Small Business Retirement Plan Tax Credit: How to Claim Up to $5,000 for Startup Costs

Small-Employer Pension Plan Startup Tax Credit Overview

A tax credit for small-employer pension plan startup costs may be awaiting you. You may be able to claim a tax credit of up to $5,000 when you set up an SEP, a SIMPLE IRA, or a qualified plan such as a 401(k).

Eligibility Requirements for the Startup Credit

You qualify to claim this credit if you meet all of these conditions:

• You had 100 or fewer employees who received at least $5,000 in compensation from you for the preceding year.
• You had at least one plan participant who was not a highly compensated employee.
• In the three tax years before the first year you're eligible for the credit, your employees didn't receive contributions or accrue benefits in another plan you sponsored.

How the Startup Credit Amount Is Calculated

The credit is 50% of your eligible startup costs, up to the greater of these two amounts:

• $500.
• The lesser of:
  • $250 multiplied by the number of non–highly compensated employees who are eligible to participate in the plan.
  • $5,000.

You may claim the credit for ordinary and necessary costs to set up and administer the plan and to educate your employees about the program.

How Long You Can Claim the Credit

You can claim the credit for each of the plan’s first three years and may choose to start claiming the credit in the tax year before the plan becomes effective. You can't deduct startup costs and claim the credit for the same expenses. However, you aren't required to claim the allowable credit.

Additional Credit for Auto-Enrollment Features

If you add an auto-enrollment feature to your pension program, you can claim a tax credit of $500 per year for a three-year taxable period, beginning with the first taxable year. However, adding this feature introduces two major administrative responsibilities:

• Distributing an annual notice to eligible employees explaining the feature, including employees' rights to make their own deferral elections.
• Withholding wages from automatically enrolled participants at the plan's default deferral rate.

How to Claim the Credit

Claim the tax credit by filing IRS Form 8881 with your tax return. Most commonly offered employer retirement plans qualify, including:

• Traditional pension plans
• 403(b) plans
• Profit-sharing plans
• Money purchase plans
• SEP IRAs
• SIMPLE IRAs

Is This Credit Right for Your Business?

If you recently acquired or started a new business and are ready to put more money into employee benefit plans, you can investigate this credit to help with the costs of administering pension programs. It can significantly reduce the financial burden of establishing a retirement plan and help you support your employees’ long-term financial health.

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