The government continues to add tax incentives to encourage small businesses to adopt 401k plans, if they do not already offer one to employees, and to encourage existing plans to increase their coverage through plan design changes like automatic contributions. Here is what you need to know about the tax credits that might be available to you if you are a small business with less than 100 employees:
Credits – if you don’t already offer a plan:
1. Start-Up Tax Credit
The cost of administering a 401k plan are one of the biggest deterrents for small businesses. To help solve this issue the SECURE Act now allows small businesses to receive a tax-credit for them.
Any cost associated with establishing, administering or educating EEs about the plan are eligible for the credit for the first 3 years of the plans existence.
Not all eligible small businesses are treated the same. Employers with less than 50 employees are eligible for a credit equal to 100% while those with 51-100 employees receive a credit equal to 50% of the cost.
Finally, as they do, the IRS also puts a cap on the amount of the credit. The maximum annual credit is the lesser of:
- $5,000 or,
- $250 x # of non-highly compensated employees (in 2024 defined as those who earned < $150k in 2023 and are not a 5% or greater owner of the company)
2. Employer Contribution Tax Credit
In addition to incentivizing small businesses to offer a 401k plan, the new tax laws also want to promote employer contributions to those plans. Small businesses can receive a tax credit for contributions they make to employee 401k accounts.
The credit is pretty substantial, the maximum credit is $1,000 of contributions made to each eligible employee. An eligible employee for this credit (in 2023) are those employees who earned under $100k.
Even better, the credit can be claimed for the first 5 years although it is phased out over this time. Employers with less than 50 employees can claim 100% of the credit for the first 2 years, 75% in the third year, 505 in the fourth and 25% in the fifth year. No credit can be claimed after 5 years. Employers with more than 50 employees can still claim the credit but the percentage of the credit is reduced by 2% for every employee over 50.
For new and existing plans:
3. Automatic Enrollment Tax Credit
An additional credit to promote plans to adopt automatic enrollment is available to existing plans that add an automatic enrollment feature and new plans that include it as part of their initial plan design.
The credit is $500 and is available in each of the first three years following the adoption of the automatic enrollment provisions. Any new plans being set-up in 2023 or 2024 will surely want to include automatic contributions to their plan design to qualify for the credit because they will be required to add it in 2025 regardless.
4. Military Spouse Tax Credit
Because military families may move repeatedly throughout a servicemember’s career, spouses may have to wait to become eligible to participate in a plan at each new location. The military spouse tax credit was created to help spouses of active-duty uniformed service members attain 401k eligibility sooner than what the general eligibility provisions might allow for.
To be eligible for the credit employers must allow spouses of active-duty service members to enroll in the plan within two months, from their date-of-hire, and once eligible they should be immediately eligible for the same employer contributions as other employees and all employer contributions to military spouses need to be 100% vested when made.
Eligible employers may earn a $200 credit for each military spouse that participates in the plan. Another credit (up to $300) applies to employer contributions made to each military spouse. The credit applies for the tax year in which the military spouse starts participating—and for the next two years. The employer may rely on the employees self-certification of their status as an eligible spouse.
If you want to learn more, reach out and we can help you determine what credits you are eligible for and help you calculate the potential tax benefit.