Start-up Tax Credits for Small Employers
Updated
by
Richard Phillips, EA, AIFA, CPC, CPFA, QPA, QKA
A small employer is allowed to claim a tax credit for certain "start-up" costs relating to a new plan as well as certain contributions to eligible employees.
Tax credits are significantly more valuable than deductible expenses because the credit offsets dollar-for-dollar an employer's tax liability.
The qualified start-up costs include expenses incurred in the establishment or administration of the plan, and expenses attributable to retirement-realted education of the employer's employees. To qualify, the plan must cover at least one non-highly compensated employee.
An eligible small employer is an employer who has 100 or fewer employees who received more than $5,000 in compensation in the prior year.
However, the employer will not be eligible for the credit if the employer maintained any plan (qualifed plan, SEP, or SIMPLE) during the three tax years preceeding the tax year for which the employer intends to claim a credit.
All employers that constitute a control group under IRC §414(b) or (c) are treated as a single employer for purposes of applying this provision IRC §45E.
Amount of the Start-up Cost Credit
The credit is 50% of qualified start-up costs for small employers (defined above). The SECURE Act increased the maximum credit for taxable years beginning January 1, 2020 to be the greater of:
- $500 or
- the lesser of $5,000, or $250 for each eligible non-highly compensated employee
The credit is an aggregate credit, regardless of the number of plans adopted by an eligible employer, and is applicable for the first three years of the plan.
Additional credit for automatic enrollment. An additional credit of $500 is available if the plan includes an Eligible Automatic Contribution Arrangement (EACA).
Additional Credit for Employer Contributions
The SECURE Act adds a new section, IRC §44E(f), which provides an additional tax credit for employer contributions to an eligible plan.
The employer credit is for contributions up to $1,000 per employee who's FICA wages are not in excess of $100,000 (indexed for inflation).
The credit starts out at 100% and phases out over 5 years. Other phase-out rules apply as the employee headcount increases above 50.
Tax Year | Contribution Credit per Employee | % of Applicable Credit |
1 | up to $1,000 per eligible employee | 100% |
2 | up to $1,000 per eligible employee | 100% |
3 | up to $1,000 per eligible employee | 75% |
4 | up to $1,000 per eligible employee | 50% |
5 | up to $1,000 per eligible employee | 25% |
Adoption of MEP or PEP
The credits apply to single employer plans as well as Multiple Employer Plans (MEP) and Pooled Employer Plans (PEP).
