Small Business Tax Credit for 401k Startup Costs
According to U.S. Department of Labor statistics, 64 percent of all employees in medium- and large-sized firms are covered by an employment-based retirement plan, compared with only 34 percent at small firms. One reason cited by small businesses for not offering retirement plans is the high costs associated with set-up and administration of a retirement plan.
Startup costs have always been a major hurdle to small businesses who what to start a 401k plan, but a provision of The Economic Growth and Tax Relief and Reconciliation Act (EGTRRA) now helps scale this barrier to employee saving opportunities. EGTRRA implemented a credit for employers to offset the startup 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 become 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 401k). The credit equals 50% 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 can choose to start claiming the credit in the tax year before the tax year in which the plan becomes effective.
You must have had 100 or fewer employees who received at least $5,000 in compensation from you for the preceding year. At least one participant must be a non-highly compensated employee. The employees generally cannot be substantially the same employees for whom contributions were made or benefits accrued under a plan of any of the following employers in the three-tax-year period immediately before the first year to which the credit applies.
- A member of a controlled group that includes you.
- A predecessor of (1) or (2).
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, the part of the general business credit attributable to the small employer pension plan startup cost credit cannot be carried back to a tax year beginning before January 1, 2002.
To take the credit, get Form 8881, Credit for Small Employer Pension Plan Startup Costs, and the instructions.