At the very end of 2022, President Biden signed into law the Setting Every Community Up for Retirement Enhancement 2.0 Act (SECURE 2.0). Now that the year is well underway, small employers would be well-advised not to forget about a key feature of the law: marked improvements to the small employer pension plan start-up cost tax credit.
If your organization is a smaller one, and it’s reached a point where launching a qualified retirement plan for employees is feasible, this tax break may very well sweeten the deal.
Increased percentage for start-up costs
SECURE 2.0 increases the credit from 50% to 100% of eligible plan start-up costs for employers with up to 50 employees. Employers with 51 to 100 employees continue to be eligible for a credit of 50% of qualified plan start-up costs.
In either case, an existing annual cap based on the number of employees, with a maximum of $5,000, still applies. This portion of the credit is available for the first three tax years of the plan’s existence.
New credit for employer contributions
SECURE 2.0 also provides a credit amount for all or a portion of employer contributions to qualified plans for the first five employer tax years beginning with the one that includes the plan’s start date.
Specifically, the amount of the small employer pension plan start-up cost tax credit is increased by the “applicable percentage” of employer contributions on behalf of employees, up to a per-employee cap of $1,000. The applicable percentage is:
- 100% in the first and second tax years,
- 75% in the third year,
- 50% in the fourth year, and
- 25% in the fifth year.
No credit is available in the sixth and subsequent years.
It’s important to note that the applicable percentage is based on the date the plan was established, not when employees begin to participate in the plan. Also, the amount of the credit allowed for employer contributions is reduced for employers with 51 to 100 employees. The reduction is equal to 2% multiplied by the number of employees exceeding 50 multiplied by the amount of the credit.
No credit is allowed for contributions if the employer has more than 100 employees. In addition, no credit is allowed for employer contributions on behalf of an employee who makes more than $100,000. The $100,000 figure will be adjusted for inflation in multiples of $5,000 in tax years beginning after 2023. Other limitations under the Internal Revenue Code may apply.
Now may be the time
Essentially, SECURE 2.0 divides the small employer pension plan start-up cost tax credit into two separately calculated portions: 1) a qualified start-up cost portion available for the first three years of the plan’s existence, and 2) an employer-contribution portion available for its first five years. The revised rules apply to tax years beginning after December 31, 2022.
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