For many clients, retirement income planning is as simple as determining how to maximize contributions to an employer-sponsored retirement savings plan—often the primary source of a client’s retirement savings, at least during the accumulation phase of planning. But what about small business clients, where the ability to simply access an employer-sponsored plan falls on their shoulders?
Most of these clients know of the various retirement plan options, but what is often overlooked is the valuable tax credit that can help small business owners get their plans off the ground—and by helping clients understand the strict IRS requirements for claiming this credit, you can turn a planning burden into tax savings for small businesses.
The Start-Up Credit Basics
The tax credit for qualified retirement plan startup costs is available only to small business owners—employers are eligible if, during the preceding tax year, they employed 100 or fewer employees who received at least $5,000 in annual compensation from the employer (the same definition that generally applies for SIMPLE retirement plans). Further, the plan must be available to at least one employee who is a non-highly compensated employee (for 2015, a highly compensated employee is one who owns 5% of the business or who has earned more than $120,000).
Importantly, the small business client is only eligible for the credit if its employees were not able to participate in another retirement plan sponsored by the client, a member of a controlled group or a predecessor of either within three years of establishing the new plan (essentially, this requirement ensures that the plan truly is a newly-established retirement plan).
The credit is equal to 50% of the ordinary and necessary costs of starting up the retirement plan, including both the costs of setting up and administering the plan and costs related to educating employees about the plan, up to a maximum credit of $500 per year. The credit is available for three years, with the option of first claiming the credit in the year before the year in which the plan becomes effective.
If the entire value of the plan cannot be maximized in a single year, the client has the option of carrying it back or forward to another tax year, so long as that tax year doesn’t begin prior to January 1, 2002. In order to claim the credit, the client files Form 8881 with the IRS.
Choosing the Plan
Choosing to establish a retirement plan is only the first step for the small business client, as the IRS has established several types of plans that are specifically designed for small business owners. The startup tax credit is available to employers who establish a qualified plan—whether specifically designed for small businesses (a SEP IRA, SIMPLE IRA) or other qualified plan (such as a 401(k) or an ESOP).