Are there special tax credits available for setting up a new plan?

Yes, employer who establishes a retirement plan may be eligible for a plan start-up tax credit. This provision first became available with the passage of the Economic Growth and Tax Relief and Reconciliation Act (EGTRRA) effective for tax years beginning on 1/1/2002. It allows employers to offset the startup costs as well as the cost of educating employees about the new plan.

What plans are covered: eligible plans include qualified plans (401(k), profit-sharing, money purchase, defined benefit, cash balance, etc.) and IRA-based plans, such as SEP or SIMPLE.

Who can claim this credit: employer who established a plan and…

  1. Employer has 100 or fewer employees who received at least $5,000 in compensation for the preceding year: and
  2. A plan has at least one non-highly compensated employee; and

Who is a highly compensated employee?

  • Those who own more than 5% of the business;
  • Certain family members of those who own more than 5% of the business (spouses, parents, grandparents, grandchildren);
  • Those who earned income greater than $115,000 in prior year (adjusted annually);
  • Employer has not maintained a qualified retirement plan during the three-year period immediately before the first effective year of the plan.

What costs are eligible: expenses incurred to start the plan and educate employees about the plan.

How much is the credit: 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, i.e. to get a $500 credit at least $1,000 should be spent.

How is the credit claimed: Credit is claimed by completing IRS Form 8881, Credit for Small Employer Pension Plan Startup Costs.

When the credit may be claimed:

  • The credit may be taken for qualified costs incurred during each of the three years starting with the taxable year in which the plan became effective; or
  • For the year preceding the year in which the plan becomes effective and the first two years of the plan.
  • 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. However, the startup cost credit cannot be carried back to a tax year beginning before January 1, 2002.

What about remaining expenses: While the qualifying expenses that are offset by this credit are not deductible, the remaining qualifying expenses that are not offset by this credit are deductible as long as they are ordinary and necessary business expenses.