Secure 2.0 Act Employer Retirement Plan Startup Tax Credits for Small Business Owners

The legislation expands tax credits for small employer retirement-plan startup costs, among other things.  The SECURE 2.0 Act introduces new and enhanced tax credits to help small business owners establish affordable retirement plans. These provisions encourage employers to offer benefits to their employees by incentivizing retirement savings and reducing the costs of starting retirement plans. SECURE 2.0 expands existing credits and creates a new credit for small businesses that make employer-matching or nonelective contributions. 

Additionally, the Act introduced a new tax credit for small employers that provides special benefits to military spouses. Eligible small employers should be informed about these significant potential tax benefits.    

What is the SECURE 2.0 Act

Nearly three years after the original SECURE Act was passed, the SECURE Act 2.0 was signed into law on December 29, 2022. This new legislation builds on its predecessor with a comprehensive package of approximately 100 provisions designed to enhance retirement savings in retirement plans and IRAs, reduce the costs of establishing new workplace retirement plans, and renew the focus on Roth accounts.  

Increased Small Employer Retirement Plan Tax Credit   

Section 102 of the Secure Act 2.0 significantly boosts the small employer tax credit for retirement plan start-up costs for eligible employers. Effective for tax years beginning after December 31, 2022, the credit increases from 50% to 100% of qualified expenses, with an annual cap of $5,000 for employers with up to 50 employees. The IRS has instructions about how to qualify and claim this tax credit. 

This dollar-for-dollar reduction in federal taxes applies to costs associated with establishing, administering, or providing employee education for a new retirement plan. For many small employers, this enhanced credit could offset or even fully cover the expenses of implementing and running a retirement plan during its first three years, making it more feasible to offer valuable benefits to employees.

Here’s a breakdown:     

Eligibility:

• Employers with 50 or fewer employees: To qualify, employers must have at least one non-highly compensated employee (NHCE).
• Employers with 51-100 employees: The credit amount differs for this group (details below).  

Credit Amount for Employers with 50 or Fewer Employees:

• Increased Credit: The credit has been raised from 50% to 100% of qualified startup costs.
• Maximum Credit: Employers can claim up to $5,000.
• Qualified Plans: This applies to starting SEP, SIMPLE, defined benefit, and defined contribution plans (including 401(k) plans).
• Definition of Qualified Costs: According to Internal Revenue Code Section 45E, qualified costs are ordinary and necessary expenses to set up, administer, and educate employees about the plan.     

Duration:

• Three-Year Availability: The start-up credit can be claimed for up to three years, including the initial credit year and the subsequent two taxable years.  
• First Credit Year Election: Employers can choose to implement the first credit year during the taxable year the plan takes effect or the preceding taxable year.

Credit Amount for Employers with 51-100 Employees:   

• Credit Percentage: The amount is 50% of eligible startup costs.
• Credit Limits: The maximum credit is the greater of $500 or the lesser of:
  • $250 multiplied by the number of NHCEs eligible to participate in the plan.
  • $5,000.

By increasing the start-up credit, the SECURE Act 2.0 aims to encourage more small businesses to establish retirement plans, making it easier and more affordable for employers to provide retirement benefits to their employees.     

Examples of Increased Start-Up Credit for Small Employers

Example 1:

Acme corp:

• Size: 25 employees, with 22 non-highly compensated employees (NHCEs).
• Action: Established a retirement plan in 2023.
• Start-Up Costs: $7,000.
• Credit Calculation:
  • Eligible to claim 100% of start-up costs, up to $5,000.
  • It is calculated as $250 per NHCE (22 NHCEs x $250 = $5,500).
  • Since the maximum credit is capped at $5,000, Company X can claim $5,000.
• Duration: This credit is available for three years.

Example 2:

Acme2 Corp:

• Size: 75 employees, with 50 non-highly compensated employees (NHCEs).
• Action: Established a retirement plan in 2023.
• Start-Up Costs: $7,000.
• Credit Calculation:
  • Eligible to claim 50% of start-up costs.
  • Calculated as 50% of $7,000 = $3,500.
• Duration: This credit is available for three years.

These examples illustrate how the increased start-up credit can significantly reduce the financial burden on small businesses when establishing retirement plans, making it more feasible for them to offer valuable benefits to their employees.

New Employer Contribution Tax Credit (Section 102(b))

The employer contribution credit, effective for tax years starting after December 31, 2022, is available to employers with 100 or fewer employees. Key features include:

• Five-year duration
• Up to $1,000 per employee earning $100,000 or less
• A fixed percentage of employer contributions
• Separate from and addition to the start-up costs, credit

Eligible employers can potentially benefit from both the start-up credit and this new employer contribution credit, enhancing the financial incentives for offering retirement plans to employees.

Section 102(b) introduces a new provision offering additional tax credits and incentives for eligible employers who provide defined contribution plans such as 401(k), 403(a), SEP, and SIMPLE plans, specifically for businesses with fewer than 100 employees.

• Credit Calculation: The credit is based on employer contributions to their employees’ plans, up to a maximum of $1,000 per employee annually, excluding employees earning more than $100,000 annually.  
• Credit Distribution:
  • First and Second Year: Employers can claim 100% of contributions.
  • Third Year: Employers can claim 75% of contributions.
  • Fourth Year: Employers can claim 50% of contributions.
  • Fifth Year: Employers can claim 25% of contributions.
• Eligibility:
  • Employers with up to 50 employees can qualify for the full credit.
  • For employers with 51 to 100 employees, the credit decreases by 2% for each additional employee over 50.
• Exclusions: This credit does not apply to defined benefit plans.

This new provision encourages small businesses to offer retirement benefits by providing substantial tax relief for employer contributions over the initial five years.   

Employer Contribution Credit Examples 

1. Acme Corp (22 employees, all under $100,000 salary):
   • Annual contribution: $50,000
   • Credit: $22,000 for years 1-2, decreasing percentages for years 3-5
2. Acme 2 Corp (75 employees, 60 under $100,000 salary):
   • Annual contribution: $60,000
   • Credit calculation: $60,000 – [$60,000 x (25 x 2%)] $60,000 – [$60,000 x 50%] $60,000 – $30,000 = $30,000
   • Credit: $30,000 for years 1-2, decreasing percentages for years 3-5

Both companies benefit from substantial tax credits initially, with amounts based on eligible employees and contributions, capped at $1,000 per employee. Acme 2 Corp’s credit is reduced due to having over 50 employees.    

Conclusion 

The employer tax credits introduced by recent legislation offer significant advantages to small businesses while enhancing financial security for both employers and employees. By substantially reducing the out-of-pocket expenses associated with establishing and maintaining retirement plans, these credits make it more feasible for small employers to offer valuable benefits. This, in turn, can lead to increased employee satisfaction and improved retention rates, creating a win-win situation for businesses and their workforce. 

If you have any questions about how these credits apply to your specific situation or how to implement a retirement plan for your business, don’t hesitate to contact Huckabee CPA for a free initial consultation.