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Retirement Plan Startup Costs Tax Credit

Summary: You may be able to claim a tax credit of up to $5,000 when you set up a SEP IRA, a SIMPLE IRA or a 401(k) plan. Click through to see how the tax credit reduces the amount of taxes you owe.

 

A tax credit for small-employer pension plan startup costs may be awaiting you. You may be able to claim a tax credit of up to $5,000 when you set up an SEP or a SIMPLE IRA or a qualified plan such as a 401(k). You qualify to claim this credit if you meet all these conditions:

  • You had 100 or fewer employees who received at least $5,000 in compensation from you for the preceding year.
  • You had at least one plan participant who was not a highly compensated employee.
  • In the three tax years before the first year you’re eligible for the credit, your employees didn’t receive contributions or accrue benefits in another plan you sponsored.

The credit is 50% of your eligible startup costs, up to the greater of these two amounts:

  • $500.
  • The lesser of these two amounts:
    • $250 multiplied by the number of non-highly compensated employees who are eligible to participate in the plan.
    • $5,000.

You may claim the credit for ordinary and necessary costs to set up and administer the plan and to educate your employees about the program.

You can claim the credit for each of the plan’s first three years and may choose to start claiming the credit in the tax year before the plan becomes effective. You can’t deduct startup costs and claim the credit for the same expenses. However, you aren’t required to claim the allowable credit.

If you add an auto-enrollment feature to your pension program, you can claim a tax credit of $500 per year for a three-year taxable period, beginning with the first taxable year. However, you should know that adding that feature adds two major administrative responsibilities to a plan:

  1. Distributing an annual notice to eligible employees that explains the feature, including the employees’ right to make their own deferral election.
  2. Withholding wages from automatically enrolled participants at the plan’s default deferral rate.

Claim the tax credit by filing IRS Form 8881 with your tax return. Most retirement plans commonly offered by employers qualify, including:

  • Traditional pension plans.
  • 403(b) plans.
  • Profit-sharing plans.
  • Money purchase pension plans.
  • SEP IRAs and SIMPLE IRAs.

If you recently acquired or started a new business and are ready to put more money into employee benefit plans, you can look into this credit to help with the costs of administering pension programs.

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