The U.S. government is offering attractive tax incentives to encourage small businesses to provide retirement plans for their employees. These incentives can significantly reduce startup and operational costs associated with these plans. It is advisable to discuss these opportunities with your accountant to ensure that you maximize the benefits available under these government incentives. This strategic approach could play a pivotal role in your business’s and your employees’ long-term financial health. Understanding these credits’ eligibility criteria and benefits can significantly impact your business’s financial planning and employee satisfaction.

Understanding the SECURE Acts

The incentive framework has been structured under two legislative measures: the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, and its subsequent enhancement with the SECURE 2.0 Act of 2022. These acts were designed to make retirement savings more accessible and affordable for businesses and their employees.

Available Tax Credits for Small Businesses

The government has introduced three distinct tax credits to aid small businesses in establishing and maintaining retirement plans:

  1. Startup Tax Credit: This credit targets the initial costs involved in setting up a 401(k) plan and/or a defined benefit plan. Under the SECURE Acts, eligible employers can claim up to 100% of the qualified startup costs*. This substantial credit aims to lower the financial barrier to creating a retirement plan, making it a more feasible option for many small businesses. The maximum tax credit is generally $5,000 per year, scaling down for businesses with fewer than 20 employees based on the formula of $250 times the number of non-highly compensated employee (non-HCE)** eligible for the plan. The tax credit is available for the first three years of the plan.

 

 

To be considered eligible for this tax credit, small business owners must meet three key criteria:

  1. Employee Threshold: Your business must have 100 or fewer employees who each received at least $5,000 in compensation in the previous year.
  2. Inclusivity Requirement: The retirement plan must cover at least one non-HCEs.
  3. New Plan Requirement: In the three tax years prior to the first year, you’re eligible for the credit, the same employees should not have received contributions or accrued benefits in another plan sponsored by you or any related entity.

The Employer Contribution Tax Credit: Introduced under SECURE 2.0, incentivizes small businesses to make employer contributions to 401(k) plans by offering a tax credit over the first few years of the plan. This credit applies to businesses that meet the eligibility criteria outlined for the startup tax credit.

The tax credit can be up to $1,000 per eligible employee annually. To be eligible, an employee must earn no more than $100,000 per year (adjusted for inflation). The actual tax credit amount varies depending on the number of employees and how long the plan has been active.

Businesses with 50 or fewer employees can receive a credit for 100% of employer contributions in the first two years (including the startup year), 75% in the third year, 50% in the fourth year, and 25% in the fifth year. This credit is available for up to five years and does not apply to defined benefit plans.

Example: Consider a business that starts a 401(k) plan in 2023 with one owner and 15 employees earning $50,000 annually. The plan offers a 3% non-elective contribution to all employees. This business could receive tax credits totaling $15,000 each for the first two years, accumulating to $52,500 over five years. Employer contributions not eligible for this tax credit can still be considered for tax deductions.

  1. For businesses with 51 to 100 employees, the tax credit operates on a sliding scale. The credit is reduced by 2% for each employee beyond 50.

 

Example: A business with 80 employees would receive a credit of 40% of employer contributions for the first two years, then 30% in the third year, 20% in the fourth year, and 10% in the fifth year. The formula: (100% – (2% x 30)) of employer contributions for the first two years, 30% (75% x 40%) for the third year, 20% (50% x 40%) for the fourth year and 10% (25% x 40%) in the fifth year).

Auto-Enrollment Tax Credit: An upcoming tax credit under SECURE 2.0 is the Auto-Enrollment Tax Credit, offering $500 for three years under specific conditions. This is particularly relevant as more 401(k) plans may become eligible due to new legislative requirements. This credit does not apply to defined benefit plans.

To claim these tax credits, businesses must file IRS Form 8881 with their tax return. It’s advisable to work closely with your accountant to ensure proper filing and maximization of potential benefits.

Final Thoughts: Financial Implications for Your Business

By covering administration fees directly from the business rather than plan assets, small business owners not only preserve more of their employees’ retirement funds but also benefit from business expense deductions. The enhanced tax credits under the SECURE acts further reduce the net cost of administering new plans, potentially offsetting costs entirely for the initial years.

As you consider starting or modifying a retirement plan, ensure you provide all relevant information to your accountant and explore every opportunity these tax credits offer. While Wealth Excel does not handle the tax credit process directly, we are here to support your accountant with any questions related to these credits. This strategic approach can provide substantial financial benefits and contribute to the long-term success of both your business and your employees’ retirement readiness.

About Wealth Excel

Wealth Excel is a highly specialized consulting and investment advisory company providing wealth-growth solutions for profitable small business owners through comprehensive tax-saving strategies, precision retirement plans, and custom-built investment portfolios. Launched in 2020 in Los Angeles, California, the Wealth Excel team has over 30 years of combined experience serving the needs of high-income and high-net-worth clientele nationwide.

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