, for years three to five.  The percentage is reduced if the small employer has 51 to 100 employees, at a reduction rate of 2 percentage points for each employee over 50.

Employer contributions that are eligible for this contribution-based Tax Credit include, for example, safe harbor and non-safe harbor matching contributions and non-elective contributions such as profit sharing contributions, but not Defined Benefit and Cash Balance Plan contributions.

You should contact your Tax Accountant to determine whether you meet all of the technical requirements for any of the small employer Federal Tax Credits.  If you qualify, you may claim the Tax Credit(s) using IRS Form 8881, “Credit for Small Employer Pension Plan Startup Costs”.

ACSI is available to help our clients learn more about how the SECURE 2.0 changes may impact your Retirement Plan.

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