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New 401(k) Tax Credits and How to Claim Them

By Damian Davila

While tax deductions and exemptions are great, they only reduce your business’s taxable income. Tax credits, on the other hand, reduce the actual amount of tax owed by your business dollar for dollar. Given their strong value, the U.S. government grants businesses certain tax credits to incentivize specific behavior. For example, in order to encourage more businesses to start providing a workplace retirement savings plan or to improve an existing one, legislators have included two tax credits in the new SECURE Act.

Let’s take a closer look at these two tax credit updates from the SECURE Act and how your small business can take steps to claim them once they become available.

Retirement Plans Startup Costs tax credit

Under the current legislation, eligible small businesses can claim 50% of necessary eligible startup costs for a workplace plan up to a maximum of $500 per year for three years. This adds up to a total of $1,500 in tax credits over the three-year period.

Here’s the fine print for eligibility: a small business with 100 or fewer employees who received at least $5,000 in compensation for the preceding year, at least one plan participant who’s not a non-highly compensated employee, and with a roster of employees who didn’t benefit from a prior plan offered by you in the three tax years before the first year your business is eligible for the credit.

What changes with the SECURE Act?

The maximum tax credit for startup costs increases from $500 to $5,000 per year (that’s a 900% increase!). The actual dollar amount is the greater of:

  • $500, or
  • The lesser of:
    • $250 multiplied by the number of non-highly compensated employees eligible for the plan
    • $5,000

Eligible businesses can still claim the startup cost for three years, so the new maximum total for startup costs credit is $15,000. This major bump in the startups costs credit definitely makes it more affordable for small businesses to set up retirement plans.

Why should I care?

This update creates a substantial economic incentive for a small business to not only set up employer-sponsored plan but also to take additional steps to educate its employees about participating in the plan. The rules of the Retirement Plans Startup Costs tax credits allows your business to claim the credit for ordinary and necessary costs to educate your employees about the plan. According to the 2019 Retirement Confidence Survey, 7 in 10 workers would find workplace education or advice on how to manage competing financial priorities to be at least somewhat helpful. Here’s a great incentive to provide this benefit to your employees, if you haven’t already.

How can you claim this tax credit?

If you qualify, you may claim the startup costs tax credit using IRS Form 8881.

You can claim the credit for each of the first three years of the plan and may choose to start claiming the credit in the tax year before the tax year in which the plan becomes effective.

The credit is part of the general business credit and you may carry it back or forward to other tax years if you can’t use it in the current year. However, you can’t carry it back to a tax year beginning before January 1, 2002.

Creation of the Automatic Enrollment tax credit

The SECURE Act proposes a new tax credit in addition to the one for startup costs: the Small Employer Automatic Enrollment Credit. Automatic enrollment in workplace plans is a proven way to increase employee plan participation. The U.S. Department of Labor reports that automatic enrollment plans could reduce the 30% non-participation rate to less than 15%, which would significantly increase overall retirement savings.

What changes with the SECURE Act?

Legislators propose a new tax credit of up to $500 per year to employers to cover startup costs for new section 401(k) plans and SIMPLE IRA plans that specifically include automatic enrollment. This tax credit is on top of the plan startup credit allowed under present law and would be available for three years for a total of $1,500 over the three-year period.

The automatic enrollment tax credit would also be available to small business employers that convert an existing plan to an automatic enrollment design.

Why should I care?

Virtually all retirement savings plans offer an automatic enrollment feature and the majority of businesses are using this feature. A survey of U.S. employers found that 68% of the surveyed companies automatically enroll workers in 401(k) plans. This tax credit is pretty much free money for your small business for a very small action!

How can you claim this tax credit?

There are no specific details on how to claim this new tax credit under the current draft of the SECURE Act. We’ll keep an eye on the developments and you can sign up to our newsletter if you would like to receive an update on this and other important 401(k) issues.

For a full breakdown of the effects of the SECURE Act on small businesses, review our article on The SECURE Act – Top 9 Impacts on Small Businesses.

Still have questions or would like to learn more about the startup cost and automatic enrollment tax credits for small businesses? Feel free to reach out to Human Interest by clicking here.