How SECURE 2.0 employer tax credits benefit small businesses
The SECURE 2.0 Act introduced new and enhanced tax credits aimed to support small business owners in establishing affordable retirement plans. These provisions are designed to encourage employers to offer benefits to their employees by incentivizing retirement savings and alleviating some of the costs associated with starting retirement plans.
Increased start-up credit
For eligible employers with no more than 50 employees and a minimum of one non-highly compensated employee (NHCE), Section 102(a) increased the small employer pension plan startup cost credit from 50% to 100%. This allows employers to claim 100% of qualified start-up costs of up to $5,000, towards starting SEP, SIMPLE, defined benefit and defined contribution plans (including 401(k) plans). The Internal Revenue Code Section 45E defines qualified start-up costs as ordinary and necessary costs to set up and administer the plan and educate your employees about the plan [1].
The start-up credit is available for up to three years, which includes the initial credit year and the subsequent two taxable years. Employers can elect to implement the first credit year either during the taxable year when the plan takes effect, or the preceding taxable year.
For employers with 50-100 employees the amount of 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 [1].
Example 1: Company X, a small business with 25 employees, 22 of which are considered NHCEs, established a retirement plan in 2023, incurring $7,000 in start-up costs. The increased startup credit allows Company X to claim 100% of eligible start-up costs, up to $5,000 (20 NHCEs x $250). This credit is available for three years.
Example 2: Company Y, a small business with 75 employees, 50 of which are considered NHCEs, establishes a retirement plan in 2023 incurring $7,000 in start-up costs. Company Y qualifies for a maximum credit of $3,500 (50% of $7,000). This credit is available for three years.
New employer contribution credit
A new provision under Section 102(b) provides additional tax credit and incentives to eligible employers offering defined contribution plans such as 401(k), 403(a), SEP and SIMPLE plans with under 100 employees. The contribution credit is calculated based on the contributions an employer makes on behalf of their plan participants, with a maximum of $1,000 per employee annually. This excludes employees that earn more than $100,000 annually. The employer can claim these credits over the span of five years, receiving 100% of contributions for the first and second year, 75% for the third year, 50% for the fourth year and 25% for the fifth year. To qualify for the full credit, the employer must have no more than 50 employees. For employers with 51 to 100 employees, the credit amount decreases 2% for each additional employee exceeding 50 [2].
Note: Employer contribution credits do not apply towards defined benefit plans.
Example 1: Let’s go back to Company X. After establishing a retirement plan, Company X decides to make employer contributions to the plan for its employees. All 22 employees make less than $100,000 annually, and the company contributes a total of $50,000 to these participants for the year. Company X qualifies for a credit of $22,000 for the first two years and a lesser percentage for years three through five.
Example 2: Let’s go back to Company Y. After establishing a retirement plan, Company Y with 75 employees decides to make employer contributions to the plan for its employees. 60 employees make less than $100,000 annually, and the company contributes a total of $60,000 to participants for the year. Company Y qualifies for a credit of $30,000 for the first two years and a lesser percentage for years three through five.
Employer contribution credit = $60,000 reduced by [$60,000 X (25 X 2%)]
$60,000 – [$60,000 X 50%]
$60,000 - $30,000 = $30,000
Conclusion
These employer tax credits benefit small businesses in several ways and provide financial security for both employers and employees. Reducing the out-of-pocket expenses associated with establishing a retirement plan allows employers to offer valuable benefits, boosting employee satisfaction and retention.
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Citations:
[1] Retirement Plans Startup Costs Tax Credit, IRS
[2] Miscellaneous Changes Under the SECURE 2.0 Act of 2022, IRS
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