Small Business Tax Credit for 401(k)

  • Start-up costs have always been a major hurdle to small businesses that want to start a 401(k) plan, but a provision of The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) helps scale this barrier to employee saving opportunities. EGTRRA implemented a credit for employers to offset the start-up cost and the cost of educating employees about the new plan.

    For costs paid or incurred in tax years beginning after December 31, 2001, for retirement plans that first became effective after that date, you may be able to claim a tax credit for part of the ordinary and necessary costs of starting a SEP, SIMPLE or qualified plan (including a 401(k)).The credit equals 50 percent 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. For plans that become effective after 2002, you may choose to start claiming the credit in the tax year before the tax year in which the plan becomes effective.

    • Eligibility requirements:
      • You had 100 or fewer employees who received at least $5,000 in compensation from you for the preceding year.
      • You had at least one plan participant who was a non-highly compensated employee.
      • In the three tax years before the first year you’re eligible for the credit, your employees weren’t substantially the same employees who received contributions or accrued benefits in another plan sponsored by you, a member of a controlled group that includes you or a predecessor of either.
      • 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, it cannot be carried back to a tax year beginning before January 1, 2002.
  • To claim the credit, use Form 8881, Credit for Small Employer Pension Plan Startup Costs, and the accompanying instructions.

    Each person’s tax situation is different, so this is not to be construed as financial, tax or legal advice. If you believe that it may apply to your company or that of your client, be sure to further discuss this with a qualified accountant or tax professional.