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Tax Credit Offsets Retirement Plan Costs


According to U.S. Department of Labor statistics, well over half of all employees in midsized and large companies can take advantage of an employment-based retirement plan. But with small companies, barely a third of employees are covered. Many small-business owners say a reason for not creating a retirement plan is the cost. However, the federal government is offering a tax break for small companies that meet certain IRS guidelines. 

If you want to offer your employees a simplified employee pension, individual retirement account, SIMPLE IRA or qualified plan, including a 401(k), your company may be able to claim a tax credit for the first three years of the plan for some of the costs — a credit of 50% of your eligible startup expenses, up to $500 per year, for:

  • Setting up and administering the plan.
  • Educating your employees about the plan.

Your small business qualifies if:

  • It had 100 or fewer employees who received at least $5,000 in compensation from you for the preceding year.
  • It had at least one non-highly compensated employee as a plan participant.
  • In the three years prior to your first-year tax credit eligibility, your employees weren't the same employees who received contributions or accrued benefits in another plan that you sponsor, a member of a controlled group that you are a part of, or a predecessor of either. 

You may decide to start claiming the credit in the tax year before the plan becomes effective. The credit is part of the IRS' general business credits, and you're allowed to carry it back or forward to other tax years if you can't use it in the current year. But you can't carry it back as far as a tax year before January 1, 2002.

Another proviso: You can't both deduct the startup costs and claim the credit for the same expenses. For example, if you're claiming a $500 credit for a $1,000 plan setup fee, you can't deduct that cost from your company's income. 

The Form 8881, Credit for Small Employer Pension Plan Startup Costs, is available to claim the credit.

Related IRS aids include:

As a small-business owner, you've probably considered the high costs of setting up and administering a retirement plan as a major hurdle. That's why this tax credit, which offsets the startup costs and expenses of educating employees about the new plan, is so attractive.
Of course, there are a lot of other factors to consider before offering a plan, and you need to consider all the details of your company's eligibility for any credits. The bottom line is that you shouldn't assume you're too small to offer a retirement plan.

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Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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