Thinking about offering a retirement plan for your employees, like a 401(k)? When it comes to attracting and retaining top talent, offering retirement plans is a major incentive for your business.
While there are 401(k) startup costs, the IRS does offers 3 tax credits to help offset those expenses. As tax credits, these directly reduce the amount of federal income tax owed on a dollar-for-dollar basis, as opposed to a deduction, which lowers your taxable income.
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What is the 401(k) Startup Tax credit?
The startup tax credit was part of the SECURE Act 2.0 that passed in 2022, with the goal of incentivizing small businesses to offer retirement plans for employees.
Who qualifies for the 401(k) Startup Tax credit?
If you are a small business with less than 100 employees, you likely qualify for the 401(k) startup tax credit. In addition to 401(k)s, this credit can also apply to startup costs associated with SEPs and SIMPLE IRAs.
The IRS offers the following qualification criteria:
- 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 (highly-compensated employees are those who have earned at least $160,000 in tax year 2025 or own more than 5% of the company)
- In the three tax years before the first year you’re eligible for the credit, your employees weren’t substantially the same employees who received contributions or accrued benefits in another plan sponsored by you, a member of a controlled group that includes you, or a predecessor of either (in other words, your business hasn’t recently offered another type of retirement plan to these same employees)
What is the amount of the 401(k) Startup Tax Credit?
If you have 50 or fewer employees who received at least $5,000, the credit is 100% of eligible startup costs:
- Up to greater of $500 OR
- The lesser of:
- $250 multiplied by the number of non-highly-compensated employees who are eligible to participate in the plan OR
- $5,000
If you have 51-100 employees who received at least $5,000, the credit is 50% of your eligible startup costs, with the same criteria listed above.
The credit is capped at $5,000 per year, with the opportunity to receive the credit every year for three years.
What are considered eligible startup costs?
This credit can be claimed against costs to set up, administer, and educate your employees about the plan.
What is the Automatic Enrollment Credit?
But the credits don’t stop there! If you add an auto-enrollment feature to your plan, you can claim a tax credit of $500 per year for a 3-year taxable period. This tax credit is available for both new and existing plans.
What is the Contribution Credit?
Your contributions to your employee’s 401(k)s also can incur tax credits for the first five years of the plan.
For businesses with less than 50 employees, the IRS calculates the contribution tax credit as follows:
- First plan year: 100% of contribution, up to $1,000
- Second plan year: 100% of contribution, up to $1,000
- Third plan year: 75% of contribution, up to $1,000
- Fourth plan year: 50% of contribution, up to $1,000
- Fifth plan year: 25% of contribution, up to $1,000
For businesses employing between 51 – 100 team members, the IRS decreases the contribution tax credit to the following:
- First plan year: 100% minus 2% for each employee exceeding 50 limit
- Second plan year: 100% minus 2% for each employee exceeding 50 limit
- Third plan year: 75% minus 2% for each employee exceeding 50 limit
- Fourth plan year: 50% minus 2% for each employee exceeding 50 limit
- Fifth plan year: 25% minus 2% for each employee exceeding 50 limit
However, there are limits: 401(k) contributions to employees who earn more than $100,000 do not qualify for this tax credit.
Set up and manage your employee retirement plans with Landmark Financial
At Landmark Financial, we help you build and administer the right retirement plan for your business and employees. Contact us to get started.