Original author: Eric Droblyen on September 16th, 2020
Edited for clarity and brevity: Gleba & Associates
Original: https://www.employeefiduciary.com/blog/small-business-401k-tax-credits

On December 20, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law. The legislation made many significant retirement plan changes, including enhanced tax credits for small businesses that start a new plan and/or add an automatic enrollment feature to any plan. For most small businesses, these changes took effect January 1, 2020.

Since the SECURE Act became law, we’ve received lots of questions from small business owners about the new tax credits. Below is a FAQ with answers to the most common questions.

What retirement plans qualify for the SECURE Act tax credits?

401(k) plans, Simplified Employee Pensions (SEPs), and Savings Incentive Match Plan for Employees (SIMPLE) IRAs qualify. 403(b) plans do not.

What are the new SECURE Act 401(k) tax credits?

The SECURE Act permits an eligible small business to claim a tax credit for adopting a new 401(k) plan and/or a new automatic enrollment feature.

  • Qualified startup costs – Before the SECURE Act, a small business could claim a tax credit equal to 50% of their “qualified startup costs,” up to a $500 limit. Now, the limit is the greater of (1) $500 or (2) the lesser of (a) $250 multiplied by the number of non-Highly Compensated Employees (non-HCEs) eligible for plan participation or (b) $5,000. This credit is available for up to three years.
  • Automatic enrollment – Small businesses can earn an additional $500 tax credit by adding an automatic enrollment feature to a new or existing 401(k) plan. The credit is available for each of the first three years the feature is effective.
    When combined, these credits can total up to $5,500 per year ($16,500 for 3 years).

What are “qualified startup costs?”

“Qualified startup costs” include the ordinary and necessary costs that a small business incurs to:

  • Set up and administer a qualifying retirement plan, and
  • Educate employees about the plan.

Is my small business eligible for a SECURE Act 401(k) tax credit?

To be eligible, you must meet 3 requirements:

  • Have 100 or fewer employees who were paid at least $5,000 in compensation by you in the preceding year;
  • Cover at least one non-HCE with your retirement plan; and
  • In the 3 tax years before the first year you’re eligible for the credit, your employees weren’t substantially the same employees who received contributions or accrued benefits in another retirement plan sponsored by you, a member of a controlled group that includes you, or a predecessor of either.

What is a non-Highly Compensated Employee?

A non-Highly Compensated Employee (non-HCE) is a plan participant that’s not considered a Highly Compensated Employee (HCE) by the Internal Revenue Service (IRS). The IRS defines an HCE as an individual who:

  • Owned more than 5% of the interest in the business at any time during the current or preceding year, regardless of how much compensation that person earned or received, or
  • For the preceding year, received compensation from the business of more than $125,000 (if the preceding year is 2019 and $130,000 if the preceding year is 2020), and, if the employer so chooses, was in the top 20% of employees when ranked by compensation.

How can I claim the startup tax credit?

You must file IRS Form 8881 (Credit for Small Employer Pension Plan Startup Costs) with your tax return. This form has not yet been amended to accommodate the new SECURE Act tax credits.

Can adding 401(k) feature to a profit sharing plan qualify for the startup tax credit?

No.

Can a solo 401(k) plan qualify for the SECURE Act tax credits?

No because solo 401(k) plans do not cover non-HCEs. They can only cover business owners and their spouses.

Must the automatic enrollment feature meet any requirements to qualify for the $500 tax credit?

Yes, the feature must meet Eligible Automatic Contribution Arrangement (EACA) requirements.
A QACA safe harbor 401(k) plan will meet EACA requirements.

Does automatic enrollment add special administration responsibilities to a 401(k) plan?

Yes. Automatic enrollment adds two major administration responsibilities to a 401(k) plan:

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

If the automatic enrollment feature includes an escalating default rate (commonly called an “escalator”), the employer must also remember to increase the default deferral rate for automatically enrolled employees each year.

These additional responsibilities are not particularly onerous, but making a mistake can be costly and time-consuming to fix.

How much can the tax credits reduce the cost of a new 401(k) plan?

The SECURE Act tax credits can dramatically reduce the cost of starting a new 401(k) plan. Below is an example of the possible savings. To calculate the potential savings for your small business, give us a call or send us an email and we can send over an excel document calculator. Please reach out to your CPA for more details.

 

2020 2021 2022
Automatic Enrollment?
(Yes or No)		 Yes Yes Yes
Number of Non-HCEs 10 20 30
Setup and Admin Fees
(Paid by company)		 $2,000.00 $3,000.00 $4,000.00
Startup Credit ($1,000.00) ($1,500.00) ($2,000.00)
Automatic Enrollment Credit ($500.00) ($500.00) ($500.00)
Tax-Deductible Setup and
Admin Fees		 $500.00 $1,000.00 $1,500.00

The SECURE Act tax credits make it cheaper than ever to start a new 401(k) plan!

Approximately 80% of our small business clients pay their 401(k) administration fees from a corporate bank account – not plan assets. This high rate is hardly surprising when you consider the approach is usually a win-win for the business owner. They can deduct the fees as a business expense, while keeping the portion that would been paid from their personal 401(k) account working for them until retirement.

The SECURE Act made this approach even more attractive by increasing the tax credits a small business owner can claim by starting a new plan – lowering the plan’s out-of-pocket cost for up to 3 years.