Although available for over two decades, it is still surprising to see the general lack of awareness that most employers have regarding their eligibility for a tax credit in connection with their establishment of a retirement plan.  As a result, this article is intended to familiarize readers with this tax credit so that they can evaluate its applicability to their (or their client’s) tax situation.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”)[1] initially created a three year tax credit eligibility in relation to “qualified plan start-up costs” incurred by certain small employers who establish a new “eligible employer plan”.  For this purpose, qualified plan start-up costs are any ordinary or necessary expenses incurred with regard to the establishment of such plan, its administration or certain costs incurred related to employee investment education expenses.

The value of this credit was then increased under the Setting Up Every Community for Retirement Enhancement (“SECURE”) Act for tax years beginning after December 31, 2019 from 50% of start-up costs up to a potential maximum of $500 per year to 50% of start-up costs up to a potential maximum credit of $5,000 per year.  However, Congress wasn’t done there.

In December of 2022, the SECURE 2.0 Act of 2022 (“Secure 2.0”) further incentivized employers to start new retirement plans by increasing this tax credit even more. For tax years beginning after December 31, 2022, the start-up tax credit for an employer with 50 or fewer employees increased from 50% to 100% of the start-up costs up to a potential maximum credit of $5,000 per year. However, businesses with 51-100 employees remain subject to the “old” 50% of start-up costs restriction.    Employers with over 100 employees are not eligible for this credit.  Also, the employer may not deduct any start-up costs if it claims a credit.

It is important to note that this start-up credit is only available with respect to the establishment of an “eligible employer plan”.  In general, an eligible employer plan is a tax-qualified plan under section 401(a) of the Code (such as a profit sharing plan, 401(k) plan and/or defined benefit plan, among others), Simplified Employee Pension Plan (“SEP”) or Savings Incentive Match Plan for Employees (“SIMPLE”).  In addition, in order to qualify for the credit, the newly established plan must have at least one participating non-highly compensated employee.  This final eligible plan qualification is of great importance because it effectively eliminates the credit with regard to “solo(k)” plans.

With SECURE 2.0’s increase to the start-up credit, Congress also granted another tax credit in relation to the amount of employer contributions made to start-up plans (other than defined benefit plans) for the benefit of employees earning less than $100,000. The amount of this credit is capped at $1,000 per employee for employers with 50 or fewer employees and slowly phases out for employers with between 51-100 employees. Employers with over 100 employees are not eligible for this credit.  This tax credit is further restricted to 100% of the eligible amount in the first and second years, 75% in the third year, 50% in the fourth year, 25% in the fifth year and no credit for any tax years after the fifth year.

Although beyond the scope of this article, it is noteworthy that the SECURE Act also established a tax credit for plans that implement an “eligible automatic enrollment arrangement” (“EACA”) of $500 for each of the first 3 years that the plan has such an auto enrollment feature.  This “auto enroll” tax credit is separate and distinct from the start-up tax credits that are the subject of this article and both the start-up and auto enroll credits can be claimed concurrently.  Also noteworthy is that the EACA need not be in place at the time the plan is established in order to qualify for the credit.  As with the previously discussed small plan establishment tax credit, this credit is effective for tax years beginning after December 31, 2019.

Obviously, these rules are complicated and everyone’s tax situation is different.  Consequently, as much as we hope this article helped you to better understand this topic, it is not to be construed as financial, tax or legal advice.  Therefore, if you believe that it may apply to your (or your client’s) company, be sure to further discuss it with a qualified accountant or tax professional.  For more information about this topic, please contact our marketing department at 484-483-1044 or your administrator at Legacy.