The $1.4 trillion appropriations package signed into law by President Trump on December 20, 2019 designed to fund federal agencies through September of this year contained the most significant legislative enhancements to retirement plans in over 10 years.
These law changes designed to encourage retirement savings are bundled up in one of those Congressional legislative acronyms, the SECURE Act, which is political short hand for the Setting Every Community Up for Retirement Enhancement Act. I’ll be covering the most significant ones in later blog posts, but for now, here’s a summary of two tax credits you may find valuable.
1. Increase of Tax Credit Limit for Small Employer Start-Up Costs
In 2001, Congress provided a tax credit to encourage small employers (those with 100 or fewer employees to establish retirement plans. Eligible employer plans include any qualified employer plan. 401(k) plan, SIMPLE plan, or SEP.
Small employers could receive a tax credit of 50% of the cost of to:
- Set up and administer the plan, and
- Educate the employees about the plan.
Here’s how it works. A small business is eligible if:
- It has 100 or fewer employees who received at least $5,000 in compensation for the preceding year,
- At least one plan participant who’s a Non-Highly Compensated employee, and
- Employees who didn’t benefit from a prior plan offered by you in the three tax years before the first year you are eligible for the credit.
Timing of the Tax Credit
The first credit year is the tax year the employer plan becomes effective. However, you may carry the credit back one year or forward 20 years. No double-dipping is allowed. You must reduce any deduction relating to retirement plan startup costs by the credit amount.
Increased Tax Credit
The SECURE Act expands that tax credit to $250 per Non-Highly Compensated Employee covered by the Plan. The credit will not be less than $500 nor more than $5,000. If you do the math, the maximum tax credit is $15,000 compared to the former $1,500. The new limit is effective for tax years beginning after December 31, 2019.
2. Addition of New Tax Credit for Adding Automatic Enrollment
The Secure Act also added a tax credit for those small employers that amend their 401(k) plans to add automatic contribution arrangements under which employees make 401(k) contributions by default unless they were to opt-out. The credit is $500 for the year in which the arrangement is incorporated into the plan and for each of the following two years – provided, of course, the plan is maintained – for a total of $1,500. This tax credit is also effective for tax years beginning December 31, 2019.
- A tax credit is better than a tax deduction. A tax credit can be used to reduce how much tax is owed. A tax deduction can be used to reduce the amount of taxable income.
- You aren’t required to claim the allowable credit.
- But you can’t both deduct the startup costs and claim the credit for the same expenses.
- The two tax credits are not mutually exclusive. A qualifying start-up 401(k) plan could enjoy as much as $16,500 in tax credits.
The idea – often mistaken – is that 401(k) plans are too expensive for small businesses to start-up and maintain. These two tax credits go a long way to making that idea past history. Be sure to check with your tax advisor to determine whether you could take advantage of either or both tax credits.