Effective January 1, 2023, the Secure Act 2.0 expanded the existing startup tax credit on employer plan costs and created a substantial new startup credit for contributions employer make on behalf of participants.

The tax credits are available for start-up retirement plans and are now allowed if an employer begins participating in an existing MEP or PEP.

An employer’s plan is considered a start-up if they have not covered substantially the same employees in a 401(k), 403(b), SEP or SIMPLE IRA plan in the three preceding tax years.

TAX CREDIT FOR EMPLOYER PLAN COSTS

For 50 or fewer employees, the credit covers 100% (previously 50%) of the employer’s ordinary and necessary out-of-pocket plan costs, up to an annual limit. For 51 to 100 employees, that same coverage is 50%.  To qualify, a plan must have at least one participant who is a NHCE.

Covered costs are those paid by the employer to set up and administer the plan, such as financial professional and third-party administrator (TPA) compensation, recordkeeping fees and employee education expenses. The credit does not apply to plan costs paid through plan assets or investment expenses.

The annual limit is $500 or, if greater, $250 multiplied by the number of plan-eligible non-highly compensated employees (NHCEs), up to $5,000.

You cannot both deduct the start-up costs and claim the credit for the same expenses.  Costs not eligible for the tax credit may still be considered for tax deduction purposes.   The credit is calculated on Form 8881.

Examples:

Note: All references to “employees” refer to those who received compensation of at least $5,000 in the preceding year.

Employer – 50 or less employees

Omega Company, a qualified employer, has 15 employees, 10 of whom make less than $100,000. Eight of the 10 participate in the retirement plan, and each contributes $3,000 a year. The employer’s match is 50%.

Omega Company pays annual plan costs of $4,500. To calculate the plan cost credit:

• Credit calculation: $4,500 plan costs × 100% (fewer than 50 employees) = $4,500
• Maximum credit: 8 NHCEs × $250= $2,000
• The total year 1 tax credit is $2,000, based on the maximum credit formula
• A $2,000 credit can be taken and $2,500 can be deducted as plan expenses

Employer – 51 to 100 employees

Sigma Company is a qualified employer with 90 employees, 70 of whom make less than $100,000. Of those 70, 55 participate in the retirement plan, and each contributes $3,000 a year. The employer match is 50%. To calculate the plan cost credit:

Sigma pays annual plan costs of $6,000. To calculate the plan cost credit:

• Credit calculation: $6,000 plan costs × 50% (more than 50 employees) = $3,000
• Maximum credit: 55 NHCEs × $250 = $13,750, but capped at $5,000
• The total year 1 tax credit is $3,000, 50% of employer plan costs
• A $3,000 credit can be taken and $3,000 can be deducted as plan expenses

TAX CREDIT FOR EMPLOYER CONTRIBUTIONS

For taxable years beginning after 2022, the new employer contribution tax credit is a decreasing percentage of the amount contributed by the employer for each employee earning no more than $100,000 per year, up to $1,000 annually per employee, over the plan’s first five years. This applies to defined contribution plans, such as 401(k), SEP and SIMPLE plans, that have no more than 100 employees.

The credit percentage for smaller plans (50 or fewer employees) phases down over five years from plan adoption, 25% per year. For plans with 51–100 employees, the percentage for the applicable year is reduced by 2% for each employee more than 50.

The credit is taken in lieu of the employer contribution deduction. Employer contributions not eligible for the employer contributions tax credit may still be considered for tax deduction purposes. The credit is calculated on Form 8881.

Examples:

Using Omega Company from the previous example, let’s calculate the credit:

• Employer contributions: 50% × $3,000 employee contributions = $1,500 for each of 8 employees, but cap of $1,000 per employee is used to calculate the credit
• Credit calculation: 100% × $1,000 = $1,000 for each of 8 employees
• The total year 1 tax credit is $8,000, based on $1,000 cap per employee for 8 employees
• The credit of $8,000 can be taken and $5,500 can be deducted as employer contributions.

Using Sigma Company from the previous example, the contribution credit would be calculated:

• Employer contributions: 50% × $3,000 employee contributions = $1,500 for each of 55 employees, but cap of $1,000 per employee is used to calculate the credit
• Credit calculation: 20% (100% – (2% × 40 employees in excess of 50)) × $1,000 = $200 for each of 55 employees
• The total year 1 tax credit is $11,000, based on $82,500 of total employer contributions for 55 employees
• A credit of $11,000 can be taken and $71,500 of employer contributions can be deducted as an expense.

Secure 2.0 added several provisions encouraging small employers to set up retirement plans by reducing start-up costs, increasing maximum annual contribution limits, and decreasing administrative burdens. Employers who have considered adopting a retirement plan in the past but have not due to costs, administrative burdens, or for other reasons may wish to reconsider in light of Secure 2.0.

Corrigan Krause Can Help

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