SECURE Act: Increased New Plan Startup Tax Credit & New Tax Credit for Auto-enrollment
One of the most welcomed provisions of the SECURE Act* is a significant increase in the amount of the new plan startup tax credit and creation of a new, additional tax credit for retirement plans that add an auto-enrollment feature.
The tax credit for new retirement plans has been around for nearly two decades: it first became available with the passage of the Economic Growth and Tax Relief and Reconciliation Act (EGTRRA) of 2001. Its intent has been to encourage employers to offer retirement plans by offsetting certain startup, administration and education costs.
What’s new after SECURE Act?
A higher new plan startup credit: SECURE increased the annual dollar cap from $500 for each of the first three years of the plan ($1,500 over three years) to $5,000 for each of the first three years of the plan ($15,000 over three years).
New credit for auto-enrollment: SECURE also created a new small employer tax credit to encourage adoption of automatic enrollment features for 401(k) and SIMPLE IRA plans. The $500 per year tax credit is available for three years to employers who start retirement savings plans and those with existing plans who add an auto-enrollment feature.
How is the new amount determined?
As under the old law, the startup credit applies for up to three years and may not exceed 50% of certain costs incurred in connection with starting a retirement. The new dollar amount is the greater of:
(1) $500, OR
(2) the lesser of:
(a) $250 for each eligible non-highly compensated employee (NHCE)**, OR
Consequently, the credit may be at least $500 and up to $5,000 per year, for each of the first three years of the plan.
The new auto-enrollment tax credit is $500 for three years; notably, this amount is in addition to the new plan startup credit. Here’s an example of an eligible plan with 10 employees:
|Pre-Secure Act Credit||Post-Secure Act Credit|
|Number of Eligible NHCEs||10||10|
|Plan Start-up Tax Credit||$500||$2,000|
|Auto-enrollment Tax Credit||NA||$500|
|Total Annual Credit||$500||$2,500|
What plans are covered?
SECURE didn’t change the eligible plan types for the new plan startup credit. They continue to include qualified plans such as 401(k), profit sharing, defined benefit, cash balance, etc., 403(b), and Individual Retirement Account-based programs, such as Simplified Employee Pension Plans (SEP IRAs) or Savings Incentive Match Plan for Employees (SIMPLE IRAs).
In order to qualify for the automatic enrollment credit, a plan must be a SIMPLE IRA or a 401(k) / 403(b) plan which includes either an Eligible Automatic Contribution Arrangement (EACA) or Qualified Automatic Contribution Arrangement (QACA).
Who can claim the credit?
To claim the new plan startup tax credit and the auto-enrolment credit, employers need to satisfy three conditions:
- They have no more than 100 employees who received at least $5,000 in compensation in the preceding year;
- At least one non-highly-compensated employee is eligible to participate in the plan; and
- Employers, members of the controlled group of employers, or predecessor organization didn’t maintain another retirement plan that covered substantially the same employees during the three-year period immediately before the first year of the new plan.
What costs are eligible?
New plan set-up credit: The plan sponsor must pay the fees out of company funds in order to qualify for the startup credit. Any ordinary and necessary expenses incurred to set up and administer the retirement plan and educate employees about the plan are eligible.
Auto-enrollment credit: Unlike the start-up credit, this credit is not tied to a specific plan expense. To qualify, plan sponsor must add auto-enrollment feature to a new plan or a plan already in existence.
How to claim the credit?
The startup credit is claimed by completing a relatively short – five lines in total – IRS Form 8881, Credit for Small Employer Pension Plan Startup Costs. This form is likely to undergo a revision to conform to the new amounts in effect starting in 2020. While the mechanism for claiming the new auto-enrollment credit is yet to be announced, we anticipate that it will also be done on the updated Form 8881.
When can the credit be claimed?
· The credit may be taken 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.
Note: The increased startup credit amount and the new auto-enrollment credit are available as of January 1, 2020. Therefore, it is available not only to new 2020 plans but also to plans that began in 2018 and 2019, the latter can claim a higher tax credit for tax years after December 31, 2019. In other words, employers who claimed the old $500 start-up credit for the 2018 and 2019 tax years are now eligible for the higher limit in 2020. They can also claim the auto-enrollment credit, if an eligible auto feature is a part of plan’s design.
The tax 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.
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 if they are ordinary and necessary business expenses.
*Setting Every Community Up for Retirement Enhancement Act (SECURE Act) signed into law on December 20, 2019.
** A non-highly compensated employees is one who doesn’t fall into a classification of a highly compensated employee (HCE). An HCE is:
- Anyone who owns more than 5% of the business;
- Certain family members of those who own more than 5% of the business (spouses, parents, grandparents, grandchildren) directly or via attribution rules;
- Those who earned income greater than $130,000 in prior year (adjusted for inflation)
*** Assumes constant costs and employee count in years 1-3
For discussion purposes only and in no way represents legal or tax advice. For advice regarding your specific circumstances, the services of an appropriate legal or tax advisor should be sought.