What did the SECURE Act change about the start-up tax credit?
Since 2002 a federal income tax credit has been available for starting a retirement plan. All the SECURE Act changed was the amount of the start-up credit for tax years after 2019. So everything else stays the same. Discussed separately, the SECURE Act also added a tax credit for adding auto-enrollment to a plan.
How much is the tax credit?
The amount of the tax credit is 50% of the costs to set up and administer the plan or educate employees about the plan. The minimum tax credit is $500. The maximum tax credit is the lesser of $5,000 and $250 multiplied by the number of non-highly compensated employees who are eligible to participate in the plan.
Are large employers eligible for the SECURE Act start-up credit?
It depends on what you mean by large! An employer who had more than 100 employees with more than $5,000 in compensation in the preceding year is not eligible for the tax credit.
Are plans that only cover an owner eligible for the SECURE Act start-up credit?
No, the plan must have at least one eligible employee who is not a highly compensated employees. By definition, individuals who own more than 5% of an employer are considered highly compensated.
Can an employer get a credit for establishing a SEP or SIMPLE IRA?
Yes, if they otherwise qualify.
Can an employer get a credit for establishing a cash balance plan?
Yes, if they otherwise qualify.
How many years can the credit be claimed?
Maximum of three years.
What type of plan related expenses can be used for the tax credit?
Expenses related to the administration, establishment of the plan along with retirement-related education expenses for employees. Additionally, the fees must be paid by the employer – not the plan. Common eligible fees include setup fees, plan document fees, consulting fees regarding the plan, TPA fees and record-keeper fees.
An employer established a 401(k) in 2019 and never had sponsored any other plan before that. Can the employer get the higher SECURE Act start-up credit for the cost associated for 2020 and 2021?
Yes. The SECURE Act modified the existing Internal Revenue Code Section 45E. So, for 2019 the employer could claim the lower credit under IRC 45E in effect prior to the SECURE Act. For 2020 and 2021, the employer would be able to claim the higher SECURE Act credit.
An employer sponsored a SEP (or SIMPLE IRA) from 2014 to 2019. In 2020, they start a 401(k) plan. Can the employer get the SECURE Act start-up credit for the cost associated with starting the 401(k) plan?
No. In order for an employer to qualify for the SECURE Act start-up credit, the employer cannot have sponsored a “qualified employer plan” in the three years preceding the first year for which the tax credit could be claimed. “Qualified employer plan” includes qualified plans, annuity plans under 403(a), SEPs and SIMPLE IRAs.
An employer sponsored a SEP (or SIMPLE IRA) from 2018 to 2019. In 2020, they start a 401(k) plan. Can the employer get the SECURE Act start-up credit for the cost associated with starting the 401(k) plan?
Yes, but only for one year. In order for an employer to qualify for the SECURE Act start-up credit, the employer cannot have sponsored a “qualified employer plan” in the three years preceding the first year for which the tax credit could be claimed. “Qualified employer plan” includes qualified plans, annuity plans under 403(a), SEPs and SIMPLE IRAs
So, 2018 is the first year for which the client could qualify for the credit based upon the SEP (or SIMPLE IRA). Therefore, the client only has one additional year for the start-up credit.
Can an employer get a credit for both its new cash balance plan and new 401(k) plan?
The employer can combine the expenses of both plans for purposes of determining the tax credit, but the maximum credit for the combined plans will be determined as if there is a single plan.
In 2020, a charity starts a 401(k) plan or 403(b) plan. The charity has never had a retirement plan before. Can the employer get the SECURE Act start-up credit for the cost associated with starting the retirement plan?
Usually not. An organization that has always been tax exempt is not eligible for the tax credit. But, then again, why would they need the credit? Tax exempt charities generally do not pay federal income tax. If there is some type of combination of exempt and non-exempt organizations, we suggest the employer consult with their attorney.
In 2020, a governmental employer starts a 401(a) plan. The governmental employer has never had a retirement plan before. Can the employer get the SECURE Act start-up credit for the cost associated with starting the 401(a) plan?
Usually not. Governmental employers are not eligible for the tax credit. But, then again, why would they need the credit? Governmental entities generally do not pay federal income tax. If there is some type of combination of governmental and non-governmental organizations, we suggest the employer consult with their attorney.
What if a plan is a small plan for year 1 but crosses over to a large plan in year 2 or 3; do they still get the credit for all three years or for the first year only?
The determination is made each year. So, the employer would only get the tax credit for the first year.
In regards to calculating the NHCEs for the amount of the tax credit, is that something that is determined on a year-by-year basis or a set number based on the count for the first year?
It is determined each year.
Is the maximum credit based on the first year applicable to the next two years? Meaning if the plan has 10 NHCEs in 2020, their maximum is 50% of costs up to $2,500. But if in 2021, they’ve increased to 15 NHCES, is the tax credit for 2021 increased to $3,750?
The credit amount is determined annually.
What is the first year that the employer may claim the credit?
The year the plan is established or the year prior to plan establishment. For example, if setup or plan documents fees are paid in the prior year so that the plan will be ready to start on January 1st, the employer may be able to claim the credit in the prior year.
Can an employer take a deduction for the same expenses for which it claims the tax credit?
An employer may not deduct expenses for which the employer claims the tax credit (i.e. – the employer gets the deduction or the tax credit).
Can the employer elect to take the deduction instead of claiming the tax credit?
Yes.
If the employer cannot deduct the expenses for which it claims the tax credit, is the tax credit really valuable?
The employer should discuss the matter with their CPA, but for the vast majority of our clients, the credit is valuable.
How does the employer claim or report the credit?
Prior to the SECURE Act, the credit was calculated on IRS Form 8881. The credit is generally reported on the Schedule K-1 for partnerships or S-corporations and on the annual General Business Credit IRS Form 3800 for other entities.
Here is the Form 8881 revised in regard to the SECURE Act in December 2020.
Is the start-up credit refundable?
No.
If a plan sponsor does not need the start-up credit in the current year, can it be carried forward?
We suggest that plan sponsors discuss this with their CPA or other tax advisor.