Tax Credits For Small Business Plans

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After 2 years of COVID uncertainty, employees have reassessed what they most value in a workplace.   According to a Glassdoor survey, four in five employees indicate they want Benefits more than a pay raise, and a 401(k) ranks in the top five requested benefits.

Offering an employer sponsored retirement plan is essential for attracting and retaining high performing employees in the current tight labor market.  Your plan could be the difference between a top candidate working for you, or your competitor.  Also, employees who feel their employer is invested in their future are more likely to be engaged in their workplace and stay with the company longer, reducing the high cost of employee turnover.

Employer retirement plans are great for employee retention and tax savings.  So, what is stopping you from creating a retirement plan for your business? The answer we hear most often: Cost.  

The expense to start a retirement plan for a new business can be daunting.  The initial plan set up cost can range from $500 to $2,000 and the ongoing TPA (third part administrator) fees can range from $750 to $3,000 per year.  These expenses scare many new business owners from starting an employer sponsored retirement plan, especially in the early years when cash flow is tight.

There are resources to help alleviate these costs in the form of tax credits to start your retirement plan.  A dollar-for-dollar tax credit (up to $5,000/year) is available to eligible employers for starting a SEP, SIMPLE IRA or qualified plan such as a 401K.

To determine which plan is best for your business’s cash flow and tax structure, contact our business and tax planning experts. They will help determine which plan is optimal for your business.

What makes you eligible?

  • You had fewer than 100 employees who received more than $5,000 in compensation from you last year.
  • You had at least one plan participant who was a non-highly compensated employee (NHCE)
  • In the prior three tax years (before the first year you are eligible for the credit), your employees were not the same employees who received contributions or accrued benefits in another plan sponsored by you.  This also includes members of a controlled group (including yourself) and a predecessor of either of the individuals listed above.

How much is the credit?

  • 50% of the start-up cost, up to the greater of $500, or
  • The lesser of $250 times the number of NHCEs who are eligible to participate in the plan, or $5,000

What eligible start-up costs are considered “ordinary and necessary”?

  • Costs to set up and administer the plan.
  • Costs to educate your employees about the plan.

What are the eligible tax years for the credit?

  • The tax credit is available for the first three years of the plan.
  • You also have the option to elect the credit for the tax year before the plan becomes effective.

Auto-enrollment tax credit:

  • The IRS gives employers a $500 per year tax credit for adding the auto-enrollment feature to their retirement plan.  
  • The three-year tax credit starts during the year the auto-enrollment feature is included.

Please note: You are unable to deduct the costs of starting your plan as well as take the tax credit for the same expenses.  You do, however, have the option to forego the allowable tax credit.

Multiple employer plans:

If the tax credits are not enough to start your retirement plan during early cash constrained years, there is the option of using a MEP (multiple employer plan).  Multiple employer plans are adopted by two or more unrelated parties and are essentially individual employer plans, adopted by multiple unrelated plan sponsors.  MEPs were created to help businesses share the expenses of starting a retirement plan by spreading the expenses of the retirement plan across multiple employers.   This allows you to obtain the key benefits of having a 401(K) without shouldering the full expense alone during the early growth years.