CAPITAL CITIES

Small Business Tax Credit for 401(k) Startup Costs

According to U.S. Department of Labor statistics, 64 percent of all employees in medium- and large-sized firms are covered by an employment-based retirement plan, compared with only 34 percent at small firms. One reason cited by small businesses for not offering retirement plans is the high costs associated with set-up and administration of a retirement plan.

Startup costs have always been a major hurdle to small businesses who want to start a 401(k) plan, but there is a federal tax credit that helps scale this barrier to employee saving opportunities. This credit for employers will offset the startup cost and the cost of educating employees about the new plan.

For costs paid or incurred during the tax years, you may be able to claim a tax credit for part of the ordinary and necessary costs of starting a SEP, SIMPLE, or qualified plan (including a 401k). The credit equals 50% of the cost to set up and administer the plan and educate employees about the plan, up to a maximum of $500 per year for each of the first three years of the plan. You can choose to start claiming the credit in the tax year before the tax year in which the plan becomes effective.

You must have had 100 or fewer employees who received at least $5,000 in compensation from you for the preceding year. At least one participant must be a non-highly compensated employee. The employees generally cannot be substantially the same employees for whom contributions were made or benefits accrued under a plan of any of the following employers in the three-tax-year period immediately before the first year to which the credit applies.

  1. You.
  2. A member of a controlled group that includes you.
  3. A predecessor of (1) or (2).

The credit is part of the general business credit, which can be carried back or forward to other tax years if it cannot be used in the current year.

Be sure to check with your tax and accounting advisors on how best to take advantage of this tax credit.

To claim the credit, the employer must file IRS Form 8881 - Credit for Small Employer Pension Plan Startup Costs.

Information provided in partnership with 401khelpcenter.com, LLC.
THIS ARTICLE IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND IS NOT INTENDED AS LEGAL, TAX OR INVESTMENT ADVICE. CONSULT WITH A QUALIFIED PROFESSIONAL BEFORE ACTING ON ANY INFORMATION CONTAIN IN THIS ARTICLE.