401(k) tax credits: Employer tax advantages of a 401(k)

Offering an employer-sponsored retirement plan has several tax advantages, including tax credits for starting a 401(k) and offering an employer match or non-elective contribution. Many of these tax advantages are a result of the SECURE Act 2.0. Below, we outline 401(k) tax credits available to small businesses.

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401(k) tax credits for small businesses

The original SECURE Act created several new tax benefits for small businesses starting a retirement plan. For example, the original bill added a startup tax credit (more on this below) and an automatic enrollment credit, which provides employers with a $500 tax credit for three consecutive years if a plan has an auto-enroll feature.

SECURE 2.0, which was passed in December 2022, expands on most of these incentives. The following are the most relevant 401(k) tax credits for employers.

1. Tax credits for new plans 

For small businesses with no more than 50 employees, the SECURE Act 2.0 increases the existing tax credit to cover 100% of plan start-up costs up to $5,000 per year for the first three years. This could mean a total of $15,000 in tax credit savings.

Medium-sized businesses with 51 to 100 employees are still subject to original SECURE Act tax credits which cover up to 50% of administrative costs, capped annually at $5,000 per employer for three years.

Keep in mind that there are additional limitations to this credit. The credit is 50% of your eligible startup costs, up to the greater of $500 or the lesser of $250 multiplied by the number of NHCEs who are eligible to participate in the plan, or $5,000.

2. Tax credits for employer contributions

SECURE 2.0 also added a new tax credit for small businesses with no more than 50 employees based on a percentage of employer contributions. Employers can receive a tax credit of up to $1,000 for each employee earning $100,000 or less in the prior year. Businesses with 51 to 100 employees also qualify for this credit, but the amount is phased out by a percentage of 2% points for each employee for the preceding taxable year in excess of 50 employees.

For all employers taking advantage of the credit, the amount phases out based on the number of years the plan has been in existence:

• 100% in the first and second years

• 75% in the third year

• 50% in the fourth year

• 25% in the fifth year.

To visualize how much an employer can save with these new and existing tax credits, let’s assume a small business with 45 employees starts a new 401(k) plan with auto-enrollment in 2026. The plan costs $5,000 to start and set up for the first three years. 30 employees make less than $100,000 annually, and the small business makes a $1,000 non-elective contribution for each employee over the course of five years. 

This small business may earn an estimated $121,500 in tax credits from 2026 to 2030.

Differences between tax deductions and tax credits for businesses

As a refresher: 

• Tax deductions lower your taxable income

• Tax credits reduce your tax bill by the tax credit amount 

For example, if you spent exactly $5,000 on starting a new retirement plan, when netted with the SECURE 2.0 startup tax credit, your startup costs would be equal to zero. Keep in mind that the retirement plan startup tax credits are nonrefundable.

A tax deduction, on the other hand, can reduce your total tax liability. For example, if your small business owes $50,000 in taxes and you use a small business tax deduction of $1,000, your taxable income is now lowered to $49,000, which doesn’t change your tax rate. 

Other tax advantages of a 401(k) plan for employers

Beyond the credits offered by SECURE 2.0, standard IRS deductions remain a powerful tool for lowering business taxes.

The 25% compensation deduction rule 

Under IRC Section 404, employers can generally deduct up to 25% of the total compensation paid or accrued during the year for all eligible employees, if that amount is provided as an employer contribution, like an employer match or profit-sharing. It’s important to note that employee salary deferrals do not count toward this 25% limit. The compensation used for the calculation is subject to annual caps ($350,000 for 2025; $365,000 for 2026), while total account additions per individual cannot exceed Section 415 limits ($70,000 for 2025; $73,000 for 2026, excluding catch-ups).

Tax advantages for employees

Like employers, there are several tax advantages for employees with a 401(k) plan. Employees who contribute pre-tax dollars to their 401(k) plan can lower their tax bill for the year since it lowers their taxable income. This can work to an employee’s advantage over time, because once they reach retirement age (and are ready to withdraw from their retirement savings), they will not have to pay as many taxes because they will presumably be in a lower tax bracket. 

Interested in discussing the tax benefits of adding a retirement plan to your business? Want to learn about how a 401(k) can create a competitive advantage in recruiting and retaining employees? Talk to us today.