If you are a small business owner who has established a retirement plan this year, you may be eligible to receive a tax credit for the cost of implementing a plan. And a tax credit can be better than a tax deduction. The same legislation that Congress passed in 2001 that increased benefit and contribution limits – which the Pension Protection Act of 2006 extended – provided a tax credit to encourage small businesses to establish retirement plans. This tax credit is in addition to the tax deduction you may receive for the contributions to the plan. The tax credit may be claimed for a maximum period of three years for retirement plans established for the 2002 plan year or later.
Here are some questions and answers about the tax credit:
Who is an eligible employer?
The tax credit is available to employers with no more than 100 employees who earned at least $5,000 in the previous year.
How much is the tax credit?
The credit is limited to 50% of the first $1,000 in expenses; therefore, the credit cannot exceed $500. The credit is nonrefundable, i.e, you may not generate an income tax refund for the credit.
What expenses are eligible?
Expenses eligible for the tax credit include those defined as the plan’s start-up costs, which are ordinary or necessary for the establishment of the plan. These include expenses incurred to establish the plan, administrative fees and costs incurred to educate employees about the plan.
What plans are eligible for the tax credit?
Eligible plans include SEP IRAs, SIMPLE IRAs and qualified plans, such as 401(k) plans, profit-sharing plans, and defined benefit plans. The plan must cover at least one employee who is not classified as a highly compensated employee.
How do you claim the tax credit?
You must file IRS Form 8881 – Credit for Small Employer Pension Plan Startup Costs.
Check the fine print with your tax adviser to see if you are eligible to take advantage of the tax credit.