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401(k) Tax Credits for Small Businesses


As a result of the SECURE Act, effective January 1, 2021 (1), the time has never been better for a small business to consider offering a retirement plan to their employees. This is because those that start a new 401(k) plan and/or add an automatic enrollment feature to an existing plan may be eligible to claim a tax credit of up to $5,000 per year for up to three years to help offset the costs of starting a SEP, SIMPLE IRA or qualified plan such as a 401(k) plan.


Understand how taking advantage of the potential benefits of this new legislation is important for the financial wellness of small business. Below are some of significant aspects of the tax credit to understand.





Credit Amount

The credit equates to 50% of your eligible startup costs, up to the greater of:

  • $500; or

  • The lesser of:

  • $250 multiplied by the number of non-Highly Compensated Employees (NHCE) who are eligible to participate in the plan, or

  • $5,000 (2)

Defining Qualified Startup Costs

Qualified startup costs include the costs that a small business incurs to:

  • Set up and administer a qualifying retirement plan, and

  • Educate your employees about the plan.

Automatic Enrollment Additional Tax Credit

Small businesses can earn an additional $500 tax credit by adding an automatic enrollment feature to a new or existing 401(k) plan. The credit is available for each of the first three years the feature is effective.

Retirement Plans that Qualify

  • 401(k) Plans

  • Simplified Employee Pensions (SEPs)

  • Savings Incentive Match Plan for Employees (SIMPLE) IRAs

Retirement Plans that DO NOT Qualify

  • 403(b) Plans

Eligibility

According to the IRS, you are eligible to claim this credit if:

  • You had 100 or fewer employees who received at least $5,000 in compensation from you for the preceding year;

  • You had at least one plan participant who was a NHCE; and

  • In the three tax years, preceding the first year you are eligible for the credit, your employees were not substantially the same employees who received contributions or accrued benefits in another plan sponsored by you, a member of a controlled group that includes you, or a predecessor of either. (2)


Important Extras


In order to use this tax credit to your advantage you should also be aware of the following:

  • Adding a 401(k) feature to a profit-sharing plan does NOT qualify for the startup tax credit

  • Solo 401(k) Plans do NOT qualify for the SECURE Act tax credits because they do not include NHCE’s.

  • The automatic enrollment feature must meet Eligible Automatic Contribution Arrangement (EACA) requirements to qualify for the $500 tax credit.

  • Automatic enrollment does add special administration responsibilities to a 401(k) plan. Speak with your plan advisor to better understand these responsibilities and how they can be mitigated. (1)

Conclusion

Taking full advantage of the SECURE Act tax credits can dramatically reduce the cost of starting a new 401(k) plan. Additionally, if you’re a small business paying your 401(k) administration fees from a corporate bank account and not plan assets, you will be able to more fully enjoy the plan’s lower out-of-pocket cost for three years when you decide to start a new plan. For more information on your small businesses’ eligibility for tax credits or how to best leverage these tax credits, contact your plan advisor today.


5th Street Advisors specializes in assisting small business owners maximize the benefits of adding a retirement plan to their business. Please reach out to us at info@5thstreetadvisors.com to learn more.



(1) https://www.employeefiduciary.com/blog/small-business-401k-tax-credits

(2) https://www.irs.gov/retirement-plans/retirement-plans-startup-costs-tax-credit