Fed Tax Incentives: Credit for Small Employer Pension Plan Startup Costs
Background
Eligible small employers claim the credit on Form 8881 for qualified startup costs incurred in establishing or administering an eligible employer plan under IRC § 45E. See 26 U.S.C. § 45E(a)–(d), of the Internal Revenue Code (IRC).
Amount of the Credit
The credit equals 50% of qualified startup costs paid or incurred during the tax year. The maximum credit is $5,000 per year for the first credit year and each of the next two years (up to $15,000 total). IRC § 45E(b). No credit is allowed beyond the first three years. IRC § 45E(b)(2).
Eligible Employer
An employer qualifies if:
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100 or fewer employees who received at least $5,000 in compensation in the preceding year. IRC § 45E(c)(1)(A).
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At least one non-highly compensated employee participates. IRC § 45E(d)(1)(B).
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Did not maintain a qualified plan for substantially the same employees in the prior three years. IRC § 45E(c)(2).
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Grace period: If eligibility fails after adoption, employer remains eligible for two years. IRC § 408(p)(2)(C)(i)(II).
Eligible Employer Qualification
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100 or fewer employees earning ≥ $5,000 in prior year. IRC § 45E(c)(1)(A).
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At least one non-highly compensated employee participates. IRC § 45E(d)(1)(B).
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Highly Compensated Employee definition (see IRS Retirement Plan Definitions):
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Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or
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For the preceding year, received compensation from the business of more than
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$125,000 (if the preceding year is 2019),
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$130,000 (if the preceding year is 2020 or 2021),
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$135,000 (if the preceding year is 2022),
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$150,000 (if the preceding year is 2023) and
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$155,000 is 2024 (if the preceding year is 2024) and, if the employer so chooses, was in the top 20% of employees when ranked by compensation.
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Two-year grace period applies if eligibility fails after plan adoption. § 408(p)(2)(C)(i)(II)
Qualified Startup Costs
Qualified startup costs include ordinary and necessary expenses to:
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Establish or administer an eligible employer plan. IRC § 45E(d)(1)(A)(i).
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Provide retirement-related education to employees. IRC § 45E(d)(1)(A)(ii).
Qualified Employer Plan
Includes:
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401(a) plans with tax-exempt trusts (§ 501(a)).
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403(a) annuity plans.
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Simplified Employee Pension (§ 408(k)).
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SIMPLE IRA (§ 408(p)). § 4972(d)(1)(A).
Excludes governmental and tax-exempt employer plans. § 4980(c)(1).
Eligible Tax Years
Credit applies for three years. Employer may elect to treat the preceding tax year as the first credit year if startup costs were incurred before plan effective date. IRC § 45E(b), (d)(3).
Coordination & Limitations
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No double benefit: Startup costs used for the credit cannot also be deducted. IRC § 45E(e)(2).
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Election not to claim credit is permitted. IRC § 45E(e)(3).
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Credit is part of the general business credit; unused amounts may be carried back or forward under IRC § 39.