Frequently Asked Questions About Startup Plan Tax Credits

By Scott Cloud, MBA, CPC

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Signed into law on December 29, 2022 as part of the Consolidated Appropriations Act of 2023, SECURE Act 2.0 expanded existing tax credits and introduced new tax credits for employers that establish a new employee retirement savings plan in 2023 or later.  This article describes those tax credits and answers some of the most common questions asked by employers who are considering establishing an employee retirement savings program.

Under SECURE Act 2.0, employers who establish a brand new retirement plan in 2023 or later are eligible for two different types of “Startup Plan Tax Credits”:

1. Startup Plan Tax Credits on Plan Expenses, and
2. Startup Plan Tax Credits on Employer Contributions

An employer is eligible for the tax credits only if it has any “non-highly compensated employees” (NHCEs) who are eligible for the plan.  The term NHCE will be used throughout this article, and refers to anyone who: 1) does not own more than 5% of the retirement plan’s sponsoring employer, 2) is not related – as a spouse, child, parent, or grandparent – to anyone who owns more than 5% of the retirement plan’s sponsoring employer, and 3) does not have gross annual wages above $135,000 (indexed).

Question 1: What is the Startup Plan Tax Credit on Plan Expenses?

The Startup Plan Tax Credit on Plan Expenses covers some – or all – of the plan’s service fees that are paid by the employer during each of a new plan’s first three years, up to a maximum tax credit amount of $5,500 per year.

For an employer with 50 or fewer employees, this tax credit is equal to 100% of the plan’s service fees that are paid by the employer, but capped at $250 for each NHCE who is eligible for the plan.  For example, if an employer pays $2,500 in service fees for the plan’s first year but it only has six NHCEs eligible for the plan during that year, this tax credit would be limited to $250 x 6 NHCEs = $1,500 for that year.

For an employer with 51 to 100 employees, this tax credit is equal to 50% of the plan’s service fees for each of the plan’s first three years.  The $250 limit for each eligible NHCE also applies, but it typically doesn’t come into play for an employer with 51 to 100 employees.  For example, if an employer has 60 employees and pays $4,000 in service fees for a year, the tax credit amount for that year would be $4,000 x 50% = $2,000.

Please also note the following with regard to the Startup Plan Tax Credit on Plan Expenses:

1. This tax credit existed prior to 2023, but was capped at 50% of plan expenses.  SECURE Act 2.0 raised the cap from 50% to 100% for employers with fewer than 51 employees.
2. The minimum annual tax credit amount is $500, so an employer with only one eligible NHCE would get a tax credit of $500 despite the $250-per-NHCE tax credit cap.
3. If the plan includes an “automatic enrollment” provision (whereby newly-eligible employees are automatically enrolled to contribute 401(k) at a rate that is pre-determined by the employer), a tax credit of $500 applies in addition to the tax credit amounts described above.
4. Only service fees that are paid by the employer are eligible for this tax credit.  Service fees that are charged to employee accounts are not eligible for this tax credit.

Question 2: What is the Startup Plan Tax Credit on Employer Contributions?

Employers with 50 or fewer employees will get a tax credit based on employer contributions (nonelective and/or match) that are made to employees during a new plan’s first five years.  This tax credit is separate from – and in addition to – the Startup Plan Tax Credit on Plan Expenses (described in Question 1 above).  To receive this tax credit, the employer must make employer contributions.

The tax credit on employer contributions will apply as follows:

• The amount will be based on the employer contributions that were made to employees with gross wages below $100,000 during the year, and
• The tax credit amount is calculated as follows:
  • Year 1 (i.e., the year the plan is effective) – 100% of the employer contribution amount (up to the first $1,000 per employee)
  • Year 2 – 100% of the employer contribution amount (up to the first $1,000 per employee)
  • Year 3 – 75% of the employer contribution amount (up to the first $1,000 per employee)
  • Year 4 – 50% of the employer contribution amount (up to the first $1,000 per employee)
  • Year 5 – 25% of the employer contribution amount (up to the first $1,000 per employee)

Employers with 51 to 100 total employees are also eligible for this tax credit, although the tax credit amount is phased out as the number of employees increases (and is eliminated altogether once the total number of employees exceeds 100).

Question 3: Are non-profits or governmental employers eligible for Startup Plan Tax Credits?

Unfortunately not.  Only for-profit employers are eligible for Startup Plan Tax Credits.

Question 4: What types of retirement plans are eligible for Startup Plan Tax Credits?

