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It’s not too late to establish a retirement plan and claim SECURE Act tax credits

Jan 18, 2021

It’s not too late for your business to establish a retirement plan and claim valuable tax credits.

The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) made several changes favorable to small businesses. Instead of employers having to create, sign and date a profit-sharing or qualified retirement plan — such as a 401(k) — by no later than the last day of the plan year (e.g., December 31), employers now have the ability to establish a plan by their business’s tax filing deadline.

This means, depending on how your business is structured, you have until March 15 or April 15 of this year to establish a retirement plan. If you file an extension, you have until September 15 or October 15. However, we generally recommend not waiting past July 31, which is when you’re required by the IRS to file Form 5500 providing information on the retirement plan’s participant information, plan assets and operations.  

Why create a retirement plan by your tax deadline? Because your business can claim up to $5,500 per year in tax credits, for up to three years in a row. 

Tax credits for creating a new retirement plan

Small businesses can qualify for some big tax credits. The SECURE Act increased the tax credits for establishing a brand-new retirement plan to 10 times what they used to be. 

However, not every business will be able to claim the max credit amount. That’s because the tax credit is limited to $250 per employee, up to 20 participants, which equals the max total of $5,000. An additional $500 credit is available for setting up auto-enrollment. Both credits are available for up to three years, for a total of $16,500 available to claim.

How to qualify for the tax credits

There are several requirements your business must meet to be able to claim the tax credits. First, you must be a small employer, which means, in the preceding tax year, you had no more than 100 employees and they received at least $5,000 in compensation. 

Second, you must cover at least one non-highly compensated employee (NHCE).

Third, your retirement plan must be new. It cannot replace another retirement plan, like a SIMPLE or SEP IRA, as then it would cover substantially the same employees. Solo 401(k) plans are not eligible for the credit either. 

Fourth, the credit can only be claimed if the employer pays or incurs some or all of the costs of the plan, and is limited to 50% of the costs charged to the employer. This means you cannot get the tax credits if plan-related fees are paid from plan assets (i.e., participants pay some of the plan’s fees).

Finally, you may elect to have the preceding tax year be the first credit year and claim the credit for qualified start-up costs paid or incurred during that tax year. For example, a calendar-year eligible small employer whose plan is first effective on January 1, 2021, may elect to treat 2020 as the first credit year and claim the credit on its 2020 tax return for qualified start-up costs incurred in 2020.  

One last tax benefit

While some businesses have struggled during the COVID-19 pandemic, others prospered during 2020 and are now wondering how to minimize their tax burden. One way to do so is by creating a new retirement plan. That way, the business reduces its tax liability by securing tax credits and deductions for expenses incurred and employer contributions made to the plan while saving payroll taxes on employer contributions that may have otherwise been paid as cash compensation. 

Employees can contribute up to $19,500 (or $26,000, if age 50 or older in 2021) to the 401(k). While not every employee will be able to contribute that much, it’s a good idea for business owners to do so if their cash flow provides that flexibility.

When the owner takes distributions from the 401(k) account in retirement, the tax rate they will pay on those distributions is often less than their tax rate today since their taxable income will not be as high as it was during their working years.

As you can see, there are a multitude of tax benefits to establishing a retirement plan for your business.

Ready to establish your retirement plan?

Wipfli can help. Our team can handle everything from document design and creation, to plan structure, record-keeping, third-party administration, compliance and more. No matter your needs, we’re here to assist and ensure you qualify for the relevant tax credits. Click here to learn more, or continue reading on:

SECURE Act becomes law with significant impact on retirement savings
What impact will the SECURE Act have on your business?
The SECURE Act: What individuals need to know

Author(s)

Thomas Krieg, CPA
Partner
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