401(k)RetirementSmall BusinessTax Planning

Benefit of 401(k) tax credit for small business that start 401(k) plans

My brother John Novak, a well established 401(k) expert, shared some calculations that he made for his own clients illustrating the impact of the SECURE act tax credit for small businesses that want to start a 401(k) plan. This is the first analysis of this type that I’ve seen using “real life” 401(k) plan fees in an analytical calculation. Neither the IRS nor plan administrators have published this yet, apparently. The law was passed in late December and the tax credit is already effective and available now for 2020. We understand that these examples are shared for illustrative and educational purpose, not offered as tax advice or  assurance of any tax benefit.

The SECURE Act intends to advance government’s goals of increasing access to defined contribution plans among employees, promoting lifetime income options, and facilitating retirement plan installations for small businesses via further tax incentives.   The following examples illustrate the positive impact for small business plans via one significant change to the existing tax credit and a new tax credit.

The IRS defines small businesses in this way, generally 100 or fewer employees in the preceding year:  https://www.irs.gov/retirement-plans/retirement-plans-startup-costs-tax-credit

Sec. 103.  Increased Credit Limitation for Small Employer Retirement Plan Start-Up Costs  “Part A”

The SECURE Act increases the current $500 tax credit cap (for the plan’s first 3 years) to the greater of (1) $500 or (2) the lesser of (a) $5,000 or (b) $250 multiplied by the number of non-highly compensated employees eligible to participate in the plan.

The credit is still limited to 50% of the start-up costs.

Section 104.  Small Employer Automatic Enrollment Credit 

“Part B”

 Additionally, if the new plan automatically enrolls employees into the plan on a uniform basis (but at no minimum rate), the employer will get an additional annual credit for start-up costs of $500 per year. And all of this is effective Jan 1, 2020. Yes, effective for new plans beginning now!

Example 1: American 401k  $250 startup fee + $500 + $20 annual

A small business employer with 10 NHCEs wants to establish a Safe Harbor 401k plan for her employees and is willing to do automatic enrollment.    With no credits, the employer startup cost would be $950 ($250 + $500 + $200) then $700 per year after year 1.

Part A: Startup Tax Credit For 3 Years

The greater of $500 or [the lesser of $5,000 or ($250 x 10 = $2,500], so the greater amount is $2,500 tax credit available.

The total employer fee in year 1 is $950.

The credit being limited to a cap of 50% of total startup and administration fees, means that the most tax credit under Part A is $475 for year 1.    The employer net cost for year 1 is $475.

In years 2 and 3, the cost is $700, so the employer net cost is $350.

Part B: Automatic Enrollment Tax Credit For 3 Years

If automatic enrollment is elected, there is a $500 tax credit per year for 3 years.

The employer net cost for year 1 would be $0 ($475 – $500 is less than $0)

The employer net cost in years 2 and 3 would be $0 ($350 – $500 is less than $0).

Note:  For the net amount payable by the employer, in excess of IRS tax credits, these are deductible business expenses each year.

Example 2: T. Rowe Price 401k   $375 startup fee + $1075 + $15 annual

A small business employer with 10 NHCEs wants to establish a Safe Harbor 401k plan for her employees and is willing to do automatic enrollment.    With no credits, the employer startup cost would be $1,600 ($375 + $1,075 + $150) then $1,225 per year after year 1.

Part A: Startup Tax Credit For 3 Years

The greater of $500 or [the lesser of $5,000 or ($250 x 10 = $2,500], so the greater amount is $2,500 tax credit available.

The total employer fee in year 1 is $1,600.

The credit being limited to a cap of 50% of total startup and administration fees, means that the most tax credit under Part A is $800 for year 1.    The employer net cost for year 1 is $800.

In years 2 and 3, the cost is $1,225 so the employer net cost is $612.50.

Part B: Automatic Enrollment Tax Credit For 3 Years

If automatic enrollment is elected, there is a $500 tax credit per year for 3 years.

The employer net cost for year 1 would be $300.

The employer net cost in years 2 and 3 would be $112.50.

Note:  For the net amount payable by the employer, in excess of IRS tax credits, these are deductible business expenses each year.

Leave a Reply

Your email address will not be published. Required fields are marked *