Among the many popular provisions included in the Secure 2.0 Act was the creation of more generous startup tax credits as an incentive for smaller businesses to offer a retirement plan.
Before the passage of the law in late 2022, a three-year credit was available to offset up to 50% of administrative costs of launching a 401(k) or similar plan, with an annual cap of $5,000. The Secure 2.0 Act increased the startup credit from 50% to 100% for employers with up to 50 employees, starting in 2023.
Utilizing the more generous credit would seem like an easy decision, especially as business owners in many states are now required to start a retirement plan. Thanks to the Secure 2.0 Act, they have a great opportunity to reduce or eliminate the cost of doing so.
Yet, according to a new analysis published by the National Bureau of Economic Research, only about 5.5% of “apparently eligible” firms have claimed the enhanced credit. This is up from about 1% prior to the enhancement, the authors observe, but it is still far below the level of utilization policymakers would have hoped for.
Perhaps even more striking, the authors find, most business owners only claim the credit for one year despite being eligible for up to three years. That means they’re leaving potentially thousands of dollars in savings on the table even after realizing meaningful tax savings in year one.
What’s behind the under-utilization? To help answer the question, the authors examine big differences in credit take-up rates by industry, firm owner education levels, and use of tax preparation services. They also document evidence of “tax preparer learning,” whereby uptake among a tax preparer’s clients increases after that preparer first utilizes the credit for a client.
The bottom line, according to the analysis, is that the typical resource-strapped and time-constrained small-business owner requires the guidance of experts — namely wealth management professionals and certified public accountants — to fully utilize this (and many other) possible tax-saving strategies. Likewise, advisors and tax preparers need to educate themselves about the latest developments in the tax code.
Who Is Claiming the Credit?
The authors find that higher average firm wage levels are positively associated with credit uptake, although the marginal effects are modest in size. There also seems to be a modest firm-size effect, with something of a sweet spot in the six-to-20 employee range.
Specifically, businesses in this size cohort are about 0.9 percentage points more likely to claim the credit compared with the full sample. Firms with 21 to 50 employees are 0.4 percentage points more likely to claim the credit.
This distribution cuts across the general trend of larger employers leading the utilization of new retirement plan features or tax-management strategies, the authors say. Again, this could be a reflection of other tax priorities taking precedence as growing firms’ financial situation increases in complexity, but the real cause requires more investigation.
Business Structure Matters, Too
A given small business’ organizational structure is also associated with substantial differences in credit claiming, according to the research.
Compared to S corporations, for example, C corporations and partnerships are 2.6 and 1.8 percentage points, respectively, less likely to claim the credit. This difference across organizational structures may be related to the ability of firm owners to “use” the credit (i.e., actually reduce tax liability) in a given year.
“For C corporations, general business credits (a class of credits including the Section 45E credit) can offset only the entity-level tax,” the authors point out. “If the C corporation has negative net income, for instance, the credit cannot be used immediately and must be carried over to a different year.”
By contrast, for S corporations and partnerships, general business credits are passed through to owners.
“So long as the owners have positive tax liability (e.g., related to other sources of income), they will generally be able to use the credit immediately,” the authors explain. “Furthermore, because partnership structures can be more complicated than S corporations, the burden of tracking general business credits across ownership tiers may increase the cost of claiming the Section 45E credit, perhaps explaining why partnerships also take up the credit at a lower rate.”
A Word on ‘Preparer Learning’
In the analysis, the authors filter their results according to whether a business owner’s tax preparer has ever claimed the credit for a different client in some year prior to the current year — suggesting that the preparer is aware of the credit’s existence. In such cases, the authors find, uptake is higher than the average by about 11 percentage points.
The effect of “preparer awareness” is much larger than the effect of the preparer having any specific credential, such as being a CPA or enrolled agent. This suggests that lack of awareness may play a substantial role in incomplete uptake versus the level of experience or credentialing that a tax preparer brings to the table.
At the same time, the authors point out, uptake among this group is still “very far from 100%” even after the 11 percentage-point boost from having a preparer with such experience. It’s not completely clear why awareness doesn’t create higher uptake, but one possible explanation is that other tax priorities take precedence over the startup plan credit.
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