An employer is eligible for Startup Plan Tax Credits on Plan Expenses for a brand new SEP-IRA, SIMPLE IRA, 401(k) plan, profit sharing plan, money purchase plan, or defined benefit/cash balance plan.

An employer is eligible for Startup Plan Tax Credits on Employer Contributions for a brand new SEP-IRA, SIMPLE IRA, 401(k) plan, profit sharing plan, or money purchase plan, but defined benefit/cash balance plans are not eligible for this credit.

Question 5: If an employer changes from one type of retirement plan to another, do the Startup Plan Tax Credits “start over” with the new plan?

Unfortunately not.  Startup Plan Tax Credits apply to plan service fees/expenses for a new retirement savings program’s first three years, and they apply to employer contributions for a new retirement savings program’s first five years.  Both types of tax credits start in the first year that the employer maintains any one of the plan types listed in Question 4 above; the tax credits do not “start over” if the employer changes from one type of plan to another.

Question 6: If an employer established a new retirement plan prior to 2023, is it eligible for Startup Plan Tax Credits?

If an employer established a new retirement plan prior to 2023, it can claim the Startup Plan Tax Credit on Plan Expenses for any of the three years that remain.  For example, if an employer established a new retirement plan in 2022, the Startup Plan Tax Credit on Plan Expenses (described in Question 1 above) would apply in 2023 (Year 2) and 2024 (Year 3).  The credit would also apply for 2022, but with the cap of 50% that was in place prior to SECURE Act 2.0.

If an employer established a new retirement plan prior to 2023, it can claim the Startup Plan Tax Credit on Employer Contributions for any of the five years that remain.  For example, if an employer established a new retirement plan in 2022, the Startup Plan Tax Credit on Employer Contributions (described in Question 2 above) would apply in 2023 (Year 2), 2024 (Year 3), 2025 (Year 4), and 2026 (Year 5).

If an employer maintained a SEP IRA or SIMPLE IRA for three or fewer years prior to starting a 401(k) plan, it would get the Startup Plan Tax Credit on Employer Contributions for years 2-5.  If the employer maintained a SEP IRA or SIMPLE IRA for four years prior to starting a 401(k) plan, it would only get the Startup Plan Tax Credit on Employer Contributions for Year 5.  If it maintained a SEP IRA or SIMPLE IRA for five or more years prior to starting a 401(k) plan, it wouldn’t be eligible for the Startup Plan Tax Credit on Employer Contributions.

Question 7: What types of service fees qualify for the Startup Plan Tax Credits on Plan Expenses?

An employer can claim this tax credit on “ordinary and necessary costs to 1) set up and administer the plan, and 2) educate employees about the plan”.  This is generally interpreted to include costs associated with plan administration, account recordkeeping, and initial employee education/enrollment.  It is debatable whether fees for ongoing investment advisory services qualify, although if those fees are charged to employee accounts (as they are in most retirement plans), they wouldn’t qualify regardless because only amounts that are invoiced to the employer are eligible for this tax credit.

Question 8: Is the Startup Plan Tax Credit on Employer Contributions calculated “in the aggregate” or is it calculated “employee-by-employee”?

As an example, in a new 401(k) plan’s first year, a business has 40 eligible employees who had gross wages below $100,000 but only 10 of the 40 made 401(k) contributions and received an employer match, and those matching contributions totaled $20,000.  The tax credit is calculated “employee-by-employee”, so it only applies to any employee who gets an employer contribution, and it’s capped at $1,000 for each of those employees.  In this example, the tax credit amount would be $10,000 in Year 1 and in Year 2 despite there being 40 eligible employees and a total matching contribution of $20,000.  (In this example, the tax credit amount would be $7,500 in Year 3, $5,000 in Year 4, and $2,500 in Year 5.)

Summary

For an employer that establishes a brand new retirement savings plan in 2023 or later, the Startup Plan Tax Credits introduced by SECURE Act 2.0 will cover most – or all – service fees for the plan’s first three years, and a significant portion of the employer contribution expense for the plan’s first five years.  While the new tax credits are limited to for-profit employers with 100 or fewer employees, they are arguably the most impactful provision of SECURE Act 2.0 at expanding employee access to retirement savings through work.

If you have questions about how the Startup Plan Tax Credits would apply to a new retirement plan for your business or a client’s and/or to request an estimate of tax credits that would apply during a specific retirement plan’s first five years, please email us at [email protected].