Plan sponsor tax credit: Take credit for offering a 401(k)

Small businesses often struggle to balance two important, yet competing objectives: attracting employees with a strong benefits package, and keeping business costs low. Fortunately, a low cost 401(k) plan can help to bridge the gap between these disparate priorities. Offering a qualified retirement plan, like a 401(k), may qualify certain businesses for a startup cost tax credit, which can offset some of the costs of launching a retirement benefit.

The Credit for Small Employer Pension Plan Startup Costs covers 50% of all the ordinary and necessary eligible startup costs companies incur to set up a qualified retirement plan, up to a maximum of $500 per year. These startup costs include any necessary plan setup and administration fees (e.g., Form 5500 and auditing costs), as well as money spent on employee education. The result is a reduction in the amount of tax a business owes on a dollar-for-dollar basis. 

An employer may qualify for the credit if:

  • They had 100 or fewer employees who received at least $5,000 in compensation for the preceding year
  • They had at least one plan participant who was a non-highly compensated employee (did not own 5% or more of the company and received less than $120,000 in compensation, or was in the bottom 80% of compensation for employees)
  • No employees received benefits in another qualified retirement plan by the same employer

If your company meets these qualifications, you can claim the tax credit for each of the first three years of the plan (so long as you continue to qualify). It’s part of the general business credit, and if you can’t use it in the current year, you can carry it backward or forward.

An important caveat to note is that if you’re claiming the credit for certain plan expenses, you can’t deduct those same expenses. For example, if you’re claiming a $500 credit for a $1,000 plan set-up fee, you can’t also deduct that cost from your company’s income. You can take a tax deduction for the expenses in lieu of the credit, but taking the credit, when available, is almost always a better deal! You can, however, deduct any additional expenses in excess of the credit.

Illustration: Plan Startup Tax Credit 

Cathy, owner of Cathy’s Caps, wants to start a 401(k) for her small business. She currently has eight employees and wants to help them save for retirement, but she also has to manage her company’s costs. Cathy chooses a Guideline 401(k) plan with a monthly base fee of $39 and $8 per participating employee.

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* $39  x 12 months 

**$8 x 8 employees x 12 months 

Cathy’s Caps can take a credit of $500 for the first year of the plan and can also deduct $236 of additional plan administration expenses from company income (total cost of the plan minus the $1,000 used to calculate the credit). In years two and three, if Cathy’s Caps continues to have eight employees, its costs would be $1,236 annually and would be offset by a $500 tax credit. 

Guideline’s low and transparent pricing in combination with the plan startup tax credit drives down employer costs of offering a 401(k). Simultaneously, by offering high quality investments to plan participants without any added fees, Guideline enables businesses to provide a valuable benefit to employees.

Disclaimer: This content is for informational purposes only and is not intended to be construed as tax advice.  You should consult a tax professional to determine what types of tax credits or deductions your company is eligible to claim.

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